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QualityQualityCost Cost
ManagementManagementPrepared by
Douglas Cloud Pepperdine University
Prepared by Douglas Cloud
Pepperdine University
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1. Define quality, describe the four types of quality cost.
2. Prepare a quality cost report, and explain its use.
3. Explain why quality cost information is needed and how it is used.
4. Describe and prepare three different types of quality performance reports.
ObjectivesObjectivesObjectivesObjectives
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
After studying this After studying this chapter, you should chapter, you should
be able to:be able to:
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The Meaning of Quality
A quality product or service is one
that meets or exceeds customer
expectations.
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Distribution of Color Density of Distribution of Color Density of Sony Television SetsSony Television Sets
Distribution of Color Density of Distribution of Color Density of Sony Television SetsSony Television Sets
Sony of Tokyo TVs
Sony of San Diego TVs
Lower Specification
Limit
Upper Specification
Limit
Target Value
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Measuring the Costs of QualityMeasuring the Costs of QualityMeasuring the Costs of QualityMeasuring the Costs of Quality
Prevention costs
Appraisal costs
Internal failure costs
External failure costs
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Quality Cost MeasurementQuality Cost Measurement
Prevention Costs Appraisal (Detection) Costs Quality engineering Inspection of materials
Quality training Packaging inspection
Recruiting Product acceptance
Quality audits Process acceptance
Design reviews Field testing
Quality circles Continuing supplier verification
Marketing research Prototype inspection
Vendor certification
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Internal Failure Costs External Failure Costs
Scrap Lost sales (performance- related)
Rework Returns/allowances
Downtime (defect-related) Warranties
Reinspection Discounts and defects
Retesting Product liability
Design changes Complaint adjustment
Repairs Recalls
Ill will
Quality Cost MeasurementQuality Cost Measurement
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Estimating Hidden Quality CostsEstimating Hidden Quality CostsEstimating Hidden Quality CostsEstimating Hidden Quality Costs
The Multiplier Method
The Market Research Method
The Taguchi Quality Loss Function
Hidden Quality Costs are opportunity costs resulting
from poor quality.
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The Multiplier MethodThe Multiplier Method
The multiplier method assumes that the total failure cost is simply some multiple of measured failure costs:
Total external failure cost = k(Measured external failure costs)
where k is the multiplier effect
If k = 4, and the measured external failure costs are $3 million, then the actual external failure costs are estimated to be $12 million.
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The market research method uses formal market research methods to assess the effect of poor quality on sales and market share.
Customer surveys and interviews with members of a company’s sales force can provide significant insights into the magnitude of a company’s hidden costs.
The Market Research MethodThe Market Research Method
Market research results can be used to project future profit losses attributable to poor quality.
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The Taguchi Quality Loss FunctionThe Taguchi Quality Loss Function
The Taguchi loss function assumes any variation from the target value of a quality characteristic causes hidden quality costs.
Furthermore, the hidden quality costs increase quadratically as the actual value deviates from the target value.
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L(y) = k(y – T)²k = A proportionately constant dependent
upon the organization’s external failure cost structure
y = Actual value of quality characteristic
T = Target value of quality characteristic
L = Quality loss
The Taguchi Quality Loss FunctionThe Taguchi Quality Loss Function
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The Taguchi Quality Loss FunctionThe Taguchi Quality Loss Function
$ Cost
Lower Specification
Limit
Target Value
Upper Specification
Limit
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Quality Cost ReportQuality Cost Report Time GainedTime Gained Unit No. (Lost) (Unit No. (Lost) (yy) ) y-T (y –T)y-T (y –T)² k(y-T)²² k(y-T)²
1 -1 -1 1$ 2.00
2 2 2 48.00
3 4 4 1632.00
4 -3 -3 9 18.00
Units 30$60.00
÷ 4 ÷ 4
Average 7.5$15.00
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Quality Costs % of Sales
Prevention costs:
Quality training $10,000
Reliability engineering 65,000 $ 75,000 1.50 %
Appraisal costs:
Materials inspection $ 5,000
Product acceptance 20,000
Process acceptance 75,000 100,000 2.00
Goates CompanyGoates CompanyQuality Cost ReportQuality Cost Report
For the Year Ended June 30, 2001For the Year Ended June 30, 2001
ContinuedContinued
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Quality Costs % of Sales
Internal failure costs:
Scrap $150,000
Rework 100,000 250,000 5.00 %
External failure costs:
Customer complaints $150,000
Warranty 250,000
Returns and allowances 175,000 575,000 11.50
Total quality costs $1,000,000 20.00 %
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External FailurePreventionAppraisalInternal Failure
57% 25%
10%8%
Quality Cost CategoriesQuality Cost Categories
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AQL—Quality Cost GraphAQL—Quality Cost Graph
Cost
0
Percent Defects
100%
Failure
Control
Optimal (AQL)
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Zero-Defect Quality Cost GraphZero-Defect Quality Cost Graph
Cost
0Percent Defects
100%
Failure
Control
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Strategy PricingStrategy PricingStrategy PricingStrategy Pricing
Revenues (1,000,000 @ $20) $20,000,000
Cost of goods sold -15,000,000
Operating expenses - 3,000,000
Product-line income $ 2,000,000
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Strategy PricingStrategy PricingStrategy PricingStrategy Pricing
Data from the low-level instruments are:
Quality costs (estimated):
Inspection of materials $ 200,000
Scrap 800,000
Rejects 500,000
Rework 400,000
Product inspection 300,000
Warranty work 1,000,000
Total estimate $3,200,000
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Reports: New Product Analysis, Project #675
Projected sales potential: 44,000 unitsProduction capacity: 45,000 unitsUnit selling price: $60Unit variable costs: $40Fixed costs:
Product development $ 500,000Manufacturing 200,000Selling 300,000 Total $1,000,000Projected break-even: 50,000 unitsDecision: RejectReason(s): The break-even point is greater than the production
capacity as well as the projected sales volume.
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ISO 9000 StandardsISO 9000 StandardsISO 9000 StandardsISO 9000 Standards
ISO 8402: Quality—Vocabulary
ISO 9000: Quality management and quality assurance standards—Guidelines for selection and use
ISO 9001: Quality systems—Model for quality assurance in design/development, production, installation, and servicing
ISO 9002: Quality systems—Model for quality assurance in production and installation
ISO 9003: Quality systems—Model for quality assurance in final inspection and test
ISO 9004: Quality management and quality system elements—Guidelines
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Controlling Quality CostsControlling Quality CostsControlling Quality CostsControlling Quality Costs
Zero-defect standards reflects a philosophy of total quality control and calls for products and services to be produced and delivered that
meet the targeted value.
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Types of Quality Types of Quality Performance ReportsPerformance Reports
Types of Quality Types of Quality Performance ReportsPerformance Reports
1. Progress with respect to a current-period standard or goal (an interim standard report)
2. The progress trend since the inception of the quality-improvement program (a multiple-period trend report)
3. Progress with respect to the long-range standard or goal (a long-range report)
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Prevention costs:
Quality training $ 80,000 $ 80,000 $ 0
Reliability engineering 160,000 160,000 0
Total prevention costs $240,000 $240,000 $ 0
Appraisal costs:
Materials inspection $ 75,000 $ 83,000 $ 8,000F
Product acceptance 40,000 40,000 0
Process acceptance 65,000 55,000 10,000U Total appraisal costs $180,000 $178,000$ 2,000 U
AMD, Inc.AMD, Inc.Interim Standard Performance Report: Quality CostsInterim Standard Performance Report: Quality Costs
For the Year Ended June 30, 2004For the Year Ended June 30, 2004
Actual Costs Budgeted Costs Variance
ContinuedContinuedContinuedContinued
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Internal failure costs: Scrap$ 50,000 $ 44,000 $ 6,000 U Rework 100,000 96,500 3,500
U Total internal failure $150,000 $140,500 $ 9,500U
External failure costs: Customer complaints $ 65,000 $ 65,000 $ 0 Warranty 78,000 68,500 9,500
U Repair 87,000 79,000 8,000
U Total external failure $230,000 $212,500$17,500 U
Total quality costs $800,000 $771,000 $29,000U
AMD, Inc.AMD, Inc.Interim Standard Performance Report: Quality CostsInterim Standard Performance Report: Quality Costs
For the Year Ended June 30, 2004For the Year Ended June 30, 2004
Actual Costs Budgeted Costs Variance
Percentage of actual sales 10.0% 9.64% 0.36% U
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Multiple-Period Trend ReportMultiple-Period Trend ReportMultiple-Period Trend ReportMultiple-Period Trend Report
Quality Costs Actual Sales % of Sales
2000 $1,000,000 $5,000,000 20.0 %
2001 990,000 5,500,000 18.0
2002 900,000 6,000,000 15.0
2003 899,000 6,200,000 14.0
2004 800,000 8,000,000 10.0
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Multiple-Period Trend ReportMultiple-Period Trend ReportMultiple-Period Trend ReportMultiple-Period Trend Report
Internal External Prevention Appraisal Failure Failure
2000 2.0 % 2.0 % 6.0 % 10.0 %
2001 3.0 2.4 4.0 8.6
2002 3.0 3.0 3.0 6.0
2003 4.0 3.0 2.5 4.5
2004 4.1 2.4 2.0 1.5
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25
20
15
10
5
0
2000 2001 2002 2003 2004
Multiple-Period Trend Graph: Total Quality Costs
Per
cent
age
of S
ales
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012345
6789
10
2000 2001 2002 2003 2004
PreventionAppraisalInternal FailureExteral Failure
Per
cen
tage
of
Sal
esMultiple-Period Trend Graph: Individual
Quality Cost Categories
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0%10%20%30%40%50%60%70%80%90%
100%
2000 2001 2002 2003 2004
Exteral FailureInternal FailureAppraisalPrevention
Per
cen
tage
of
Sal
esMultiple-Period Trend Graph:
Relative Quality Costs
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End ofEnd of
ChapterChapter
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