Cost of Poor Quality

“Are you saying I can reduce my costs by improving quality? How can that be? Quality costs money, right?”

Not really. The catch is in exactly what is meant by “quality”.

There are three basic kinds of quality: design quality, manufacturing quality, and service quality.

Design quality refers to the features that are included in or omitted from the design. In this sense, higher quality may refer to a greater number or higher level of features. Heated leather seats instead of cloth seats. A self-closing trunk. Sterling silver versus silver plate or stainless steel. Generally, but not always, this type of quality costs more. But it usually sells at a higher price, resulting in higher profits in the end. (Sometimes, the price of such items is influenced more by exclusivity than cost to produce. This is called “marketing”.)

Manufacturing quality refers to how well the product delivered to the customer matches the product design. Bubbles or blisters in the paint, poorly fitting hood or trunk lid, or torn seat covers would all be examples of poor manufacturing quality. Service quality refers to the degree to which the customer experience matches the ideal. Did the customer get the product they wanted, in the right quantity, when they needed it? Were they charged the correct amount?

While higher design quality may equate to higher costs, higher manufacturing and service quality almost always results in lower costs.

The costs of poor quality (COPQ) are many, not all of which are easily measurable. Warranty costs, customer returns, claims, scrap, and rework are just the tip of the iceberg. The costs of answering the phones, tracking the complaints, restocking, shipping replacements, or holding extra inventory can be estimated with some accuracy.

But the highest costs may be the least visible and most difficult to estimate: The cost of replacing a customer lost due to bad product or poor service, the negative word-of-mouth when they tell their friends or post negative reviews online, the opportunity cost when the product on the shelf has to be used to replace a defective one rather than sold to another customer. These are high but essentially unknowable costs.

The costs associated with quality, or lack of quality, can be divided into categories:

Failure costs: Those costs incurred when products or services do not meet their goals. These can be further divided into:

Internal Failure Costs: Those costs incurred when a quality failure is detected inside the organization, such as scrap and rework.

External Failure Costs: Those costs incurred when a quality failure is detected outside the organization, by a customer or regulatory body. These include warranty costs, customer returns, claims, fines, bad publicity, lost sales, lost customers, etc.

Masking Costs: Most authors stop with internal and external failure costs, but there is an additional category of costs incurred due to frequent quality failures: the costs that businesses incur to mask or hedge against failures. These are the costs of excess capacity, excess inventory, excessive lot sizes, and other measures taken to reduce the impact of quality failures.

As an example, in many industries it is common to manufacture more of a product than needed, so that when the non-conforming product is rejected in inspection, there is sufficient product remaining to meet orders. If my average yield is 90%, then I may “start” 120 items when I have orders only for 100. The business is paying for 20% more capacity and 20% more raw material inventory than if the yield were 100%.

Appraisal (Detection) Costs: Those costs incurred to ensure that quality failures do not reach the customer, such as inspection or testing.

Prevention Costs: Those costs incurred to ensure that quality failures do not occur in the first place.

In general, external failures are much more expensive than internal failures. Thus investments in detection can yield high returns. But detection costs money and internal failures are also expensive. So an investment in prevention can yield even higher returns by eliminating more failure costs and potentially reducing the need for detection expense.

When you are trying to estimate your cost of poor quality, think about all of these: