Cost of Quality

Numerous quality programmes have come and gone. Only cost-of-quality (COQ) systems has stood the test of time as a bona fide infrastructural input for managing quality improvement in an organization – manufacturing, service or IT. Globally, for thousands of companies, including winners of the Malcolm Baldrige Award or the European Quality Award, COQ systems marked the beginning of their prosperous journey into quality.

By combining a powerful philosophy with a practical technique, COQ systems make quality improvement justifiable for just about every business organization, regardless of size, because such systems are not capital intensive. In a typical company employing 500 persons, representatives from three to four departments, including a key cost accountant, can establish a COQ system after about 20 to 30 hours of meetings, if approached properly. Once established, one person has to spend about 80 to 100 hours per annum to maintain the system. The COQ system facilitates problem identification. Solving problems is an additional effort, involving numerous team-hours per annum.

When many companies begin the quality journey, it is not unusual for them to discover COQ estimates averaging between 20% and 35% of sales revenue. In 1990, Tata Steel, winner of the JRD Quality Values Award 2000, estimated their COQ at one-third of sales revenue! It is also not unusual for companies to reduce their COQ by 10% per annum, or as a percentage of sales by 3% per annum.

Initially, managers with some basic formal training in quality tools, deliver significant improvements and recurring COQ savings. This initial success creates the need for advanced quality techniques if the same pace of improvement and related cost reductions is to be maintained. Basic seven quality tools are simply inadequate. To maintain the momentum CEOs generally introduce seven management tools and seven creativity tools, as well as, problem solving methodologies that encompass quality function deployment, statistical process control, breakthrough improvement, benchmarking and process reengineering.

COQ systems measure the cost of poor quality in an organization. Developed in the early 1950s by Dr J M Juran and other leaders in the quality profession, the technique was widely published in quality literature by 1960. Today, COQ systems are an essential infrastructural input for managing quality. COQ systems measure total quality costs, which can be broken into four components: prevention costs, appraisal costs, internal failure costs, and external costs.

The idea that failure costs can be reduced through marginal discretionary investments in prevention, and even appraisal, activities is largely what makes COQ accounting so meaningful to an organization. The ratios between the four cost components, total quality costs, and total sales provide management with two valuable insights. First, these ratios reveal how much opportunity exists for quality improvement. Second, they help steer ongoing quality improvement efforts toward the greatest possible economic payoff.

A COQ system is a relevant quality infrastructural input that organizations can build to initiate and sustain their quality improvement efforts. The system’s success should not be judged by traditional cost accounting standards nor by newer performance measurement technologies. Instead, its success should be judged by quality cost reductions over time, and by managements’ commitment to it and other quality improvement initiatives.