Measuring Money and Quality
Since their inception in 1943, quality-cost systems have helped many organizations direct improvement activities and measure their quality systems’ effectiveness. The concept originated with Armand V. Feigenbaum, who developed a dollar-based reporting system he called “cost of quality” while working at General Electric’s Schenectady Works. It tallied the costs related to developing a quality system and inspecting products, as well as the cost incurred when a product failed to meet requirements. That first report--which categorized costs as preventive, appraisal, and internal and external defects--got management’s attention. In 1951, Feigenbaum published his groundbreaking book on the subject, Total Quality Control (Third Edition, McGraw-Hill, 1991).
During the late 1950s, Philip Crosby, another quality-costs pioneer, attended a seminar based on research done by GE. “It was the first time I had seen money and quality put together in some measurable form,” Crosby recalled, “and it made me think about it.” As a result, he began to apply the concept to his own activities. His book, Cutting the Cost of Quality (Industrial Education Institute, 1965) showed how measurements could justify prevention as a means of achieving improvement. He divided quality costs into four categories: rework, scrap, warranty and quality control.
The term “quality cost” reflected the prevailing assumption of the 1950s: Quality products cost more to produce. Given management’s change in attitude toward quality and the new dimensions in the original concept, IBM coined the more accurate term “poor-quality cost” (PQC), which we’ll use here.
Poor-quality cost varies among organizations and depends on product complexity, the technology involved, how customers use the product and the effectiveness of the organization’s quality management system. In many cases, PQC accounts for more than 40 percent of a product’s sales price. For example, before it started its quality improvement process, IBM reported that its PQC ranged between 20 percent and 40 percent of revenue.
“When we analyzed what we were spending on quality, we were surprised and disturbed,” reports John Akers, IBM’s former chairman. “Roughly one-quarter was what we call prevention and appraisal cost, and roughly three-quarters were failure costs.”
Although poor quality costs your organization money, good quality saves it. It’s as simple as that. If you don’t measure the cost of poor quality, you can’t control it. If you can’t control it, you can’t manage it. So why don’t managers insist on the same sound financial control over poor-quality cost that they exercise over the purchase of materials--especially when PQC often exceeds a company’s total materials budget?
The importance of poor-quality cost was recognized by the U.S. Department of Defense when a requirement for PQC systems was included in military standard MIL-Q-9858A. It’s too bad ISO 9001:2000 doesn’t emphasize PQC as a key driver of organizational quality. Granted, a PQC reporting system is only one of many tools needed in a comprehensive, companywide quality system. However, it’s an important one because it directs management’s attention and measures the success of the organization’s improvement efforts.
Poor-quality cost is defined as all costs incurred to help employees do the job right every time. This includes process designs that have nonvalue-added activities included in them, the cost of determining if the output is acceptable, and any costs incurred by the organization and the customer because the output didn’t meet specifications and/or customer expectations.
During the 1960s and 1970s, PQC primarily measured manufacturing and warranty costs. More recently, management realized that all departments make errors associated with PQC. Numerous studies show that managerial PQC accounts for 35 percent to 80 percent of the total costs incurred by these departments--and these percentages don’t even consider indirect PQC. For example, a study of Saab’s research and development operations found that 78 percent of the company’s R&D costs were PQC. At IBM, 63 percent of the accounting department’s expenses were PQC.
Given today’s focus on external customers and business processes, it’s imperative that we consider how poor-quality cost affects our customers as well as the amount of money we spend on internal customer-related activities. Most of the time the indirect PQC is greater than the direct quality cost. You can’t make good business decisions if you aren’t measuring your indirect PQC. These factors require organizations to redefine the way they measure and quantify their poor-quality cost because it’s much higher than we imagine. I’ve yet to find an organization whose direct and indirect poor-quality cost is less than 20 percent of sales; often it’s more than 100 percent. Most organizations can double their profits by cutting PQC by 20 percent. A PQC system is the best way to measure and identify potential improvement opportunities.
H. James Harrington is CEO of the Harrington Institute Inc. and chairman of the board of Harrington Group. He has more than 45 years of experience as a quality professional and is the author of 22 books. Visit his Web site at www.harrington-institute.com.
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