15-1 Copyright 2004 by Nelson, a division of Thomson Canada Limited.

Quality Costs and

Productivity:
Measurement,
Reporting, and
Control
15
PowerPresentation prepared by
David J. McConomy, Queens University
15-2 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Learning Objectives
Identify and describe the four types of
quality costs.
Prepare a quality cost report and
explain the difference between the
conventional acceptable quality level
(AQL) view and the zero defects view
of quality cost control.
15-3 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Learning Objectives
Explain why quality cost information is
needed and how it is used.
Explain what productivity is and
calculate the impact of productivity
changes on profits.
15-4 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Eight Dimensions of Quality

Performance
Aesthetics
Serviceability
Features (quality of design)
Reliability
Durability
Quality of Conformance
Fitness of Use
15-5 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Quality Defined
Features (Quality of Design) refer to characteristics
of a product that differentiate functionally
similar products.
Example: Compare first class air travel with economy travel.
First Class typically offers more leg room, better meals
and more luxurious seats.
Quality of Conformance is a measure of how well
the product meets its requirements or
specifications.
Example: If a Honda Civic does what it is designed to do
and does it well, quality exists. For example, if
economy cars are designed to provide reliable, low-
cost, low-maintenance transportation, the desired
quality exists.
15-6 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Measuring Quality Costs
Prevention costs

Appraisal costs

Internal failure costs

External failure costs
15-7 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Examples of Quality Costs
Prevention costs Appraisal Costs
Quality engineering Inspection of raw materials
Quality training programs Testing of raw materials
Quality planning Packaging inspection
Quality reporting Supervising appraisal activities
Supplier evaluation and selection Product acceptance
Quality audits Process acceptance
Quality circles Inspection of equipment
Field trials Test equipment
Design reviews Outside endorsements
15-8 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Examples of Quality Costs
Internal failure costs External failure costs
Scrap Cost of recalls
Rework Lost sales
Downtime (defect related) Returns/allowances
Reinspection Warranties
Retesting Repairs
Design changes Product liability
Customer dissatisfaction
Lost market share
Complaint adjustment
15-9 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Estimating Hidden Quality Costs

The Multiplier Method

The Market Research Method

Taguchi Quality Loss Function
Hidden Quality Costs are opportunity
costs resulting from poor quality.
15-10 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
The 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 $2 million,
then the actual external failure costs are estimated to be $8
million.
15-11 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
The Market Research Method
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
companys sales force can provide significant
insights into the magnitude of a companys hidden
costs.
Market research results can be used to project future
profit losses attributable to poor quality
15-12 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
The 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.
15-13 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Reporting Quality Costs
Quality Costs % of Sales
Prevention costs:
Quality training $35,000
Reliability engineering 80,000 $115,000 4.11%
Appraisal costs:
Materials inspection $20,000
Product acceptance 10,000
Process acceptance 38,000 68,000 2.43%
Internal failure costs:
Scrap $50,000
Rework 35,000 85,000 3.04 %
External failure costs:
Customer complaints $25,000
Warranty 25,000
Repair 15,000 65,000 2.32%
Total quality costs $333,000 11.90%
======= =====
15-14 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
20.5%
25.5%
34.5%
Prevention costs Appraisal costs
Internal failure costs External failure costs
19.5%
Reporting Quality Costs
(continued)
15-15 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
AQL Quality Cost Graph
Cost
0
Optional (AQL)
Percent Defects
100%
Cost of Failures
Cost of Control
15-16 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Zero-Defect Graph
Total
Quality
Cost
Cost
0
Percent Defects 100%
15-17 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Multiple-Period Quality Costs
Quality Costs Actual Sales % of Sales
2001 $440,000 $2,200,000 20.0
2002 423,000 2,350,000 18.0
2003 412,500 2,750,000 15.0
2004 392,000 2,800,000 14.0
2005 280,000 2,800,000 10.0
Assume the following data:
15-18 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Multiple-Period Trend Graph:
Total Quality Costs
5
10
15
20
0 1 2 3 4 5
% of
Sales
Year
15-19 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Multiple-Period Total Quality Costs
Total Quality Costs as a % of Sales
0
5
10
15
20
25
2001 2002 2003 2004 2005
Column 2
%of Sales
15-20 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Multiple-Trend Analysis for
Individual Quality Costs
Internal External
Prevention Appraisal Failure Failure
2001 6.0%
1
4.5% 4.5% 6.0%
2002 6.0 4.0 3.5 4.5
2003 5.4 3.6 3.0 3.0
2004 5.6 3.2 3.1 2.6
2005 4.4 2.4 3.0 2.3
Assume the following quality cost data:
1
Expressed as a % of sales
15-21 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Multiple-Trend Analysis for
Individual Quality Costs
%
of sales
0
5
10
15
20
25
2001 2002 2003 2004 2005
External Costs
Internal Costs
Appraisal
Prevention
15-22 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Productivity: Measurement and
Control
Productivity is the relationship between output and the
inputs used to produce the output.
Total productive efficiency is the point at which
two conditions are satisfied:
1. for any mix of inputs to produce a given output,
no more inputs are used than are necessary
to produce that output
2. given the mixes that satisfy the first condition,
the least costly mix is chosen.
15-23 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Illustration of Productivity
Improvement
Technical Efficiency is the condition where no
more of any one input is used than necessary
to produce a given output.
Technical efficiency improvement is when
less inputs are used to produce the same
output or more output are produced using
the same input.

15-24 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Illustration of Productivity
Improvement
Same output, fewer inputs:

INPUTS OUTPUT
15-25 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Illustration of Productivity
Improvement
More outputs, same inputs:
INPUTS OUTPUT
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Input trade-off efficiency is when a less costly input
mix is used to produce the same output.
Combination I: Total cost of inputs = $20,000,000

INPUTS OUTPUT
Illustration of Productivity
Improvement
15-27 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Illustration of Productivity
Improvement
Combination II: Total cost of inputs = $27,000,000

INPUTS OUTPUT
Of the two combinations that produce the same
output, the least costly combination would be
chosen.
15-28 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Partial Productivity Measures
Partial Productivity Measurement:
Measuring productivity for one input at a time.
Partial Measure = Output/Input
Operational Productivity Measure:
Partial measure where both input and output are
expressed in physical terms.
Financial Productivity Measure:
Partial measure where both input and output are
expressed in dollars.
15-29 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Partial Productivity Measures
Example 1:
In 2000, Tick-Tock Company produced 100 clocks
and used 200 direct labour hours and 50
kilograms of raw materials. Compute the labour
and materials productivity ratios.

Answer:
Labour productivity ratio = 100 clocks/200 hours
= 0.5 clocks per hr
Materials productivity ratio = 100 clocks/50 kilogram
= 2 clocks per kilogram
15-30 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Partial Productivity Measures
Example 2:
In 2001, Tick-Tock Company produced 100 clocks and used
175 direct labour hours and 40 kilograms of raw materials.
Compute the partial productivity ratios. Compared to 2000,
has productivity improved?
Answer:
A. Ratios computed:
Labour productivity ratio =100 clocks/175 hrs
=0.57 clocks per hr
Materials productivity ratio =100 clocks/40 kilograms
=2.5 clocks per kilogram

B. Ratios compared: 2000 2001
Labour 0.50 0.57
Materials 2.00 2.50
Both ratios have improved, so productivity has improved.
15-31 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Profile Measurement
Profile Measurement provides a series or a vector of
separate and distinct partial operational measures.

Example:
Kankul implements a new production and assembly process in
2001. Only now lets assume that the new process affects both
labour and materials. The following data for 2000 and 2001 are
available
2004 2005
Number of motors produced 120,000 150,000
Labour hours used 40,000 37,500
Materials used (kg) 1,200,000 1,428,571
15-32 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Profile Analysis with No Trade-offs
Partial Productivity Ratios

2004 Profile
a
2005 Profile
b


Labour productivity ratio 3.000 4.000
Materials productivity ratio 0.100 0.105
a
Labour: 120,000 / 40,000; Materials: 120,000 / 1,200,000
b
Labour: 150,000 / 37,500; Materials: 150,000 / 1,428,571
15-33 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Profile Analysis with Trade-offs
Partial Productivity Ratios

2004 Profile
a
2005 Profile
b


Labour productivity ratio 3.000 4.000
Materials productivity ratio 0.100 0.088
a
Labour: 120,000 / 40,000; Materials: 120,000 / 1,200,000
b
Labour: 150,000 / 37,500; Materials: 150,000 / 1,700,000
15-34 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Profit-Linked Productivity
Measurement
Profit-Linkage Rule: For the current period,
calculate the cost of the inputs that would have
been used in the absence of any productivity
change and compare this cost with the cost of
the inputs actually used. The difference in costs
is the amount by which profits changed because
of productivity changes.

To compute the inputs that would have been used (PQ), use
the following formula:
PQ = Current Output/Base-Period Productivity Ratio
15-35 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Profit-Linked Productivity
Measurement
Example:
Tick-Tock Company provided the following data for 2000 and 2001:
2000 2001
Production (no. of clocks) 100 120
Selling price $500 $500
Materials used (kg.) 50 72
Labour hours used 200 228
Cost per kg. of material $5 $5
Cost per hr. of labour $10 $10
15-36 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Profit-Linked Productivity
Measurement

Compute the profit change attributable to productivity changes.

PQ (materials) =120/2 =60 kgs.
PQ (labour) =120/0.5 =240 hrs.
Profit change:
Input
Matls
Labour

PQ PQ x P AQ AQ x P (PQ x P) - (AQ x P)
60
240

$ 300
2,400
$2,700
72
228

$ 360
2,280
$2,640
$ (60)
120
$ 60
Profits have improved by $60 because of productivity changes.
15-37 Copyright 2004 by Nelson, a division of Thomson Canada Limited.
Price-Recovery Component and
Gainsharing
The difference between the total profit change and
the profit-linked productivity change is called the
price-recovery component.

Gainsharing is providing to a companys entire
workforce cash incentives that are keyed to
quality and productivity gains.