copq training materials
TRANSCRIPT
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SYSTEMS Quality Consulting 1
Cost of Quality as a Driver for
Continuous ImprovementPresented by
Roger E OlsonPartner
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SYSTEMS Quality Consulting 2
Agenda
1. Linking Quality Improvement to Profits2. Cost of Quality Definitions and Types 3. Understanding Cause and Effect in
COQ Measurements4. Establishing COQ Baseline5. Cost Driver Analysis
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SYSTEMS Quality Consulting 3
1. Linking Quality Improvement to Profits2. Cost of Quality Definitions and Types 3. Understanding Cause and Effect in
COQ Measurements4. Establishing COQ Baseline5. Cost Driver Analysis
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SYSTEMS Quality Consulting 4
History/Background of COQ
• Joseph Juran first discussed cost of quality analysis in 1951 in the first edition of Quality Control Handbook
• Armand Feigenbaum identified the four cost categories in 1956 in “Total Quality Control” in the Harvard Business Review, Vol. 34, No 6
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History/Background of COQ
Armand Feigenbaum’s original categories• Cost of Control
– Prevention costs– Appraisal (i.e., inspection) costs
• Costs of Failure of Control– Internal defect costs– External defect costs
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History/Background of COQ
• The Quality Cost Committee was established by the then ASQC in 1961
• Philip Crosby, a former CEO, popularized the concept of COQ with his book Quality is Free in 1979
• The current revisions of ISO 9000, QS-9000 and AS9100 reference the use of COQ in quality improvement
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History/Background of COQ
Crosby’s categories• Price of Conformance (POC/COC)
– Prevention costs– Appraisal costs
• Price of Nonconformance (PONC/CONC)– Internal defect costs– External defect costs
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Deming, Juran, Crosby on COQ
• Deming – the cost of nonconformance, and the resulting loss of good will, is so high that measuring it is not necessary
• Juran – as defect prevention increases, the cost of scrap/rework decreases faster. Need to know where to look
• Crosby – money is the language of management, you need to show them the numbers
(Philosophy)
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Juran and Crosby on COPQ
The cost of poor quality (COPQ = PONC):• “COPQ is the sum of all costs that would
disappear if there were no quality problems.”- Juran
• “You can easily spend 15 - 30% of your sales dollars on PONC.” - Crosby
• “In most companies the costs of poor quality runs at 20 - 30% of sales.” - Juran
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Something to Think About…
• Net profits for many companies is less than 5% of sales
• COPQ on the average is 17% of sales• Total COQ on the average is 25% of sales• COPQ is some companies is as high as 40%
of sales• COPQ is typically 3 to 6 TIMES as large
as profits
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Example 1
Paper Mill – April 2004 Report to New CEO• Sales: $220,000,000 (460 employees)• POC: $7,600,000• PONC: $35,300,000• COQ: $42,900,000• EBITDA: $12,678,000• Net Profit: $3,150,000
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Example 1
Paper Mill – April 2004 Report to New CEO• Sales: $220,000,000• POC: $7,600,000 (>90% appraisal)• PONC: $35,300,000• COQ: $42,900,000• EBITDA: $12,678,000• Net Profit: $3,150,000• Net Profit/Sales = 1.43%
3X 11X
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Example 1
Paper Mill – April 2004 Report to New CEO• Sales: $220,000,000• POC: $7,600,000• PONC: $35,300,000• COQ: $42,900,000• EBITDA: $12,678,000• Net Profit: $3,150,000• Net Profit/Sales = 1.43%
~ 5X
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Example 2a
Transportation Industry Supplier (1998)• Sales: $130,000,000 • COC: $4,400,000 (92% appraisal)• COPQ: $18,500,000• COQ: $22,900,000• EBITDA: $6,531,000• Net Profit: $2,050,000
3X 9X
• Net Profit/Sales = 1.57%
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Example 2b
Transportation Industry Supplier (2003)• Sales: $185,000,000 • COC: $8,600,000 (45% appraisal)• COPQ: $8,100,000• COQ: $16,700,000• EBITDA: $19,900,000• Net Profit: $6,650,000
0.5X 1.2X
• Net Profit/Sales = 3.6%
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Don’t Let Poor Quality Costs Eat Your Profits!
COPQ
Profits
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1. Linking Quality Improvement to Profits
• Background of Quality Costs• Evolution of Quality• Traditional vs Value Driven Quality Strategy
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What is Quality?
Quality is “fitness for use”
(Joseph Juran)
Quality is “conformance to requirements”
(Philip B. Crosby)
Quality of a product or service is its ability to satisfy the needs and expectations of the customer
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““Inspection with the aim of finding the bad ones Inspection with the aim of finding the bad ones and throwing them out is too late, ineffective and and throwing them out is too late, ineffective and
costly. Quality comes not from inspection but costly. Quality comes not from inspection but improvement of the process.improvement of the process.””
Dr. W. Edwards DemingDr. W. Edwards DemingFounder of the Quality EvolutionFounder of the Quality Evolution
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All quality improvement of a lasting nature occurs as the result of a project. Joseph Juran
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Traditional “Strategy”
• Historically, organizations tend to treat strategic planning and quality improvement planning as two separate and unrelated activities
• Strategic planning tends to be regular and scheduled, but with no follow up
• Continuous improvement is not a process, it happens randomly, with no connection to the “big picture”
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Value Driven Quality Strategy
• Starts with a focus on the customer• Organizations treat strategic planning and
quality improvement planning as an integrated activity
• Strategic planning is a function of need, not the calendar
• Continuous improvement is a process, it happens regularly, with a connection to the “big picture”
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1. Linking Quality Improvement to Profits2. Cost of Quality Definitions and Types 3. Understanding Cause and Effect in
COQ Measurements4. Establishing COQ Baseline5. Cost Driver Analysis
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Cost of Quality Definitions and Types
Total Quality Costs represent the difference between the actual (current) cost of a product or service and what the reduced cost would be if there were no possibility of substandard service, failure to meet specifications, failure of products, or defects in their manufacture.
Campanella, Principles of Quality Costs
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Prevention
The costs of all activities specifically designed to prevent poor quality in products or services. Examples include:
• Quality planning• New product reviews• Quality education
• Process capability evaluations• Supplier capability surveys• Quality improvement projects
These are all planned, proactive activities
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Income StatementIncome
Sales $4,100,000Returns ($105,000)
Income $3,995,000
Cost of Goods SoldLabor $960,600Materials $1,118,000
COGS $2,078,600Expenses
Salaries $483,800Services $98,400Depreciation $194,340Training $3,300Supplies $36,900Interest $61,500Rent $287,000Accounting $24,600Legal $28,200Office Supplies $16,400Travel $28,700Licenses/Certification $12,300Meals and Ent. $15,300Advertising $82,000Sales Shows $41,000Repairs $44,600Telephone $20,500Utilities $36,900
Expenses $1,515,740
Profit $400,660
Hidden Quality Costs
Prevention Costs
• Quality Planning $4,000
• Engineering design $10,000
• Quality Training $2,000
• Preventive maint. $4,000
$20,000
$20,000
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Prevention
In the ideal situation, prevention costs will be the largest portion of the Total Cost of Quality.
Typically, prevention is less than 10% of TCOQ
It should be over 70%!
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Appraisal
The costs associated with evaluating or auditing products or services to assure conformance to quality standards and performance requirements. Examples:
• Incoming inspection/test• Calibration of inspection/test equipment• Final inspection/test
These are all planned activities
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Income StatementIncome
Sales $4,100,000Returns ($105,000)
Income $3,995,000
Cost of Goods SoldLabor $960,600Materials $1,118,000
COGS $2,078,600Expenses
Salaries $483,800Services $98,400Depreciation $194,340Training $3,300Supplies $36,900Interest $61,500Rent $287,000Accounting $24,600Legal $28,200Office Supplies $16,400Travel $28,700Licenses/Certification $12,300Meals and Ent. $15,300Advertising $82,000Sales Shows $41,000Repairs $44,600Telephone $20,500Utilities $36,900
Expenses $1,515,740
Profit $400,660
Hidden Quality Costs
Appraisal Costs
• Inspector wages $40,000
• In-process inspect $75,000
• Quality audits $20,000
• Calibration services $40,000
• Supplies $15,000
• QC floorspace $50,000
• Regulatory approval $10,000
$250,000
$250,000
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Appraisal
Appraisal costs should be the second largest category, but should not exceed prevention costs.
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Internal Failures
All costs resulting from products or services not conforming to requirements or customer/user needs which occur beforedelivery/shipment of product, or the furnishing of a service. Examples include:• Scrap/rework• Reinspection/retesting• Material Review Board
These are non-value added and reactive
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Income StatementIncome
Sales $4,100,000Returns ($105,000)
Income $3,995,000
Cost of Goods SoldLabor $960,600Materials $1,118,000
COGS $2,078,600Expenses
Salaries $483,800Services $98,400Depreciation $194,340Training $3,300Supplies $36,900Interest $61,500Rent $287,000Accounting $24,600Legal $28,200Office Supplies $16,400Travel $28,700Licenses/Certification $12,300Meals and Ent. $15,300Advertising $82,000Sales Shows $41,000Repairs $44,600Telephone $20,500Utilities $36,900
Expenses $1,515,740
Profit $400,660
Hidden Quality Costs
Internal Failure Costs
• Labor (rework) $110,000
• Materials (rework) $95,000
• Eng. redesign $30,000
• Failure analysis $20,000
• Software fix $40,000
• Fire loss – equip. $70,000
• Rework space $35,000
$400,000
$400,000
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Internal Failures
• The goal is to identify all internal failures and resultant costs, and then systematically identify and eliminate root causes until internal failure costs are eliminated.
• Remember, all firefighting is a the result of a failure!
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External Failures
All costs resulting from products or services not conforming to requirements or customer/user needs which occur after delivery/shipment of product, or the furnishing of a service.
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External Failures - Examples
The costs incurred when the customer finds the failure– Processing customer complaints– Field repairs– Recall costs– Returned goods– Processing returned materials– Warranty costs– Loss of reputation– Penalties– Customer incurred costs These are non-value added
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Income StatementIncome
Sales $4,100,000Returns ($105,000)
Income $3,995,000
Cost of Goods SoldLabor $960,600Materials $1,118,000
COGS $2,078,600Expenses
Salaries $483,800Services $98,400Depreciation $194,340Training $3,300Supplies $36,900Interest $61,500Rent $287,000Accounting $24,600Legal $28,200Office Supplies $16,400Travel $28,700Licenses/Certification $12,300Meals and Ent. $15,300Advertising $82,000Sales Shows $41,000Repairs $44,600Telephone $20,500Utilities $36,900
Expenses $1,515,740
Profit $400,660
Hidden Quality Costs
External Failure Costs
• Returns $105,000
• Labor $60,000
• Materials $40,000
• Consulting Services $37,000
• Legal $25,000
• Travel $15,400
• Meals & Entertain $3,000
• Repairs $44,600
$330,000
$330,000
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Income StatementIncome
Sales $4,100,000Returns ($105,000)
Income $3,995,000
Cost of Goods SoldLabor $960,600Materials $1,118,000
COGS $2,078,600Expenses
Salaries $483,800Services $98,400Depreciation $194,340Training $3,300Supplies $36,900Interest $61,500Rent $287,000Accounting $24,600Legal $28,200Office Supplies $16,400Travel $28,700Licenses/Certification $12,300Meals and Ent. $15,300Advertising $82,000Sales Shows $41,000Repairs $44,600Telephone $20,500Utilities $36,900
Expenses $1,515,740
Profit $400,660
Prevention: $20,000Appraisal: $250,000COC $270,000
Int. Failure: $400,000Ext. Failure: $330,000COPQ $730,000
COPQ/Sales = 18.3%
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Income StatementIncome
Sales $4,100,000Returns ($105,000)
Income $3,995,000
Cost of Goods SoldLabor $960,600Materials $1,118,000
COGS $2,078,600Expenses
Salaries $483,800Services $98,400Depreciation $194,340Training $3,300Supplies $36,900Interest $61,500Rent $287,000Accounting $24,600Legal $28,200Office Supplies $16,400Travel $28,700Licenses/Certification $12,300Meals and Ent. $15,300Advertising $82,000Sales Shows $41,000Repairs $44,600Telephone $20,500Utilities $36,900
Expenses $1,515,740
Profit $400,660
Prevention: $20,000Appraisal: $250,000COC $270,000
Int. Failure: $400,000Ext. Failure: $330,000COPQ $730,000
TCOQ $1,000,000(TCOQ/Sales = 24.4%)
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TCOQ Summary
Sales: $4,100,000Profit: $400,660
COC/Sales = 6.5%COPC/Sales = 17.8%TCOQ/Sales = 24.4%
COPQ/Profit = 1.8TCOQ/Profit = 2.5
Prevention: $20,000 (2%)Appraisal: $250,000 (25%)COC $270,000 (27%)
Int. Failure: $400,000 (40%)Ext. Failure: $330,000 (33%)COPQ $730,000 (73%)
TCOQ: $1,000,000 (100%)
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PONC
POC
Over time, PONC is reduced to 1/10 - 1/20 of its original level
POC is increased initially,then slowly decreased over time
But, POC never goesaway completely
Year 1 Year 2 Year 3 Year 4 Year 5
Price of Conformance and Price of NonconformanceOver Time
Tota
l Cos
t of Q
ualit
y
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PONC
POC
Year 1
Tota
l Cos
t of Q
ualit
y
THE Barrier to Reducing COPQ
You must INCREASEthe POC, mostlyPrevention costs, BEFORE COPQ will start to drop.
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Prevention
Appraisal
Failure
Time
Cos
tsSpending more on
prevention will reduce appraisal and failure
costs over time
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In the Beginning COQ Category Maturity~65% Failure <10%~25% Appraisal <20%<10% Prevention >70%
How the Percentages Should Change Over Time
PreventionAppraisal
Failure
% of Total COQ
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Something to Think About…
• A survey by the Illinois Manufacturers’Association revealed a 400% margin of error in cost of poor quality assessments.
• Companies initially reported an average of 6%cost of poor quality (6% of sales).
• A later, in-depth assessment showed the average to be closer to 25% (25% of sales).
• The Survey Conclusion: 75% of the cost of poor quality is hidden, and not obvious!
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Something to Think About…
• Over 70% thought their organizations COPQ was less than 10 percent of sales
• Twenty-seven percent admitted they had no idea what their companies COPQ was
• One of the conclusions of those conducting the survey: “too many people still do not understand the relationship between cost and quality”
Results of an ASQ survey of CEOs:
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Failu
re C
o sts
Process Time
Prevention
Component
Subsystem/Assembly
Final Inspection
Receiving Inspection
Litigation loss
Field Failure/Repair
$1
$10
$100
$1000
$10,000
Failure costas a functionof detectionpoint inprocess
Artificial HipInternal
External
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1. Linking Quality Improvement to Profits2. Cost of Quality Definitions and Types 3. Understanding Cause and Effect in
COQ Measurements4. Establishing COQ Baseline5. Cost Driver Analysis
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Why Study Cause and Effect and COQ?
A key finding in a four-year study* for the Institute of Management Accountants, of more than thirty industry leaders, is the importance of understanding the cause and effect relationship among strategy, quality, productivity, profitability and competitiveness.
* Atkinson, Hamberg and Ittner, Linking Quality to Profits, 1994
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Understanding Cause and Effect in COQ Measurements
The study found that without exception the successful companies in the study based quality related decisions on a clear understanding of the cause-and-effect relationship between the goals they wanted to accomplish and the step required to achieve those goals.
Atkinson, Hamberg and Ittner, Linking Quality to Profits, 1994
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The High Level Cause and Effect View
Effective Quality Improvement
Higher Quality
Increased Productivity
Increased Profitability
Increased Competitiveness
Which Leads to
Which Leads to
Which Leads to
Which Leads to
It allStartsHere!
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Any Similarity?
Effective Quality Improvement
Higher Quality
Increased Productivity
Increased Profitability
Increased Competitiveness
Which Leads to
Which Leads to
Which Leads to
Which Leads to
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The Problem Is…..
When Senior ManagementDoesn’t Understand
High QualityLeads to
Increased Productivity
Increased Profitability
Increased Competitiveness
Which Leads to
Which Leads to
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The Cause and Effect Framework
Step 1. The quality process embraces the strategic vision and goals of top management, aligning the objectives and priorities of the quality process and the business.
Atkinson, Hamberg and Ittner, Linking Quality to Profits, 1994
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The Cause and Effect Framework
Step 2. Improvement projects are chosen on the basis of improving profitability and customer satisfaction by eliminating the high payback root cause of poor quality and the related nonvalue-added activities and waste. (We will look at how to do this in a later chapter – Cost Driver Analysis)
Atkinson, Hamberg and Ittner, Linking Quality to Profits, 1994
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The Cause and Effect Framework
Step 3. Productivity gains from higher quality are trapped and held by making the organizational alterations necessary to eliminate nonvalue-added activities and waste. This means we have to institutionalize process improvements. We need to monitor and measure those processes to insure the gains don’t go away.
Atkinson, Hamberg and Ittner, Linking Quality to Profits, 1994
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The Cause and Effect Framework
Step 4. Profitability gains from higher productivity are trapped and held by redeploying resources from nonvalue-added activities into value-added activities. Note: Most companies are not good at this step!
Atkinson, Hamberg and Ittner, Linking Quality to Profits, 1994
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Short-Term Cost of Quality and Total Quality Management (Quick Fix)
2. Fewer people todo same work-
false improvements!
5. Poor quality
1. Cut budget
3. More errorsAnd rework
4. Totalcosts
increase
Pacific Bell Cost of Quality Handbook, 1992
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SYSTEMS Quality Consulting 58
Long-Term Cost of Quality and Total Quality Management
2. Teams improve processes and productivity
5. Improved qualityAnd profitability
1. Invest inquality
improvement
3. Fewer defects and rework
4. DecreaseIn
Totalcosts
Pacific Bell Cost of Quality Handbook, 1992
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1. Linking Quality Improvement to Profits2. Cost of Quality Definitions and Types 3. Understanding Cause and Effect in
COQ Measurements4. Establishing COQ Baseline5. Cost Driver Analysis
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Establishing COQ Baseline
• Two Approaches• Advantages and Disadvantages of each
approach• Getting started
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Two Approaches
• Ad-hoc informal system– Purpose is to quickly get a good estimate of
how large TCOQ and COPQ are– Output is TCOQ report for a point in time
• Formal Cost of Quality System– Permanent feature of management reporting
and decision making system– Provides detailed ongoing reports
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Ad-hoc informal system
• Cross functional team• Meets for two weeks to two months and
then disbands• Reviews existing quality, defect, rework
reports• Conducts interviews to assess extent of
failure costs• Reports on TCOQ and COPQ as of a
given date
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Advantages and Disadvantages of an Ad-hoc informal system
• Advantages– Can have report in two to four weeks– Less cost than formal system
• Disadvantages– Typically underestimates COPQ and does not
get managements attention
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Formal COQ System
• Cross functional team• Involves finance department• Requires training of all employees on cost
of quality concepts• Requires ongoing data collection efforts
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Advantages and Disadvantages of a Formal COQ System
• Advantages– Data is very accurate– Root cause analysis and problem solving is
easier• Disadvantages
– Slower to get first report– Adds infrastructure (costs) although these will
be more than offset IF COQ projects are successful
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Starting a COQ Program
• Senior management support is critical for either approach
• Senior management must be open to the possibility that COPQ is large (Why?)
• COQ programs cannot be started from the bottom up (Why?)
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Starting a COQ Program
1. Determine level of detail to be included1. Level 1 Assessment deals with internal and
external failures only2. Level 2 Assessment adds appraisal costs3. Level 3 Assessment adds prevention costs
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COQ Assessment Problems
• When ongoing periodic assessments are made, the cost of poor quality may continue to increase over the first 2-3 years, due to assessment team members getting better at identifying poor quality costs
• The first assessment may identify far more improvement than the organization can handle
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Potential COQ Assessment Problems
• Avoid the expectation that a cost of quality assessment solves any problems – it is a data gathering exercise
• Level 1 assessments are most useful when used to identify significant opportunities for savings, to avoid drowning in minutia
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The COQ Challenge
• Many COQ costs appear to be appraisal, but when you dig deeper, they are only there because some process is not working right.
• Some COQ costs are currently seen as not related to COQ.
• Remember: “ COPQ is the sum of all costs that would disappear if there were no quality problems.” -Juran
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For every cost, and cost category, be willing to ask this question: “If all of our processes (admin and manufacturing) produced the correct results the first time, would this cost still be here?”
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1. Linking Quality Improvement to Profits2. Cost of Quality Definitions and Types 3. Understanding Cause and Effect in COQ
Measurements4. Establishing COQ Baseline5. Cost Driver Analysis
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Cost Driver Analysis
• Definition• Methodology• Root Cause Analysis• Percent Allocation and Cost• Add Common Root Cause Costs
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Cost Driver Analysis
1. For each failure there is a root cause2. Causes are preventable3. Prevention is always cheaper
The underlying beliefs:
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Cost Driver Analysis
What is it?A powerful technique that integrates the
problem solving tools of the quality process with the poor-quality cost assessment.
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Cost Driver Analysis-How To
1. Determine the root cause of the poor-quality costs
2. Identify the activity percentages and calculate the cost of poor quality related to each root cause
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Cost Driver Analysis-How To
3. Combine the financial impacts of common root causes to determine the total financial impact of the root cause
4. Perform a cost-benefit analysis for the high financial impact root cause to determine the financial payback
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Internal Failure costsScrap $66,500 14.9Repair $1,900 0.4Rework $2,500 0.6Failure analysis $4,000 0.9
Total Internal Failure costs $74,900 16.8
External Failure costsFailures - manufacturing $14,500 3.2Failures - Engineering $7,350 1.6Penalties $198,714 44.4Failures - Sales $4,430 1.0Warranty charges $31,750 7.1Failure analysis $7,600 1.7
Total External Failure costs $264,344 59.1
Total Quality Costs $447,144 100
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Penalties Incorrect shipments
Late shipments
Partial shipments
Poor-Quality-Cost Element
Cost Drivers
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Identify the Percentages
Penalties
Partial Shipments$198,714
80%
15%
5%
$198,714X 80%
$158,971
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Identify the Percentages
Penalties
Partial Shipments
ExcessiveDowntime
$198,714
80%
15%
5%
90%
10%
$198,714X 80%
$158,971X90%
$143,074
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Identify the Percentages
Penalties
Partial Shipments
ExcessiveDowntime
ToolBreakage
$198,714
80%
15%
5%
90%
10%
75%
15%
$198,714X 80%
$158,971X90%
$143,074X75%
$107,306
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Identify the Percentages
Penalties
Partial Shipments
ExcessiveDowntime
ToolBreakage
Hard Spots inRaw Material
$198,714
80%
15%
5%
90%
10%
75%
15%
95%
5%
$198,714X 80%
$158,971X90%
$143,074X75%
$107,306X95%
$101,940
$101,940
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Identify the Root Cause
Penalties
Partial Shipments
ExcessiveDowntime
ToolBreakage
Hard Spots inRaw Material
Root Cause of Poor Quality
Poor-Quality-Cost Element
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Last Thoughts
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Failure To Include White Collar Costs
Prominent quality experts maintain that the inability of COQ systems to accurately capture white-collar costs and indirectquality costs is a fatal shortcoming and probably the single most frequently found reason for failure.
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Failure To Include White Collar Costs
Examples:• Disruption of operations due to out of
conformance purchases and production• Excessive inventory levels maintained to
accommodate poor quality• Poor quality related schedule changes• Opportunity costs of lost consumer goodwill
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Need to have a “CoQ Process”
• “Doing” Cost of Quality needs to be more that just data collection and analysis
• Need to create a process that takes Cost of Quality data and turns it into actions that results in lower Cost of Poor Quality (PONC/CONC)
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The COQ Process
1. Commitment2. COQ Team3. Gather data (COQ assessment)4. Pareto analysis5. Determine cost drivers6. Process Improvement Teams7. Monitor and measure8. Go back to step 3
TypicallyMissing
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“Wished I had understood that Cost of Quality stuff better”
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Key Points
• COPQ is big, usually 15-20% of sales!• COPQ is usually 3-5X profits, can be 10X.• Understanding poor cost of quality drivers is the
key to understanding the right project to work on.• Must capture white collar/indirect COPQ costs.• Prevention/Appraisal costs have to go up, before
overall COQ can go down. There are no exceptions to this!
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Questions
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SYSTEMS Quality ConsultingTraining and ConsultingISO 9001 ISO 14001
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