Quality Cost & Productivity

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CHAPTER

Quality Costs and Productivity: Measurement, Reporting, and Control

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Objectives Objectives 1. Identify and describe the four types of quality costs. 2. Prepare a quality cost studying report and explain After this After studying this the difference between the conventional viewshould of acceptable quality chapter, chapter, you you should level and the view espoused by total quality control. be able to: be able to: 3. Tell why quality cost information is needed and how it is used. 4. Explain what productivity is, and calculate the impact of productive changes on profits.

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Quality Defined A quality product or service is one that meets or exceeds customer expectations...

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Quality Defined … on the following eight dimensions: Performance

Durability

Aesthetics

Quality of conformance

Serviceability Features Reliability

Fitness for use

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Quality Defined … on the following eight dimensions: Performance Aesthetics Serviceability Features Reliability

How How consistently consistently Durability and well and well aa product product The appearance of The functions appearance functions of tangible Quality of tangible products products Measures the ease of Measures the ease of (style, beauty) (style, beauty) conformance maintaining maintaining and/or and/or Characteristics of Characteristics of aa repairing the product Fitness for use repairing the product product that differentiate product that differentiate The probability The probability that that the the functionally similar functionally similar product or will product or service service will products products perform its perform its intended intended function function for for aa specified specified length length of of time time

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Quality Defined … on the following eight dimensions: The length of time Performance aAproduct measurefunctions of how a product meets its Aesthetics specifications The suitability of the

Serviceability

product for carrying out its advertised Features functions

Reliability

Durability Quality of conformance Fitness for use

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Quality Defined

A defective product is one that does not conform to specifications.

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Quality Defined Zero defects means that all products conform to specifications.

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Quality Defined The definition of quality-related activities imply Incurred to Incurred to four categories of quality costs: prevent Incurred to prevent poor Incurredpoor to 1) Preventive costs quality determine quality or or determine services being Incurred when whether products services being Incurred when whether products 2) Appraisal costs Incurred produced products and and services Incurred when produced productswhen and and services 3) Internal failure costs products and services not conform to products and services do not conform todo services fail to conform to requirements services fail to conform to requirements 4) External failure costs conform specifications conform to to specifications requirements requirements after after being being delivered delivered

Examples of Quality Costs Prevention costs Quality engineering Quality training programs Quality planning Quality reporting Supplier evaluation and selection Quality audits Quality circles Field trials Design reviews

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Examples of Quality Costs Appraisal Costs Inspection of raw materials Testing of raw materials Packaging inspection Supervising appraisal Product acceptance Process acceptance Inspection of equipment Testing equipment Outside endorsements

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Examples of Quality Costs Internal failure costs Scrap Rework Downtime (defect related) Reinspection Retesting Design changes

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Examples of Quality Costs External failure costs Cost of recalls Lost sales Returns/allowances Warranties Repairs Product liability Customer dissatisfaction Lost market share Complaint adjustment

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Measuring Quality Costs Hidden Quality Costs are opportunity costs resulting from poor quality.  The Multiplier Method  The Market Research Method  Taguchi Quality Loss Function

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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.

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 company’s sales force can provide significant insight into the magnitude of a company’s hidden costs. Market research results can be used to project future profit losses attributable to poor quality.

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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.

The Taguchi Quality Loss Function $ Cost

Lower Specification Limit

Target Value

Upper Specification Limit

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The Taguchi Quality Loss Function L(y) = k(y – T)² k = A proportionately constant dependent upon the organization’s external failure cost structure y = Actual value of quality characteristic T = Target value of quality characteristic L = Quality loss

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Quality Cost Report Unit Actual Diameter (y)

y-T

(y –T)²

k(y-T)²

1

9.9

-0.10

0.010

$ 4.00

2

10.1

0.10

0.010

4.00

3

10.2

0.20

0.040

16.00

4

9.8

-0.20

0.040

16.00

Total

0.100

$40.00

Average

0.025

$10.00

Image Products Quality Cost Report For the Year Ended March 31, 2004 Prevention costs: Quality training Reliability engineering Appraisal costs: Materials inspection Product acceptance Process acceptance Internal failure costs: Scrap Rework External failure costs: Customer complaints Warranty Repair Total quality costs

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Quality Costs

% of Sales

$35,000 80,000

$115,000

4.11%

$20,000 10,000 38,000

68,000

2.43

$50,000 35,000

85,000

3.04

$25,000 25,000 15,000

65,000 $333,000

2.32 11.90%

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Relative Distribution of Quality Costs External Failure (19.5%)

Internal Failure (25.6%)

Prevention (34.5%)

Appraisal (20.4%)

Quality Cost Graph Total Quality Costs

Cost

Failure Costs

Control Costs 0 AOL Percent Defects

100%

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Contemporary Quality Cost Graph Cost

Total Quality Costs

Failure Costs

Control Costs 100%

0 Percent Defects

Trend Analysis

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Assume Assume the the following following data: data: 2000 2001 2002 2003 2004

Quality Costs $440,000 423,000 412,500 392,000 280,000

Actual Sales $2,200,000 2,350,000 2,750,000 2,800,000 2,800,000

% of Sales 20.0% 18.0 15.0 14.0 10.0

Multiple-Period Trend Graph: Total Quality Costs % of Sales 20 15 10 5

0

1

2

Year

3 5

4

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Multiple-Trend Analysis for Individual Quality Costs Assume the following quality cost data: Prevention

2000 2001 2002 2003 2004 1

2.0%1 3.0 3.0 4.0 4.1

Expressed as a % of sales

Appraisal

2.0% 2.4 3.0 3.0 2.4

Internal Failure

6.0% 4.0 3.0 2,5 2.0

External Failure

10.0 % 8.6 6.0 4.5 1.5

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Multiple-Period Trend Graphic: Individual Quality Cost Categories

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Percentage 10 of Sales

9 8 7 6 5 4 3 2 1 0

Prevention Appraisal Internal failure External failure

0

1

2

3

4

Year

Productivity: Measurement and Control

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Productivity Productivity isis concerned concerned with with producing producing output output efficiently, efficiently, and and isis itit specifically specifically addresses addresses the the relationship relationship of of output output and and the the inputs inputs used used to to produce produce the the outputs. outputs.

Productivity: Measurement and Control Total productive efficiency is the point at which two conditions are satisfied: 1. for any mix of inputs that will produce a given output, no more of any one input is used than necessary to produce the output 2. given the mixes that satisfy the first condition, the least costly mix is chosen.

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Technical Efficiency 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. Current productivity Inputs: Labor Capital

4

Outputs:

6

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Technical Efficiency Same Output, Fewer Inputs Inputs: Outputs: Labor

3

Capital

6

More Output, Same Inputs Inputs: Outputs: Labor Capital

4

8

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Technical Efficiency More Output, Fewer Inputs Inputs: Outputs: Labor

3

Capital

8

Technically Efficient Combination I: Inputs: Outputs: Labor

3

Capital $20,000,000

8

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Technical Efficiency

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Technically Efficient Combination II: Inputs: Outputs: Labor

2

Capital $25,000,000

8

Of Of the the two two combinations combinations that that produce produce the the same same output, output, the the least least costly costly combination combination would would be be chosen. chosen.

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Partial Partial Productivity Productivity Measurement Measurement 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.

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Profile measurement provides a series or a vector of separate and distinct partial operational measures.

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Profile Productivity Measures Example 1: The productivity of both labor labor and materials moves in the same direction: Number of motors produced Labor hours used Materials used (lbs.)

Labor productivity ratio Material productivity ratio

2003 120,000 40,000 1,200,000

2004 150,000 37,500 1,428,571

150,000/37,500 150,000/37,500 Partial Productivity Ratios 150,000/1,428,571 150,000/1,428,571

2003 Profile

2004 Profile

3.000 0.100

4.000 0.105

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Profile Productivity Measures Example 2: Assume the same data as Example 1 except the material used is 1,700,000 pounds. Number of motors produced Labor hours used Materials used (lbs.)

Labor productivity ratio Material productivity ratio

2003 120,000 40,000 1,200,000

2004 150,000 37,500 1,700,000

150,000/37,500 150,000/37,500 Partial Productivity Ratios 150,000/1,700,000 150,000/1,700,000

2003 Profile

2004 Profile

3.000 0.100

4.000 0.088

Profit-Linked Profit-Linked Productivity Productivity Measurement Measurement

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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

Profit-Linked Profit-Linked Productivity Productivity Measurement Measurement Example: Kunkul provided the following data: 2003 Number of motors produced 120,000 Labor hours used 40,000 Materials used (lbs.) 1,200,000 Unit selling price (motors) $50 Wages per labor hour $11 Cost per pound of material $2

2004 150,000 37,500 1,700,000 $48 $12 $3

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Profit-Linked Profit-Linked Productivity Productivity Measurement Measurement PQ (labor) = 150,000/3 = 50,000 hrs. PQ (materials) = 150,000/0.100 = 1,500,000 lbs. Cost of labor: (50,000 x $12) Cost of materials: (1,500,000 x $3) Total PQ cost

$ 600,000 4,500,000 $5,100,000

The actual cost of inputs: Cost of labor: (37,500 x $12) Cost of materials: (1,700,000 x $3) Total current cost

$ 450,000 5,100,000 $5,550,000

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Profit-Linked Profit-Linked Productivity Productivity Measurement Measurement

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Profit-linked effect = Total PQ cost - Total current cost = $5,100,000 – $5,550,000 = $450,000 decrease in profits The net effect of the process change was unfavorable. Profits declined $450,000 because of productivity changes.

Price-Recovery Component

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The difference between the total profit change and the profit-linked productivity change is called the price-recovery component.

2004 Revenues Cost of inputs Profit

$7,200,000 5,550,000 $1,650,000

2003

Difference

$6,000,000 $ 1,200,000 2,840,000 2,710,000 $3,160,000 $-1,510,000

Price recovery = Profit change – Profit-linked productivity change = $1,510,000 – $450,000 = $1,060,000

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Chapter Eleven

The The End End

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