Many businesses are feeling the pinch due to increased competitive forces and on-going pressures to reduce costs, while at the same time facing demands for improved flexibility, superior customer satisfaction and exceptional quality levels. These may seem like conflicting requirements, right? Wrong!
“Surely higher quality levels must result in increased costs and therefore a reduced bottom line profit…or is quality a silver bullet that will cure all issues and drive profits upwards?”
While quality improvements have proven to be beneficial to business results, it can unfortunately not be over simplified. It will therefore make sense to explore the connection between quality and financial performance. Cost of quality or more aptly, cost of non-quality is that very link.
At this point two thoughts might cross your mind:
- Cost of non-quality applies only to production operations and is not applicable elsewhere in the
- Cost of non-quality is not an unfamiliar concept and any good manager will know how it is made up and that it is less than 1% of the total cost of sales – after all, very few managers will admit that quality is out of control in their business.
It is therefore important to set the record straight before we continue to explore the supposedly well–known concept called cost of non-quality. While it is normally easier to measure cost of non-quality in a production environment where things are more easily quantifiable, it can be measured in any part of the business and for any business process.
Furthermore, don’t fool yourself – your cost of non-quality could be in excess of 10 to 15 times of what you think it is unless your company is pushing world class quality limits. Often we find that the cost of non-quality accounts for between 15% and 20% of cost of sales…“No way!” will be a typical reaction at this point, but don’t stop reading now. As much as it may sound like a disaster to have a cost of non-quality equal to 20% of your cost of sales, it is clearly a huge opportunity to improve your company’s financial results.
World class companies can achieve a cost of non-quality as low as 2.5% of cost of sales, so even if you reduce from 20% to 10%, there is still a lot of possibility for further improvement. More importantly, reducing your cost of non-quality from 20% to 10% of cost of sales will push you profit up significantly without you having to increase sales or selling prices.
Now, before you get all excited about all the money you are going to save, you first need to understand what your non-quality is costing you and to understand that, you need to know what the cost of non-quality comprises of.
“Easy, cost of non-quality is the total of scrap, rework and warranty costs, but surely that cannot add up to 20% of the cost of sales?” That is exactly the point – those factors are only the tip of the cost of non-quality iceberg.
Below are a few of those costs of non-quality that we tend to overlook when reporting this indicator – that is, if you do report on it.
Cost of lost time due to duplication of work to correct errors
Whenever quality issues cause us to redo work to correct the errors, it impacts on available time to do other value adding profit generating work. The accountants call this opportunity cost. Unfortunately the time lost due to redoing work caused by poor quality is not restricted to only the people redoing the work – in many cases it can consume significant amounts of management time.
For example, managers may have to approve the expenditure for the rework, be involved in the problem solving process or in managing external stakeholder relations. In some cases the time required to correct errors can cause significant factory downtime or lead to temporary suspension of services.
Other examples include cases where incorrect or late documentation can cause incorrect customer order fulfilment or incorrect invoicing, causing customer frustration, delayed payment and ultimately lost business. Poor quality communication can result in misunderstandings, unnecessary conflict and incorrect execution of instructions.
Quality failures result in dissatisfied customers which impacts on cost of non-quality in a direct and indirect manner. Direct costs can be attributed to the time and costs incurred to deal with consumer affairs, complaint handling and product repairs or replacement.
Indirect costs include damaged reputation, reduced customer loyalty and even lost sales. Loss of reputation is however not only linked to external parties, as people in large corporates will well know – unpredictable profit and loss statements or even unpredictable forecasts can result in tremendous internal pressures from head office when actual results does not match the plan.
Other costs of doing things wrong
It is impossible to foresee all potential issues and resulting cost factors, but when considering measurement and reporting of the cost of non-quality, be sure to include all cost factors related to things going wrong or things not getting done right the first time.
The people side of cost of non-quality
In addition to those costs that we can quantify, admittedly some easier than others, there are those costs that are so difficult to measure due to its intangible nature that we are not even proposing that these be included in the analysis – unless you have reached world class levels.
Excluding these factors from the analysis does not mean that one should ignore their impact. Continuous exposure to unresolved issues or having to redo work caused by mistakes others have made can be hugely frustrating and will cause poor employee morale.
Closing thoughts and lessons learned
- Quality improvement and cost reduction are compatible, but it requires that we do not leave things to chance.
- Understanding your real cost of non-quality is key for identifying improvement opportunities that will impact directly on your bottom line profit.
- Measuring and reporting cost of non-quality will create awareness and provide justification for investing time and money in achieving the improvements.
- Real time measurement and monitoring through Visual Management techniques will make it easier to identify the issues and speed up solutions.
- Continuous improvement, driven by a common sense low cost approach will aid the fight against non-quality. Do however be careful not to get trapped into using increasingly complex tools to deal with this challenge.
- Successful organisations are constantly evolving. They change their products, services and processes and they change those things that contribute unfavourably to the cost of non-quality – this makes managing change a vital skill. When quality works, we take it for granted – it is only when it fails, that we truly realise its value.