Cost of Quality

More than any other subject of interest to business people the world over in the past decade; Quality has become a focal point of activity. But unfortunately, the most reliable and accurate measure of that "elusive" attribute, namely, the Cost of Quality, is still unclear in a lot of people's mind. Undoubtedly, you might have heard a lot of different definitions of what Cost of Quality is, what is included in it and what is excluded from it, how you go about calculating it, etc.

Well, a relatively new accounting concept can perhaps shed some light on this issue, and give us a more "concrete" way of understanding and calculating the Cost of Quality. That concept is called Activity Based Costing. As defined by Crosby ("Quality Is Free"), Cost of Quality (COQ) has two main components: Cost of Conformance and Cost of Non-Conformance.

To get to that topic however, we need to define quality first. Obviously, a product or a service that does not meet the agreed upon requirements of the customer cannot be said to have quality. Therefore, a fundamental definition of quality is "conformance to requirements".

Secondly, the system to achieve quality cannot rely on the old classic approach of appraisal. The difficulties with this are many:

• It is after the fact: the damage has already been done.
• It is very costly to spend our resources discovering errors, correcting them, or discarding the items and redoing it all over again.
• There is absolutely no guarantee that we will catch all the errors.

Cost of Quality is the amount of money a business loses because its product or service was not done right in the first place. From fixing a warped piece on the assembly line to having to deal with a lawsuit because of a malfunctioning machine or a badly performed service, businesses lose money every day due to poor quality. For most businesses, this can run from 15 to 30 percent of their total costs.

Let’s see why is Cost of Quality important: Quality processes cannot be justified simply because "everyone else is doing them" - but return on quality (ROQ) has dramatic impacts as companies mature. Research shows that the costs of poor quality can range from 15%-40% of business costs (e.g., rework, returns or complaints, reduced service levels, lost revenue). Most businesses do not know what their quality costs are because they do not keep reliable statistics. Finding and correcting mistakes consumes inordinately large portion resources. Typically, the cost to eliminate a failure in the customer phase is five times greater than it is at the development or manufacturing phase. Effective quality management decreases production costs because the sooner an error is found and corrected, the less costly it will be. 

Finally, how to use Cost of Quality:

1. Gather some basic information about the number of failures in the system,

2. Apply some basic assumptions to that data in order to quantify the data,

3. Chart the data based on the four elements listed above and study it,

4. Allocate resources to combat the weak-spots,

5. Do this study on a regular basis and evaluate your performance