LNS Research discusses the cost of quality formula and its relationship with Enterprise Quality Management Software (EQMS) adoption
In Part 1 of this series introducing an upcoming project by LNS Research on Enterprise Quality Management Software, we discussed the Strategic Objectives many companies are pursuing on their journey towards continuous improvement. In this post, the second of five, we will examine the metrics companies are using to measure the success of strategic initiatives around quality management.
Start with Cost of Quality Metric
A great starting point for many organizations is measuring Cost of Quality. It always surprises me how many companies don't measure this metric or if they do they measure it in a partial or ad hoc way. One of our main goals with this upcoming research is to help companies:
- Better define the Cost of Quality Formula
- Measure the Cost of Quality Metric in a more consistent and standardized way
- Use Cost of Quality Model as a tool for benchmarking and improving performance
Defining the Cost of Quality
Defining Cost of Quality isn't always easy, but hopefully we can change that and make it a little easier after reading this post. A great starting point is ASQ, we at LNS Research very much like their definition and believe it should be promoted as a good industry standard. Essentially, Cost of Quality is broken down into 2 main buckets, each with 2 sub-categories.
First there is the Cost of Good Quality, which is broken down into Prevention and Appraisal Costs.
The best way to think about the Cost of Good Quality is that these are the costs incurred by your company to ensure that you are delivering a quality product to market. These are the costs associated with delivering the right blend of people, processes, and technology involved in quality management.
Second there is the Cost of Poor Quality, which is broken down into Internal and External Failure costs.
The best way to think about the Cost of Poor Quality is that these are the traditional quality issues that can erode the profitability and brand equity of any company. It includes costs like scrap, defects, charge backs, warranty, recalls and more. It is also important to note that there is a well documented relationship between internal and external failure costs; in that the further along the value chain a particular quality issue is allowed to persist without being resolved (i.e. move from an internal to external failure cost), the more total cost of the issue increases exponentially. It are these External Failure costs, that many in the industry liken to an iceberg. The true size of the cost is much more than we can see in our traditional accounting system.
Measuring Cost of Quality
As a general statement Quality departments are generally very effective at measuring things; particularly at measuring internal failure costs so that piece of the puzzle usually isn't an issue. Where the challenge does arise is in measuring either External Failure costs or the Cost of Good Quality.
Measuring External Failures is a challenge because often there is a large lag in the occurrence of the costs. An end customer may not be impacted for months or even years after the product is manufactured and the costs have been "traditionally" accounted for. Second, there is a communication issue. Often companies do not have good avenues of communication with trading partners on quality issues, so a company may know what quality issues they have been charged back for but have very little insight in to the root cause of these issues.
On the Cost of Good Quality side, this is often just "not measured holistically" by companies. The people, processes, and technology that encompass all quality operations in a company are looked at as a fixed cost and not analyzed in the context of this metric. There can also be a perceived conflict of interest between quality leadership and measuring the Cost of Good Quality. Sometime it is improperly assumed that if a company starts measuring the Cost of Good Quality that the likely out come will be to just reduce the total Cost of Quality by reducing the number of full time employees.
In actuality, this is very rarely the case. As we will see in the next section, it is better thought of as a trade-off or optimization problem that balances the Costs of Good and Poor Quality to achieve a minimum Total Cost of Quality.
Benchmarking with the Cost of Quality
It is very difficult to find good benchmark data on the Cost of Quality, which is one of the main reasons we are choosing this as one of our first research projects. For those that are already attempting to benchmark the Cost of Quality, perhaps with an organization like APQC, it is important to not just benchmark the Total Cost of Quality but instead look at all 4 buckets. For benchmarking purposes, we have also found that it works best to benchmark each of these buckets as a % of revenue rather than as a raw $ cost figure.
Finally, when it comes to using benchmarking to make better decisions. Pay attention to the trade offs between good and poor quality. In our experience, it is often the case that spending or "investing" more in the Cost of Good Quality more than makes up for itself in reductions the Cost of Poor Quality. A great example of this would be the benefits of investing in Enterprise Quality Management Software, which largely has a compelling ROI for most users.
For this reason we buck the trend in traditional metaphors used around Cost of Quality. Many people like to think of the Cost of Good Quality as a tax or insurance premium to hedge against future quality defects. We like to think of it as an investment with a positive ROI in the form of reduced poor quality costs.
In terms of metrics and initiatives around Enterprise Quality Management Software, the best place for most companies to start is around the Cost of Quality. This will let companies understand where their strengths and weaknesses are regarding quality. Then, with this level setting base line complete, companies can start looking at other areas of Strategic Objectives and other metrics where quality plays a role, like: Engineering, Manufacturing, and Supply Chain metrics.
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