MEASUREMENT OF QUALITY COSTS (THE RESULTS OF QUALITY MANAGEMENT)
In relation to TQM it is well-known that the level of quality will be improved by investing in the so-called quality management costs. The group management asked Milliken Denmark’s top management to find out how high the quality costs were. The group management wanted to establish a simple quality cost system without arbitrary cost allocations.
Failure costs are normally divided into the following two groups:
1. Internal failure costs. These are costs which accrue when defects and problems are discovered inside the company. These costs are typically costs of repairing defects.
2. External failure costs. These are costs which accrue when the defect is first discovered and experienced outside the firm. The customer discovers the defect and this leads to costs of claims and as a rule, also a loss of goodwill corresponding to the lost future profits of lost customers.
Investing in preventive costs has the following effects:
1. Defects and failure costs go down.
2. Customer satisfaction goes up.
3. The need for inspection and inspection costs go down.
4. Productivity goes up.
5. Competitiveness and market shares increase.
6. Profits go up.
HOW IT STARTED: The definition of the costs on these four accounts was the following:
1. Discounts. This is an internal failure cost element. A failure has been built into the product but it is found before shipment to the customer. The customer is offered a discount in order to accept the failure.
2. Allowances. This is an external failure cost element. A failure has been built into the product and the customer finds the failure. An allowance is negotiated. If the customer does not accept the shipment the allowance is equal to the amount of invoice.
3. Returns. This is an external failure cost element. If a customer does not accept a shipment because of a failure caused by Milliken the customer may decide to send the shipment back. Returns are the freight of returned shipments.
4. Reworks. The cost to repair a product may be either internal costs or external costs depending on who finds the failure.
THE QUALITY COST THERMOMETER: The advantage of using index figures and not actual figures is that index figures are free of the distortions due to periodic changes in production volume.
THE OPPORTUNITY COST CONCEPT (THE NEW THERMOMETER):
The following eight quality cost accounts have been used since 1993:
1. Quality discounts (internal failure cost) or price reductions when selling second quality.
2. Re works/replacements (internal failure cost).
3. Final inspection cost (internal failure cost).
The costs include variable costs (wage cost, material cost etc.) and contributions to fixed production cost and depreciations.
4. Down-time cost (internal failure cost).
The causes for down-time cost are mechanical breakdown of machines, lack of raw materials, preventive maintenance, planned machine stop because of holidays etc.
The costs are calculated on a ‘full cost basis’, i.e. they include wages, depreciations and other costs calculated by using the machine time lost in the bottleneck process.
5. Returns and allowances (external failure cost).
a. Returns are calculated as full costs including freight.
b. Allowances—return pay to customers because of complaints.
6. Quality adjusters (external failure cost).