Lean Six Sigma teams must always be aware that quality comes at a cost. When talking about quality costs, many organizations consider what is known as the cost of poor quality, or CoPQ. The cost of poor quality is defined as the costs or expenses associated with defects created by a process. Quality has a broader cost – avoiding poor quality comes at an expense as well.
In some ways, the cost of poor quality is easier to measure than the cost associated with overall quality. CoPQ is usually broken into two major categories: costs associated with external failures and costs associated with internal failures. External and internal failures are often referred to as the costs of nonconformity – they are the expenses that occur when outputs do not conform to critical to quality requirements.
External failures usually occur after products or services have been delivered, which means they are directly associated with customer dissatisfaction. External failures might include revenue losses\ associated with a reduction in sales because of the quality of products, services, systems, or information. Other types of external losses include expenses associated with repairs, returns, or rework associated with a customer complaint; expenses associated with warranties; or loss of revenue or sales because of customer ill will or bad word-of-mouth.
Internal failures occur when products, services, or processes don’t conform to the requirements set by the company, and the product or service is provided to the customer in an unsatisfactory fashion. Internal failures are usually handled by scrapping the work, redoing the work, or repairing the work. Obviously, such rework results in added material and labour costs, but it also results in losses associated with delays, shortages of parts or inventory, and lack of flexibility or the ability to adapt.
For example, if a process has such poor quality that 50 percent of the items produced by it require rework, then the process might be producing 40 percent less on a daily basis than it could be. That means the process can serve fewer customers, generate less output, and contribute less overall to the company’s profit.
Calculating the Cost of Poor Quality
Understanding the cost of poor quality is critical to Lean Six Sigma organizations because it lets leaders understand how financial needs are related to the need for quality improvements. The higher the cost of poor quality, the more likely an organization will work toward improvement.
At a project or process level, the cost of poor quality might help determine budgets for improvement. If poor quality within the process is costing an organization RM5,000 a month, a project that costs RM20,000 but saves RM4,000 a month in quality would pay for itself in just five months. On the other end, a project that costs RM100,000 when the costs of poor quality are only RM1,000 a month is less likely to make sense.
The equation for CoPQ is:
CoPQ = External Failure Cost + Internal Failure Cost
While the equation seems simple, identifying all of the costs associated with poor quality can be difficult. Most experts use the metaphor of an iceberg to explain the hidden costs of poor quality. On the surface, you see the very small tip of the iceberg—the obvious costs of poor quality. These might be things such as scrap, reprocessing, warranty claims, customer returns, and extra shipping.
Beneath the surface, however, an iceberg is always much bigger. The same is usually true of the cost of poor quality, and hidden costs might include:
- Loss of customer loyalty
- Loss of morale
- Loss of employees if morale remains low for extended periods
- Conflicts associated with scheduling or rescheduling
- Higher risks of compliance issues, including fines
- Higher administrative costs
- Unpredictable revenue, sales, or production
Calculating the cost of poor quality is extremely difficult on an enterprise-wide level and still moderately difficult on a process level. A method for listing all possible costs and formulizing them to dollar amounts doesn’t exist. It’s a good idea for organizations to develop a streamlined method that is used throughout the enterprise when calculating CoPQ. At the very least, Lean Six Sigma experts in the organization might consider defining a specific way of listing costs of poor quality company-wide so that various process teams are using similar measures when they report to leadership.