Appendix 02B – Lecture Notes
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I. Appendix 2B: cost of quality (Slide #1 is the title slide)
Learning Objective 9: Identify the four types of quality costs
and explain how they interact.
A. Quality costs − Costs incurred to prevent defects or that
result from defects in products. Many companies are working
hard to reduce their quality costs. Those companies that are
succeeding have a high quality of conformance in the sense
that the overwhelming majority of the products that they
produce conform to design specifications and are free from
defects.
B. There are four broad categories of quality costs:
i. Prevention costs − Are incurred to support
activities whose purpose is to reduce the number of
defects.
Helpful Hint: Suppose an ice cream company has been
having problems with unpleasant gritty ice crystals in its ice
cream. Ask students how they would prevent the ice crystal
defect. One approach would be to investigate the
manufacturing process. Perhaps the gritty ice crystals are
caused by temperature variations in the freezer. Controlled
experiments could be run varying the temperature and
inspecting for ice crystals. If this is the cause, the variation
in temperature could be decreased or the ingredients
changed so they would be less sensitive to temperature
changes.
ii. Appraisal costs − Are incurred to identify
defective products before the products are shipped
to customers.
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Helpful Hint: Continuing the ice cream example, ask students
how they would “inspect out” the ice crystal problem. This
may be more difficult and expensive than it first appears. For
example, the problem could occur only in half-gallon
containers or at random in a small (but important) number of
containers. Or, the ice crystals could only be detected by
tasting ice cream near the bottom of the container.
“Inspecting out” the problem would make a lot of ice cream
unsaleable.
iii. Internal failure costs − Are incurred as a result of
identifying defects before they are shipped to
customers.
iv. External failure costs − Are incurred as a result of
defective products being delivered to customers.
Helpful Hint: Continuing with the ice cream example, ask
students to identify examples of internal and external failure
costs. Internal failure costs could result from throwing away
defective ice cream. External failure costs could result from
customers returning defective ice cream or failing to
purchase the ice cream company’s product at a later date.
v. Examples of each type of quality cost include:
1. Prevention − Quality training, quality circles,
statistical process control activities, etc.
2. Appraisal − Testing and inspection of incoming
materials, final product testing, depreciation of
testing equipment, etc.
3. Internal failure − Scrap, spoilage, rework, etc.
4. External failure − Cost of field servicing and
handling customer complaints, warranty repairs,
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lost sales arising from reputation of poor quality,
etc.
vi. Distribution of quality costs − Graphs are often
used to depict the relationship between the four
types of quality costs. The graph illustrates four
key concepts.
1. When the quality of conformance is low, total
quality cost is high and most of this cost consists
of internal and external failure costs.
2. Total quality costs drop rapidly as the quality of
conformance increases.
3. Companies reduce their total quality costs by
focusing their efforts on prevention and
appraisal because the cost savings from reduced
defects usually overwhelm the costs of additional
prevention and appraisal.
Helpful Hint: Continuing with the ice cream example, the
prevention activities mentioned earlier may reveal that, if
fluctuating temperatures is the problem, a simple thermostat
may solve the problem. The cost to identify the problem and
install a thermostat is much less that the costs of scrapped ice
cream, customer returns and complaints, and lost future
business.
4. Total quality costs are minimized when the
quality of conformance is less than 100%. This is
a debatable point in the sense that some experts
believe that total quality costs are not minimized
until the quality of conformance is 100%.
Learning Objective 10: Prepare and interpret a quality cost
report.
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C. Quality cost report − This report details the prevention,
appraisal, internal failure, and external failure costs that arise
from a company’s current quality control efforts.
i. When interpreting a cost of quality report managers
should look for two trends. First, increases in
prevention and appraisal costs should be more than
offset by decreases in internal and external failure
costs. Second, the total quality costs as a percent of
sales should decrease.
ii. Quality cost reports can also be prepared in graphic
form. Managers should still look for the same two
trends whether the data are presented in a graphic
or table format.
iii. Uses of quality cost information:
1. It helps managers see the financial significance of
defects.
2. It helps managers identify the relative importance
of the quality problems faced by the company.
3. It helps managers see whether their quality costs
are poorly distributed. In general, costs should be
distributed more toward prevention and to a lesser
extent appraisal than toward failures.
iv. Limitations of quality cost information
1. Simply measuring and reporting quality cost
problems does not solve quality problems.
2. Results usually lag behind quality improvement
programs. Initially, prevention and appraisal cost
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increases may not be offset by decreases in failure
costs.
3. The most important quality cost, lost sales arising
from customer ill-will, is often omitted from
quality cost reports because it is difficult to
estimate.
II. International aspects of quality
A. The International Organization for Standardization, based in
Geneva Switzerland, has established quality control
guidelines, known as the ISO 9000 standards. For a
company to become ISO 9000 certified by a certifying
agency, it must demonstrate that:
i. A quality control system is in use, and the system
clearly defines an expected level of quality.
ii. The system is fully operational and is backed up
with detailed documentation of quality control
procedures.
iii. The intended level of quality is being achieved on a
sustained basis.
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