What is Cost of Quality? (COQ)

What is the Cost of Quality? (COQ)

The cost of quality refers to the total amount of resources, time, and money expended by an organization in order to produce a product or service that meets the requirements and expectations of its customers.

The two words cost and quality has a very close relationship. Naturally, the cost of production of a basic e-book reader is different from the cost of production of a tablet PC. As a rule of thumb, the better the quality you expect from a product, the greater will be the cost of its production.

This is because, in order to produce better quality products, an organization needs to ensure quality in every field including manpower, machines, materials, etc. is very important. All the cost elements affecting the total cost for controlling and sustaining the quality are summed up as ‘cost of quality’ or ‘quality cost’.

In simple words, when the cost is incurred to maintain the desired quality standard and meet customers’ requirements, it is called quality cost or costs of quality. For example, the cost of quality for a car manufacturer would be the amount incurred for the design, look, performance, fuel consumption, mileage, engine, etc. of the car. Naturally, a car requiring frequent repair cannot satisfy the user’s expectations in terms of quality.

In the mathematical language, the cost of quality can be written as:

Quality Costs = (Actual cost of providing products or services – Cost of value-added activities).

TQM aims to produce the product keeping in mind the quality standard set by the organization. It focuses on various dimensions of quality like attributes, performance, price, services, etc. to meet customers’ expectations.

As a result, the costs and efforts are counted from the initial level of production. This eventually means that cost also is measured as much as quality is at the production level. Costs are incurred keeping in mind the standard of quality as well.

Consequently, the required measures are applied while testing the product performance along with the cost measure. The costs associated with developing quality output can be categorized into two parts, which are costly due to poor quality and the cost incurred to develop quality.

This comparison effectively results in maintaining the maximum quality of a product at an optimum cost. The concept of quality cost is not merely confined to factory operations but also expanded to support functions and customers’ expectations.

Analyzing and understanding the significance of quality costs in production enables an organization in developing quality conformance in a competitive business environment.

A number of quality cost programs are adopted by organizations to determine the magnitude of quality costs and their potential impact on the business. In addition, the practice of a quality cost program also guides the organization on how to control and minimize costs involved in waste, scrap, and rework. This program helps to identify the requirement of quality costs in current business practices.

Effective Steps of Quality Cost Program

  • Establishing a quality cost measurement system

  • Building a result-oriented long-range trend analysis

  • Setting annual development goals for total quality costs

  • Developing short-range trend analysis that aligns quality goals with organizational goals

  • Comparing the progress with the goals and taking corrective actions for better quality

Measuring Cost of Quality

There are four types of costs that help in measuring the cost of quality. These four types of costs are preventive costs, appraisal costs, internal failure costs, and external failure costs. Let us discuss these costs as follows

Prevention Costs

One of the central objectives of quality is to prevent product defects. Prevention costs are incurred to eradicate these defects. In other words, prevention cost is essentially planned to support activities that are meant to mitigate the occurrence of defects. Considering prevention costs, today’s companies apply a number of cost management techniques to safeguard products from defects.

The technique called Statistical Process Control (SPC) is used to check whether a process is in or out of quality track. Diagrams and charts are used in these techniques to represent the stages of the work process. This help in identifying the factors that cause the defects in the products. In addition, Quality Circles, where a small number of workplace team discusses on regular basis about quality improvement.

Appraisal Costs

These costs are incurred to identify the defects in products in the production process. These types of costs are also known as inspection costs. A manufacturer should essentially assess the actual usefulness of a product before delivering the same to the customers.

Activities, such as testing tools and equipment, auditing quality systems, and complying with legal requirements should also be conducted.

Internal Failure Costs

These types of costs are incurred in order to identify the various causes of defects in the rejected products. Naturally, as you can see the greater the companies indulge in internal appraisal activities; the higher the chance of catching the defects before the products are shipped.

The internal failure costs include costs incurred for scraps, re-examination, testing, re-welding, re-working of defective products, fault investigation, troubleshooting, wastage of labor and energy, etc.

For example, suppose a company has manufactured 100 mobile phones, and out of these 65 were found to be defective and rejected. In order to investigate the causes of these issues, some additional costs, such as reworking, testing, time, and effort are incurred. These all costs constitute internal failure costs.

External Failure Costs

These types of costs are incurred when a defective product is delivered to a customer and requires repairs, replacement, and warranty coverage. Such costs are incurred in almost all types of products.

While considering external failure costs, customers’ complaints are taken as feedback that helps an organization resolve the defects or replace the product. Organizations should take into account the Service Level Agreement (SLA) to fulfill their commitment to customers against such external failures.

Use of Quality Cost Information

A quality product or service is one that is designed to meet customer expectations.

Here the factors determining qualities can be

  • Specifications of the design of the product
  • Product specifications meet the needs of the customers.

The Broad categories of quality costs include

  • Prevention costs
  • Appraisal costs
  • Internal failure costs
  • External failure costs

Uses of quality cost information

  • Alerting executives to the potential impact
  • Motivating action to improve quality
  • Helping to determine types of activities to reduce quality costs
  • Prioritizing quality improvement efforts

What is Activity-based Costing?

Activity-based costing (ABC) is a costing method that identifies all the activities that an organization performs and assigns costs to those activities based on the resources they consume. It is a way to allocate costs more accurately and precisely than traditional costing methods, which may allocate costs based on broad categories such as labor, materials, and overhead.

Managing the quality of inventory and keeping inventory management costs low are some of the important priorities of organizations. Activity-Based Costing (ABC) is an important technique of inventory control and can be applied to almost all aspects of inventory management, such as purchasing, receiving, inspecting, storing, retrieving from stores, value analysis, etc.

ABC is based on the assumption that an organization should not exercise the same degree of control on all items of inventory. In other words, more rigorous control should be applied for the items that are costly while less control should be applied for the items that are less expensive.

On the basis of costs, this technique categorizes various inventory items into three classes, such as A, B, and C. The items included in group A require a large amount of investment. Therefore, inventory control should be made stringent by adopting advanced techniques.

Group C consists of a large number of items of inventory, which involve comparatively small investments. The items of group C require a minimum level of control. The investment incurred in items of group B is moderate, thus, it deserves less attention than A but more attention than C.

It uses the Pareto principle of 80–20, where approximately 80% of the store sales or profits are derived from 20% of the products. The measurement criteria can vary from the gross margin, sales value, and sales in units to GMROI.

It should be noted that a small number of highest-selling or high-value yielding products are put into the A category. The medium-selling or medium-value-yielding products are put into the B category. The remainder, low-selling or low-value yielding products are put into the C category.

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