Business Management Articles
/ Quality Management


by Rene T. Domingo

The strategies in quality management can best be described using the four categories of quality cost: external failure, internal failure, inspection or appraisal, and prevention costs. Quality cost, or cost of poor quality, which can account for 20%-30% of sales, is the cost of not doing the right thing right the first time.

Types of quality cost

External failure costs are incurred by the producer when the defective or non-conforming product is shipped out of the factory and sold to the customer, who eventually discovers the defect. Examples of these are warranty returns and replacement, transportation costs to retrieve the product, legal fees if the customers sues the company, and lost sales---present and future---due to tarnished reputation and credibility. The latter, usually the biggest, are not reflected in the cost accounting records of the company.

Internal failure costs are incurred when the company disposes or handles non-conforming products before they are sold to the customer. Examples are scrap costs and rework costs, which can include overtime, downgrading costs and losses, and man/machine downtime due to the processing of defective or inferior materials and parts. Internal failures are usually unseen by the customers, unless they make surprise visits to the supplier’s factory. Eventually, internal failure costs are spread out over good products and push up their unit production costs. In the long run, internal failure costs affect customers when he is charged higher prices for the conforming products they buy.

Inspection costs or appraisal costs are incurred to check, test, confirm, and measure the conformance of the products to customer specifications. These include the cost of maintaining a quality control or quality assurance department; installing, calibrating, and using testing equipment; the cost of taking or destroying samples; receiving and inspecting incoming raw materials; and line stop or downtime to check the process or product, the higher costs, resources, and the number of people devoted to inspecting it.

Prevention costs are incurred to avoid the production of non-conforming products. These includes designing product for manufacturability; foolproofing of process and equipment; clear process documentation; employee training on quality and statistical skills; quality planning; preventive maintenance; meeting with customers; meeting with suppliers and subcontractors; and supplier development and training.

Gray areas

While these categories provide a useful framework for identifying and reducing quality costs, they are imperfect. Some gray areas of quality costs may be difficult to force fit into one category. For instance, when 100% inspection is done on a lot rejected by the customer to sort the good from bad items, is the cost incurred due to external failure, internal failure, or inspection? While incoming inspection, or QA, may be classified under inspection costs, some may put it under prevention costs, because it prevents defective raw materials from being processed to defective products.

Another gray area is insurance premiums the company pays to cover for contingencies like fire, delayed shipment, and bad weather. Are these preventive costs (to prevent losses) or internal failure costs (high premium for lack of fire and safety procedures) or do they really fall under quality costs at all? If gray areas of quality cost are to be categorized for computational and monitoring purposes, it is wise to have a discussion and common understanding among all parties concerned. The category agreed upon must be used consistently afterwards.

Stages of quality management

Table 1 shows how the four types of quality costs could illustrate three quality management stages or styles.

The first and most common is the “firefighting” stage in which the company receives a lot of customer complaints and product returns for three reasons: inspection is lax or inaccurate; process yield is low due to high internal rejects, rework, and scrap; these internal failures in turn come from minimal or no preventive measures. Companies in this stage are usually short-lived. They have high turnover of managers, employees, and even owners and customers. They have a “blaming” culture in which people are blamed for reporting problems. Problems are hidden and allowed to explode usually beyond correction.

The second stage, which is better than the first, is the “conventional” type of quality management. Customers are happy and satisfied with the product’s quality, but the company’s product costs are high due to internal failures and inspection costs. Eventually, it will pass these on as higher prices to customers, thus eroding price competitiveness and market share. Zero defects is achieved in the market place by employing thorough and multiple inspection.

The weakness of stage two, especially in the manufacturing industry, is that often there is no improvement in yield or virgin quality because no preventive measures are taken to prevent internal rejects. Its ultimate goal is the perfection of external quality through inspection and correction at all costs; little emphasis is given to prevention. Rework or recycling cost may be significant. Because sales and customer satisfaction are high, this conventional quality management style may lull the company into complacency. It is eventually overtaken by world-class competitors who practice Total Quality Management (TQM).

Conventional quality management can yield high quality products and services from the customer’s point of view. Many successful multinational corporations have grown and expanded using this approach.

The third and ideal stage is the “total quality” stage based on the principle of everybody “doing the right thing the first time.” Through extensive and continuous preventive and quality improvement processes and programs, the company achieves almost zero defects externally and internally, using zero incoming and outgoing inspection. Prevention leads to low internal failure. Low external failure is achieved even with minimum inspection, which is made possible by low internal rejects. The results of TQM are happy repeat customers, high market share, and high profits due to low production costs (internal failure). The low-cost TQM company can even profitably cut its price to increase market share. “Firefighting” and “Conventional” companies cannot afford to adopt this strategy.

The maintenance procedure of Japan Air Lines is somewhat reflective of this preventive quality approach. After a Jumbo jet crash in 1985, JAL instituted a policy which says that after overhauling or repairing a plane, its maintenance crew shall board the plane with the passengers, whatever its destination. Sure, the plane still undergoes the standard and rigid tests and inspection before take-off, but the maintenance employees would now focus more on prevention or “doing it right the first time” while they are still on the ground, or else… To further dramatize personal responsibility, the names of the maintenance crew are posted on the planes bulkhead for passengers to see upon boarding. Contrast the JAL case with Lufthansa’s quality philosophy, as implied in its ad: We have people who check the people who check the people who check your aircraft."

Quality strategy

Companies normally start at stage one in which both external and internal failures are high. To preserve image and keep customers, it is better in the short run to go to stage two right away rather than jump to stage three, which generally requires much more time to implement than stage two. This strategy means that it is better to spend on inspection and/or rework (internal failure) than to let defective products reach the customers. Image and sales lost due to external failure may be extremely hard to recover especially if customers switch to competitors. But high cost due to increased inspection and internal failures to prevent external failures can always be recovered later. Stage two, however, is a short-term high-cost strategy, and companies should not stay in this comfort zone too long where quality improvement does not really take place. Stage two merely prevents deterioration of market share through lots of rework, sorting, and 100% inspection.

When external failure is finally reduced, stage three should immediately follow to reduce internal failure and inspection costs by implementing preventive measures. As the saying goes, “An ounce of prevention is worth a pound of cure.” In quality management, prevention is not just worth 16 times that of correction; one electrical company discovered that $1 of prevention could prevent $100,000 of external failure.

New companies should design systems based on stage three or TQM right away, and avoid the costly stages one and two. Existing companies who are at stage one can jump to stage three if they are confident and fully committed to Total Quality. This approach assumes that they can hold on to their customers while preventive measures are instituted double time. Finally, existing companies at stage two should proceed to stage three immediately, lest their competitors do so.

Plan for quality. As saying goes “If you fail to plan, you plan to fail.”

Table 1 Stages of Quality Management
Stage or Style Prevention Internal failure Inspection
External failure
1. “Firefighting” LOW HIGH LOW HIGH
2. “Conventional” LOW HIGH HIGH LOW
3. “Total Quality” HIGH LOW LOW LOW


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