Measures of Cost of Poor Quality can be divided into 4 distinct categories, each of which will be discussed in detail.
We calculate this metric not only to determine the overall sum of quality costs, but also to locate costs indirectly related to the initial problem cost.
Internal costs are the expenses incurred due to a failure to meet a customer requirement. Some examples of Internal Failure Costs are:
Other internal failure costs can be categorized as inefficient processes.
Costs corresponding to defects found after receipt by the customer are considered External Failure Costs.
These are the costs related to determining conformance to requirements. These tasks are critical to the success of most organizations, yet are considered overhead… we can't bill the customer for these expenses.
This category is actually not part of the calculation for COPQ. It is important, however, to be able to quantify these expenses so your organization begins to understand the importance of prevention. The really good news about prevention costs is that once the concept of prevention is embraced by management, we no longer have to measure it! Management will begin to focus on the improvement opportunities instead of the cost of prevention. Examples of Prevention Cost are as follows:
Learn more about COPQ in our article about the importance of cost of poor quality.
Since the language of top management is money, we can also calculate the Return on Investment, or ROI, as another summary measure of any improvement initiative. Management loves this metric, as it can detail the overall gain from the investment or the length of time until the break-even point (the moment your company has saved as much as it spent on the improvement).
Assume your company has an issue costing you $10,000 per month. In terms of annualized costs that's $120,000. Your team determines that your company needs to spend $5000 to completely eliminate this issue, including the time your team spent determining the solution. The result is an annualized ROI of 24 (120,000/ 5000 =24, your company is saving 24 times what it spent on the improvement) … management should be giving you a bonus!
But what if management wants to know how soon a new machine will pay for itself? We can also calculate this version of ROI as well. Here's an example (sorry for all the math).
You've been charged with finding a way to get more products out the door. You have an old clunky machine used in the creation of your product. It produces a unit every minute. You locate a sparkling new machine that does the same task, but it's much faster… only 15 seconds are taken to create the same product. What is the ROI from a time standpoint?
Let's make some assumptions for the sake of calculating this ROI. Assume that your total labor cost is $30 per hour (including benefits, etc.). So, you're spending $240 per day on labor for this machine.
The new machine costs $100,000. And it takes ¼ of the time that the old clunker takes. The new machine can do in 1 day what it takes the clunker 4 days to accomplish, or you'll spend $960 in labor costs to accomplish what the new machine can do in a day ($240) for a daily savings of $960- $240= $720.
Now, divide the daily savings into the cost of the sparkling new machine to determine how many working days until payoff. This calculation ($100,000/ $720) tells us that after 138.8 working days your organization has saved enough to pay for this machine. But, to clarify for management, try to state this ROI in terms of months or years. In this case, assume there are 22 working days in an average month and divide 138.8/ 22, which equals 6.31 months.
Remember, management thinks in terms of money… so if you can show them the money in terms of pain and payoff, and the numbers make sense, you're well on your way to becoming a hero within your organization.