Sample Cost of Quality Calculations

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Research provided by APQC, the international resource for benchmarks and best practices

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2012 APQC. ALL RIGHTS RESERVED

Sample Cost of Quality Calculations

Example calculations to measure the value of a quality program

Organizations commonly ask how to calculate the cost of quality. The equation differs from

organization to organization, but nonetheless, APQC sought some answers and real-life

examples during its Using Enterprise Quality Measurement to Drive Business Value study.

The 2011 study focused on measuring quality throughout an organization, not only in

manufacturing or product development. Although organizations have been devising ways to

measure quality for decades, many have not elevated the measurement of quality to an

enterprise-wide concern, instead focusing exclusively on results or finished products. The

components of the cost of quality listed below reflect the mind-set of organizations branching

out and trying to measure quality enterprise-wide.

The study team conducted a survey which asked two questions specifically related to cost of

quality:

1. Does your organization use some form of cost of quality as one of its enterprise quality

measures?

2. If yes, provide a basic definition and/or calculation.

Data was collected from a survey of 21 organizations total16 manufacturing organizations and

five service providers with annual revenue ranging from $500 million to $50 billion. The

participant group included four organizations from the aerospace and defense industry.

In addition to the data collected via the survey questions, a breakout session conducted during

the close of the project provided an opportunity for all participants to discuss the cost of quality

measure in greater depth. During the discussion, it was apparent that the majority of

organizations felt that cost of quality is one of the most important measures an organization can

collect. It also became apparent that there is no standard definition of the measure itself, no

standard components that make up the measure, nor a common way to calculate the measure.

There is a tremendous need for a basic level of standardization and clarification, especially if

organizations want to compare their cost of quality measures with other organizations.

The general lack of understanding and clarity does not mean that organizations are not using

cost of quality as a core measure. Of the 21 organizations that provided data, 11 use some type

of cost of quality measure. All 11 are from the manufacturing sector. The service-oriented

organizations that provided data indicated that cost of quality is an important measure, but they

haven't defined a cost of quality measure and feel it is difficult to define for services.

Manufacturing has a stronger history of defining quality than services, so it is a challenge for

service organizations to tread this new territory. However, service organizations resoundingly

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agree that measuring the quality of services and the processes that enable those services is

critical to sustainable, repeatable success.

Six organizations provided their internal definition of cost of quality (see table below). As with

the discussion at the end-of-project meeting, the definitions show that there is no standard

methodology to calculating cost of quality.

Sample Cost of Quality Definitions

Organization A

Rework = Standard cost of rework USD / Total revenue USD

Scrap = Work-in-progress standard cost of scrap USD - Material scrap value (USD) / Total revenue USD

Customer Quality Related Returns = $ Value of Returns / Total revenue USD

Organization B

The routine reporting is largely the cost of nonconformance (internal loss), although we periodically create a high-level estimate of gap to perfect, which would include additional categories.

Organization C

Global quality budgets + global internal failure costs + global external customer complaints (*multiplying factor) + warranty cost

Organization D

Cost of nonconformance (CoNC) is the cost associated with addressing mistakes/failures made in our products. CoNC comprises eight elements of cost:

warranty expense (cost to repair fielded units under warranty),

service bulletins (cost to correct defects in fielded units, regardless of warranty),

defect rework (cost to fix defects found in the factory during production),

stock rework (cost to fix defects of product in finished goods stock),

assembly modifications (cost to modify assemblies in production to correct design issues; e.g., adding

jumper wires/circuit cuts),

scrap (cost of discarding material damaged during production),

engineering change orders (cost of correcting design documentation errors created earlier in the

design process), and

indirect material expense (cost to dispose of purchased material no longer needed due to design

changes or product demand). This is measured as a percentage of sales.

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Organization E

The four factors are operating expenses, opportunity lost, warranty cost (cross charge to buy), and how re-spend.

Organization F

Cost of returns and allowances divided by gross sales

Conclusion Organizations need to quantify their quality efforts. This is challenging, as exemplified by the

inconsistent definitions of quality and uncertainty surrounding the measurement of quality. But

developing a cost of quality measure you can trust is important to tracking progress and gaining

support for quality programs.

Cost of quality measures need not be perfect as long as the people examining the results of

those calculations understand the limits of a cost of quality measure. Intangibles exist that

cannot be measured, and the quality of services is difficult to define. But it is not impossible, and

it can benefit an organization to track levels of quality as best it can. The organization can always

update its cost of quality calculation as it discovers more factors that contribute to improved

quality and additional costs related to maintaining and improving quality levels. Consider the

examples from this study and evaluate these calculations against the needs and characteristics

of your own organization..

For more information, read

APQC's best practices report

Using Enterprise Quality

Measurement to Drive Business

Value.

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ABOUT APQC

APQC is a member-based nonprofit and one of the leading proponents of benchmarking and

best practice business research. Working with more than 500 organizations worldwide in all

industries, APQC focuses on providing organizations with the information they need to work

smarter, faster, and with confidence. Every day we uncover the processes and practices that

push organizations from good to great. Visit us at www.apqc.org and learn how you can make

best practices your practices.

Sample Cost of Quality Calculations

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