Cost Reduction through Quality Improvement

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As a key factor of competitiveness, you must manage cost all the time, not only in times of economic downturn. Reducing the Cost Of Quality (COQ) program helps achieve this.

This training fits well into any improvement initiative, including TQM and Lean management. The COQ methodology instills a practical approach to quantifying the financial impact of the Cost Of Non-Conformance (CONC) and the Cost Of Conformance (COC). By teaching this presentation, you can improve the company culture and improve the bottom line. This presentation changes employees problem solving focus from quick fix solutions to preventing issues before they occur. This course teaches the skills to prioritize quality improvement opportunities based on the expected financial return.

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Cost Reduction through Quality Improvement

  1. 1. © Operational Excellence Consulting. All rights reserved.ReducingThe Cost Of Quality
  2. 2. 3© Operational Excellence Consulting. All rights reserved.Learning ObjectivesBy the end of the program, you should be able to:• Understand the principles and basic concepts of COQ• Calculate COQ and conduct COQ assessments• Identify COQ cost drivers within your organization• Develop a COQ strategy• Use COQ to drive prevention in your organization• Apply COQ to manage improvement projects in yourcompany
  3. 3. 5© Operational Excellence Consulting. All rights reserved.Contents 2• Phase 2: Collecting COQ Data Matching accounts with CONC items Quality costing COQ Data source Example calculations of Failure cost,Appraisal cost and Prevention cost COQ scorecard and indices Process flow for COQ reporting Collecting and reporting COQ data Role of Finance Role of line managers/supervisors Practical guidelines• Phase 3: Analyzing COQ Data Selecting quality cost bases Trends analysis Pareto analysis Variance analysis SMART criteria Set targets for improvement Case study• Phase 4: Reducing COQ & ImprovingQuality Reduce COQ through qualityimprovement programs Tools and techniques System for quality is prevention Some results from industries Sustaining COQ
  4. 4. 7© Operational Excellence Consulting. All rights reserved.Business Case for Quality Improvement& Cost Management• Quality & Cost – key competitive factors• Sustained cost advantages result fromconcentration on quality• Cost management/reduction is a continuousprocess• Inspection is a poor substitute for quality• High cost of poor quality
  5. 5. 9© Operational Excellence Consulting. All rights reserved.Philip Crosby: Law of 10Minimal defects due to prevention-based activitiesDefects found within the companyand corrected internallyCustomer finds defects and makescomplaints110100
  6. 6. 11© Operational Excellence Consulting. All rights reserved.Impact of COQ – How a CompanyApproaches ItWhere we’re headed if nothing changes• To meet PBT objectives, revenues haveto increase more than 85% in 2 yearsWhere we’re headed if we focus onAvoidable Costs• PBT objectives are met with a modestincrease in Revenues0 1 2 0 1 2Year Year
  7. 7. 13© Operational Excellence Consulting. All rights reserved.Link Between Quality Costing & ProfitsTrack quality coststo gain topmanagement’sattentionLook at highquality cost areaIdentify problemAnalyze rootcauseTake correctiveaction &InstitutionalizechangeProfit & LossStatementTotal Cost ofQualityCost of Non-ConformanceCost ofConformancePrevention-basedactivitiesUltimate impactof COQ is here!
  8. 8. 15© Operational Excellence Consulting. All rights reserved.Why Measure COQ?• Gain senior management commitment - $$$• A scorecard with a common unit ofmeasurement ($, or as % of sales)• Find areas for improvement• Allocate resources for quality improvement• Help set and monitor departmental qualityimprovement targets• Determine effectiveness of the quality plan
  9. 9. 17© Operational Excellence Consulting. All rights reserved.Cost of Non-Conformance (CONC)• The costs incurred as a result of not doingthings right the first time• Examples Mistakes Scrap Rework Equipment Downtime Handling customer complaints Warranty claims Customer return analysis
  10. 10. 19© Operational Excellence Consulting. All rights reserved.Quality engineeringand administrationInspection/test (materials,equipment, labor)ExpeditingScrapReworkRejects WarrantyclaimsMaintenance and serviceCost to customerExcess inventoryAdditionallabor hoursLonger cycle timesQuality auditsVendor controlLost customer loyaltyImprovement program costsProcess controlOpportunity cost if salesgreater than plantcapacityWe See Only the Tip of the IcebergPoor quality costs a typical company15-20% of sales annuallyLessVisibleVisible
  11. 11. 21© Operational Excellence Consulting. All rights reserved.COQ and Lean (Waste Elimination)WaitingOver-processingDefectsTransportationMotionOverproductionExcess InventoryWaste WasteReduce COQbyeliminatingwaste!Input(Man, Machines,Materials)TransformationProcess(Method)Output(Products,Services)
  12. 12. 23© Operational Excellence Consulting. All rights reserved.Philip Crosby on COQ• Companies can increase theirprofits by 5-10% of sales if aproper TQM system exists• Ideal benchmark = 2.5% ofsales
  13. 13. 25© Operational Excellence Consulting. All rights reserved.COQ Program Management• Define a problem statement• Define a program objective• Identify a COQ Program Manager (PM) or managerresponsible for team of PM’s• Provide sufficient authority to the COQ PM’s• Align incentive throughout the company with the COQobjectives• Develop a process to measure progress toward the COQobjectives• Measure and track progress• Recognize and reward the success of the COQ program
  14. 14. 27© Operational Excellence Consulting. All rights reserved.Four Phases of a COQ SystemCOQSystemIdentifyCOQItemsCollect &ReportCOQDataAnalyzeCOQDataReduceCOQ
  15. 15. 29© Operational Excellence Consulting. All rights reserved.PAF ModelCost of Quality (COQ)Cost of Conformance( COC )Cost of Non-Conformance( CONC )PreventionCostAppraisalCostInternalFailures CostExternalFailures Cost
  16. 16. 31© Operational Excellence Consulting. All rights reserved.Prevention Costs• The costs of any action taken to investigate,prevent the risk of non-conformity or defect• Examples: Quality planning Quality training Writing of procedures and instructions Process capability studies Preventive maintenance Vendor assurance
  17. 17. 33© Operational Excellence Consulting. All rights reserved.Internal Failure Costs• The costs arising within an organization due tonon-conformities or defects• Examples: Scrap Rework Retest Re-inspection Redesign Downtime Overtime Corrective action
  18. 18. 35© Operational Excellence Consulting. All rights reserved.Seven Types of Waste1. Overproduction2. Excess Inventory3. Waiting4. Excessive Transportation5. Unnecessary Motion6. Over Processing7. Defects
  19. 19. 37© Operational Excellence Consulting. All rights reserved.Waste of Lean – Excess Inventory• Extra raw materials than are required• Work-in-progress• Finished goods• Large number of equipment due to low equipmentutilization• Material with out-dated shelf life• Massive rework campaigns when problems surface• Poor inventory management technique - FILO instead ofFIFO
  20. 20. 39© Operational Excellence Consulting. All rights reserved.Waste of Lean – ExcessiveTransportation• Double or triple handling• Moving in and out of storage areas or inbetween processes• Transporting parts, materials and files ordocuments around the plant or office• Poor process flows, layouts, and workplaceorganization (5S)• Multiple sites outside of walking distance
  21. 21. 41© Operational Excellence Consulting. All rights reserved.Waste of Lean – Over-Processing• Multiple formats for the same information• Redundant approvals (checkers checking oncheckers)• Lack of effective communication• Making extra copies and excessive reporting• Providing higher quality than is necessary
  22. 22. 43© Operational Excellence Consulting. All rights reserved.Activity 2 : Identify CONC ItemsInstructions for GroupExercise:Map a business process in yourcompany and identify as manyCONC items (internal/externalfailures) that you haveencountered.Time allowed:20 minutes
  23. 23. 45© Operational Excellence Consulting. All rights reserved.CONC Checklist 2Process CONC ItemsMarketing Sales order errorsOrder entry errorsOrder cancellationsCustomer complaintsProduct liabilityWarrantyExtended warrantyProduct recallSales concessions due to earlier mistakesTrips to customers to explain problemsTrips to customers to resolve problems
  24. 24. 47© Operational Excellence Consulting. All rights reserved.CONC Checklist 4Process CONC ItemsLogistics Late deliveryWrong packingReplacementsDelivery to wrong customerLoss due to handling and storagePurchasing Purchasing change ordersLoss due to late suppliesDowngradingObsolescenceExcess inventory
  25. 25. © Operational Excellence Consulting. All rights reserved.3. Collecting COQ Data
  26. 26. 51© Operational Excellence Consulting. All rights reserved.Matching Accounts with CONC Items 1Items in AccountsObsolescence writtenoffRentRaw materialFinished goodsWork-in-progressDiscounts allowedWater & electricityProduction overheadsWarranty claimsCONC Items• Obsolescence• Storage space• Defects• Spoilage• Warranty claimsProcess involvedProduction/LogisticsLogisticsProductionMarketing
  27. 27. 53© Operational Excellence Consulting. All rights reserved.Quality Costing• Whole account• Unit pricing• Labor/resource claiming• Whole person
  28. 28. 55© Operational Excellence Consulting. All rights reserved.Unit Pricing• This method is effective when a defect orproblem is recurring• To use defect pricing, simply calculate what onedefect costs and multiply it by the number oftimes it occurs
  29. 29. 57© Operational Excellence Consulting. All rights reserved.Labor / Resource Claiming• This method involves calculating actualexpenditure on a specific activity, such as theamount of time spent by an employee performinga task or the amount of financial outlay for a one-time expense• You can gather these information from timesheets, vouchers or any other method fordetermining exactly how much was spent
  30. 30. 59© Operational Excellence Consulting. All rights reserved.Example 1: Calculating a Failure Cost ItemCost of Re-invoicingWhole process of re-invoicing 45 minsStaff cost $10/hrNo. of re-invoices per annum 156 casesMan-hours expended in re-invoicing 156 x 45 mins = 7,020 mins or 117 hrsTotal staff cost in re-invoicing 117 hrs x $10 = $1,170 per annumPaper/invoice cost $0.28 per invoicePostage cost $0.20 per invoiceOverheads $0.48 x 156 cases = $75Total cost of re-invoicing $1,170 + $75 = $1,245Relativelysmall; OKto ignore
  31. 31. 61© Operational Excellence Consulting. All rights reserved.Example 3: Calculating a Prevention CostItemCost of Quality-related Education & TrainingTraining in quality (including programs such $25,842as Quality Management Course, SQAAssessorWorkshop, QC Facilitator’s Course, SPC, etc.)Training materials (including purchase of training $3,050packages and videos)Miscellaneous (including man-hours spent $10,112attending training, internal trainers fees andoverheads)Total $39,004
  32. 32. 63© Operational Excellence Consulting. All rights reserved.COQ Scorecard (CONC Items)External Failure Costs $’000Complaint investigation & adjustment 43Returns, replacements & allowances 610Warranty expenses (rentals & repairs) 24Liability & related legal 38Goodwill losses 200Total external failure costs (% of total) 915 (19%)Internal Failure CostsDisposition 105Scrap 290Rework 2,150Retest 120Yield losses 65Downtime 910Extra safety stock (carrying cost) 50Defect-generated overtime 340Total internal failure costs (% of total) 4,030 (81%)TOTAL QUALITY COSTS 4,945
  33. 33. 65© Operational Excellence Consulting. All rights reserved.COQ IndicesSales Revenue:TCOQ * 100%Sales RevenueManufacturingCosts:TCOQ * 100%Mfg. CostsValue Added:TCOQ * 100%Value AddedDirect LabourCosts:TCOQ * 100%Direct Labour CostsSales Revenue:CONC * 100%Sales RevenueSales Revenue:COC * 100%Sales Revenue
  34. 34. 67© Operational Excellence Consulting. All rights reserved.Collecting & Reporting COQ Data• Collect and report COQ data on a periodicbasis, e.g. monthly• Line managers/supervisors collect raw data andsubmit to Finance Department periodically• Accounts clerk inputs raw data into computerand churns out COQ report or scorecard
  35. 35. 69© Operational Excellence Consulting. All rights reserved.Role of Line Managers / Supervisors• Work with Finance Department to identify qualityrelated activities and COQ items that need to bemonitored• Collect data on COQ• Analyse COQ and take appropriate correctiveactions to tackle problem areas• Pursue a continuous policy of qualityimprovement and COQ reduction
  36. 36. 71© Operational Excellence Consulting. All rights reserved.Practical Guidelines 1Do’s Don’ts•Have a clear purpose and strategy •Go it alone - involve other departments•Report only costs endorsed by the Financedepartment•Expect that the existing accounting systemwill provide the information needed•Get data and costs from standard datawhenever possible•Be too ambitious – start with a pilot study•Start with CONC items •Expect too much during the initial phase ofimplementation•Collect those quality costs that are mostaccessible•Agonize over insignificant quality costs•Concentrate on costs that do or canchange with improvement•Concentrate only on what is already known
  37. 37. 73© Operational Excellence Consulting. All rights reserved.Practical Guidelines 3• Be prepared for COQ to rise initially as peopleget better at identifying them• Attribute costs according to where they occur• Monitor overall COQ periodically• COQ should be gathered more accurately andmonitored more frequently for those areastargeted for improvement
  38. 38. 75© Operational Excellence Consulting. All rights reserved.Selecting Quality Cost Bases• Quality Cost in absolute terms• Quality Cost in relation to some appropriate base COQ as a percentage of Sales COQ per Employee COQ per dollar of manufacturing cost COQ per unit and so on…
  39. 39. 77© Operational Excellence Consulting. All rights reserved.Trend Analysis
  40. 40. 79© Operational Excellence Consulting. All rights reserved.Trend Analysis of CONC Items00.20.40.60.81.01.21.41.6J F M A M J J A S OPositive trend inCONC reductionover time
  41. 41. 81© Operational Excellence Consulting. All rights reserved.Variance Analysis• Variance = Actual – Target Example: FY10 Target Scrap Cost = 5% of sales Feb 10 Scrap Cost = 8% of sales Variance = - 3% of sales• Unfavorable variance exists if: Actual exceeds target “+” = favorable variance “-” = unfavorable variance
  42. 42. 83© Operational Excellence Consulting. All rights reserved.Set Targets for Improvement 2Establish an overall improvement goal for COQ reduction(Example: “To reduce the Total COQ/Sales by 10% thisyear”)Set operational targets that will help the company achieveits overall goals(Example: “To reduce the cost of rework by 25% thisyear” or “To reduce warranty claims by 20% this year”)Take appropriate corrective action and monitor progressagainst the targets
  43. 43. 85© Operational Excellence Consulting. All rights reserved.Case study: H&S Motors• The H&S motor company produces small motors for use inlawnmowers and garden equipment. The company instituted aquality improvement program in 1999 and has recorded thefollowing quality cost data and accounting measures for 4 years.• The company wants to assess its quality assurance program anddevelop quality index using sales basis for the 4 year period.1999 2000 2001 2002Prevention 27000 28500 74600 112300Appraisal 155000 170300 113400 107000Internal Failure 386400 469200 347800 219100External Failure 242000 192000 103500 106000Total COQ 812399 862000 641301 546402Sales 4360000 4450000 5050000 5190000Case Study
  44. 44. 87© Operational Excellence Consulting. All rights reserved.H&S: Findings & Analysis• Approximately 75% of the H&S’ total quality costs are a result ofinternal and external failures.• In 2000 company spent more money on product monitoring andinspection that resulted into high appraisal cost. With thisstrategy, H&S was able to identify more defective items, resultingin an apparent increase in internal failure cost and lower externalfailure cost.• In year 2001 & 2002, company invested on prevention activitiesi.e. training of employees, redesigning the production processand planning how to build in product quality etc.• Although prevention costs increased by more than 300 % duringthe 4 year period, they resulted in a decrease in overall qualitycosts.Case Study
  45. 45. © Operational Excellence Consulting. All rights reserved.5. Reducing COQ &Improving Quality
  46. 46. 91© Operational Excellence Consulting. All rights reserved.Reduce COQ Through QualityImprovement Programs• Top management commitment• Quality infrastructure• Quality improvement cycle• Training and education• Quality-related cost awareness• Quality-related cost participation
  47. 47. 93© Operational Excellence Consulting. All rights reserved.Tools & Techniques for QualityImprovementProblem solvingtechniques:• PDCA• A3• 8D• Six Sigma (DMAIC)• etc.Seven QC Tools:• Stratification• Check Sheets• Graphs & Control Charts• Pareto Charts• Fishbone Diagrams• Histograms• Scatter Diagrams
  48. 48. 95© Operational Excellence Consulting. All rights reserved.PDCA Problem Solving StepsIdentify the ProblemUnderstand Present SituationIdentify Root CausePlan ImprovementImplement ImprovementConfirm ResultsStandardise ImprovementReview & Follow UpStep 1Step 2Step 3Step 4Step 5Step 6Step 7Step 8PLANDOACTIONCHECK
  49. 49. 97© Operational Excellence Consulting. All rights reserved.System for Quality is Prevention• Identify cause• Take corrective action• Standardize• Identify culprits• Catch culprits• Jail culprits
  50. 50. 99© Operational Excellence Consulting. All rights reserved.Some Results from Industries 2Electronics Industry:Company C:Field returns reduced by58% within 9 months.Employees taking medicalleave declined by 76% withina year.Company D:COQ as a % of salesreduced by 50% within 6months.Cost savings of $900,000from scrap reduction within6 months.
  51. 51. 101© Operational Excellence Consulting. All rights reserved.Sustaining COQ• Understand and meeting the needs of customers• COQ is primarily a cost reduction program and must be managed assuch• Senior management support across multiple functions is critical tothe success of COQ• Take a holistic approach for optimum results, e.g. TQM program• Focus on prevention, not quick fix• Rewards and recognition• Evaluate and improve COQ system• Total Quality is a journey

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