National University – Laguna

Strategic Cost Management

A Comprehensive Guide in Understanding Cost of Quality

Written Report

BSA-221B
Catamio, Nicolette
Cataring, Kelsey Anne
Lomibao, Rizbelle
Prado, Jeidine Loise
 I. ABSTRACT:

This paper analyzes the complex dynamics of the Cost of Quality (COQ) in organizations
and looks at how it affects overall financial success, customer satisfaction, and operational
efficiency. In order to provide a thorough understanding of the actual expenditures associated
with sustaining and improving the quality of goods and services, the study uses a comprehensive
methodology that takes into account both tangible and intangible dimensions of quality.
The paper starts out by developing a conceptual framework for the Cost of Quality and
classifying the costs into internal failure, external failure, prevention, and appraisal. he research
examines market standards and best practices through a thorough review of the literature and
researches, providing insight into effective tactics for reducing costs without sacrificing quality.
The report also looks into the sometimes-disregarded qualitative consequences of low
quality, like late delivery penalties, a decline in customer trust such as complaints. By adding these
components to the COQ analysis, companies can obtain a comprehensive understanding of the
actual investment needed to meet and maintain high standards.
Within the paper, the roles and benefits of COQ will also be discussed, by deliberating
about Potential Challenges and Barriers of CoQ; Actions or Strategies to overcome the challenges
and barriers that come with CoQ.
The conclusion of this analysis emphasizes how crucial it is to comprehend and control
the cost of quality since it is a necessary element of successful organizational operations. In
today's competitive world, organizations may maximize their resources, improve customer
satisfaction, and provide a strong basis for long-term growth by implementing an anticipatory and
strategic approach to quality management.
 II. INTRODUCTION:

The phrase "cost of quality" (COQ) refers to the total amount of money a company must
invest in order to achieve and maintain a particular standard of product or service quality.
Investing in high-quality materials comes with a corresponding price tag, but it also covers the
associated costs for identifying, avoiding, and correcting faults or defects.
There are two components under CoQ, mainly; Cost of Good Quality and Cost of Poor
quality. This underlies, Prevention Cost; Appraisal Cost; Internal Failure; and External Failure.
Organizations can obtain significant insights into their operational performance by
computing and evaluating COQ. They are able to pinpoint high failure cost, rank areas for
improvement, and monitor the success of quality-related projects.

III. DISCUSSION:

Components of Cost of Quality (CoQ)

Conceptual Framework:
Cost of Good Quality

The Cost of Good Quality (COGQ) is one of the components of the Cost of Quality (COQ)
that refers to a company's total cost of ensuring that its products or services meet the
appropriate quality standards. It is classified into two types: appraisal and prevention costs.

1.1. Prevention Cost

Prevention costs are activities that are planned and design prior to operations in
order to provide high-quality outcomes to customers while minimizing the number of
defects or poor-quality products or services, as well as the demand for rework, repairs,
and other corrective actions. These costs are associated with:
o Training program: Providing employees with proper training programs before they
begin work can help them improve their abilities, knowledge, and awareness of
quality standards and processes.
o Quality Planning: It is a plan in which the company outlines all of its product or
service goals and standards, as well as understanding its consumers' wants and
needs, in order to offer high-quality products and meet their expectations.
o New product design and testing: This is a proactive approach that allows the
organization to examine the product concept and address potential issues,
allowing them to produce solutions quickly and have a better outcome for the
product or service.
1.2. Appraisal Cost
This measures and monitors quality-related during operations to ensure
compliance with quality requirements of a product or service. Examples include:
o Inspection: Performing inspections at all stages during operations to detect and
correct errors before the product proceeds further.
o Testing: Conducting tests to ensure that items fulfill performance and quality
standards.
o Quality Audits: Systematic audits of the company's activities and processes to
ensure they meet specified standards and requirements.
 o Calibration of Equipment: The process of measuring and testing equipment
results in order to assure their accuracy and reliability.

2. Cost of Poor Quality

A key concept in strategic cost management is the Cost of Poor Quality (COPQ),
which is the expense associated with creating or providing substandard goods or services.
It includes all of the costs related to mistakes, flaws, and failure to meet quality
requirements. Gaining an understanding of and regulating COPQ is crucial for increasing
operational effectiveness, boosting profitability, and fostering client satisfaction.

2.1. Internal Failure

A particular kind of cost of poor quality (COPQ) that an organization incurs when
its operations, goods, or services fall short of expectations and need to be reworked,
repaired, or replaced before being delivered to the customer is known as internal failure
costs. These expenses are internal in nature; no outside parties, such as suppliers or
customers, are involved. Examples of internal failures are as follows;
o Scrap: items or materials with defects that are unable to be sold or used,
wasting money and requiring the purchase of new materials.
o Rework: mending mistakes or flaws in processes or products that call for more
work, resources, and overhead.
o Inspection and Testing: expenses related to tasks like audits and quality control
inspections to find flaws before delivery.
o Downgrading: equipment failures or production line delays brought on by
quality problems, which can result in lost output and income.
o Warranty claims: expenses related to fixing or swapping out faulty goods that
are still covered by warranties.
Strategies to control Internal Failures:
o Implementing in place strong quality control procedures to find and get rid of
flaws early in the manufacturing process.
 o Investing money into staff training to advance their expertise in areas linked
to quality standards.
o Automating testing and inspection procedures to reduce human error and
maximize productivity.
o Examining internal failure data in order to pinpoint the underlying causes of
errors and carry out remedial measures.

2.2. External Failure

One subset of costs that falls under the broad scope of the "Cost of Poor Quality"
(COPQ) is external failure costs. The entire amount of money lost by a business as a result
of creating and providing inferior products or services is known as COPQ. The expenses
incurred after a product or service has been delivered to the client and they find a fault or
issue that falls short the anticipated quality standards are precisely the subject of external
failure costs. Types of external failures are as follows;
o Warranty Claims: when a product has to be replaced or serviced while still
covered under warranty.
o Customer Returns: Consumers sending back or asking for reimbursements for
faulty goods.
o Field service cost: dispatching technicians to customers' homes or businesses
to fix defective products.
o Lost sales: Customers who have had bad encounters with your quality are
selecting the goods of a competitor.
o Complaints Handling: expenses for staff time and resources used in handling
customer complaints.
o Brand reputation damage: Poor quality-related publicity can damage a brand's
reputation and have an adverse effect on future sales.
Strategies to control External Failures:
o Invest in quality early: Put in place strong quality management systems to
proactively find and fix possible flaws before they affect customers.
 o Conduct thorough product testing: To identify and resolve quality concerns
early on in the production process, use rigorous testing protocols at different
phases.
o Embrace a culture of continuous improvement: Motivate staff members to
immediately report quality issues and take part in root cause analysis in order
to stop such incidents from happening again.
o Utilize the customers feedbacks: Seek out and evaluate client feedback in a
proactive manner to pinpoint areas that require improvement and successfully
handle external setbacks.
o Strengthen supplier relationship: Collaborate with reputable suppliers who
have strict quality control procedures in place and place a high priority on
quality.

2.3. Appraisal Cost

One particular element of the cost of poor quality (COPQ) is the appraisal cost. It
speaks of the costs a business bears to find and fix flaws in its goods or services before
they are used by a client. This basically refers to the price of quality assurance. Appraisal
cost may be present in both cost of good or poor quality. Determining appraisal costs
benefits businesses in the following ways:
o Analyze the efficiency of their quality assurance procedures.
o Examine the amount of money was spent on quality control initiatives overall.
o Determine which aspects of their quality control system needs improvement.
In order for a corporation to manage COPQ successfully, it must minimize appraisal costs
while retaining effective fault detection.
Roles and Benefits of Cost of Quality (CoQ)
1. Cost of Quality’s Role in Identifying Problem Areas
1.1. Appraisal Costs as a Diagnostic Tool:
Role: Appraisal costs involve evaluating and inspecting products to ensure they meet quality
standards. By investing in appraisal costs, companies actively examine their products or services,
helping to identify any deviations from quality standards. This diagnostic function allows for early
detection of potential problems.
1.2. Prevention Costs for Proactive Problem Avoidance:
Role: Prevention costs are invested in proactively avoiding problems. The quality improvement
team focuses on analyzing potential issues and designing measures to prevent defects before they
occur. This proactive approach helps in identifying problem areas during the planning phase.
1.3. Root Cause Analysis to Address Internal Failure Costs:
Role: Cost of Quality involves conducting root cause analysis to identify the source of defects. For
example: The company learned that consumers who received their vegetable meal kits products
damp and expired in the past gave them low evaluations. After looking into a matter, the quality
team finds that the wholesaler is supplying the meal kit provider a next-to-expired vegetables; In
this case, the external failure (brand reputation damage) led to an investigation by the quality
team, uncovering the root cause – close-to-expiry vegetables from the wholesaler.
1.4. External Failure Costs as Indicators of Problem Areas:
Role: External failure costs, such as providing compensation for defective products, serve as
indicators of problem areas that have affected customers. By analyzing these costs, the company
can identify specific issues that need attention to prevent future external failures.
1.5. Strategic Allocation of Resources Based on Problem Areas:
Role: Cost of Quality guides strategic decision-making in resource allocation. In response to
identified problem areas, the company can adjust its budget allocation, investing more in
appraisal and prevention costs to address specific quality challenges.
1.6. Continuous Improvement through Problem Resolution:
Role: Cost of Quality contributes to continuous improvement. Problem areas identified through
internal failure costs can be addressed promptly, leading to corrective actions such as replacing
problematic ingredients. This reflects a commitment to ongoing improvement based on the
lessons learned from quality issues.

In summary, the Cost of Quality serves a critical role in identifying problem areas by
utilizing appraisal and prevention costs for continuous monitoring and proactive avoidance,
conducting root cause analysis for internal failures, using external failure costs as indicators, and
guiding strategic resource allocation for problem resolution and continuous improvement.

2. Cost of Quality’s role in Analyzation and Improvements for Quality Operation

Cost of Quality:
o Plays a vital role in the analysis of prevention costs. Prevention costs are incurred to
avoid defects and quality issues.
o Instrumental in strategic planning and design of preventive measures. By allocating
resources to prevention costs, companies aim to design processes, training programs,
and quality controls that minimize the likelihood of defects. This strategic planning
involves understanding the potential risks and challenges in the operational processes
that could lead to quality issues.
o Analyzes the root cause for further improvement by enabling organizations to
implement corrective actions and continuous improvement initiatives, addressing the
root causes to prevent similar issues in the future.
o Guides resource allocation by helping organizations determine where to invest for
optimal quality. Through analyzation of prevention costs, companies can identify
areas that require additional resources to enhance preventive measures.
o Creates a feedback loop for iterative improvements. By constantly analyzing
prevention costs and addressing root causes, organizations establish a continuous
improvement cycle.
o Serves as a decision support tool. Organizations can use the insights gained from the
analysis of prevention costs to make informed decisions about quality enhancement
initiatives
3. Roles of Cost of Quality in Reference to Good Quality:
Customer Reputation: Appraisal costs play a crucial role in ensuring that products and services
meet quality standards. By investing in these costs, companies protect their reputation, as defects
are identified and corrected before reaching customers. This prevents negative reviews and
customer disloyalty.
Proactive Quality Management: Prevention costs, such as training and proactive quality checks,
contribute to maintaining good quality. By investing in prevention, companies can avoid defects
altogether, ensuring that the product or service meets quality standards from the beginning.

4. Roles of Cost of Quality in Reference to Poor Quality:

Internal Defect Prevention: Internal failure costs highlight the importance of identifying defects
within the company before delivering products or services to customers. By incurring costs to fix
internal issues, businesses prevent setbacks and the waste of money spent on prevention costs.
Customer Relationship Management: External failure costs emphasize the potential damage to
customer relationships due to product failures after sale. The costs associated with correcting or
adjusting external failures, such as rush shipping and providing compensation, are examples of
efforts to maintain customer loyalty and company integrity.

Challenges and Considerations when Implementing Cost of Quality

1. Potential Challenges and Barriers of CoQ in Strategic Cost
1.1. Short-Term Financial Focus: Organizations may prioritize short-term financial goals
over long-term quality investments, impacting the strategic application of Cost of Quality
(CoQ).
1.2. Lack of Awareness: Some companies may not fully grasp the long-term benefits of
investing in CoQ, leading to insufficient commitment and awareness regarding strategic
quality initiatives.
1.3. Balancing Prevention and Appraisal Costs: Finding the right balance between
prevention and appraisal costs can be a challenge, as overemphasis on one at the expense
of the other may hinder optimal quality outcomes.
 1.4. Cultural Resistance: Implementing CoQ requires a cultural shift toward prioritizing
quality. Resistance to this change within the organization can impede successful strategic
integration of CoQ.
1.5. Risk of External Failure Costs: Underestimating the potential impact of external
failure costs may hinder the strategic understanding of the importance of CoQ in
preventing customer dissatisfaction and loss of reputation.

In summary, potential challenges and barriers in strategic Cost of Quality include short-
term financial focus, lack of awareness, balancing prevention and appraisal costs, cultural
resistance, and underestimating the risks associated with external failure costs.

2. Actions or Strategies to overcome the challenges and barriers that comes with CoQ
By implementing these actions and strategies, organizations can overcome challenges
and barriers associated with Cost of Quality, fostering a culture of quality, and ensuring its
integration into strategic decision-making processes.

o Educate and Raise Awareness: Conduct training sessions and awareness programs
to educate stakeholders on the long-term benefits of Cost of Quality (CoQ) and its
strategic importance in maintaining and enhancing product or service quality.
o Align with Organizational Goals: Integrate CoQ initiatives with overall
organizational goals, emphasizing the link between quality investments and long-
term business success. This alignment helps gain support and commitment from
leadership and employees.
o Conduct Risk Assessments: Regularly assess and identify potential risks associated
with external failure costs. Proactively addressing these risks helps prevent
customer dissatisfaction and loss of reputation, strengthening the strategic
position of CoQ.
o Continuous Improvement Initiatives: Implement continuous improvement
programs based on lessons learned from root cause analyses. Establish a feedback
 loop for iterative improvements, ensuring that CoQ strategies evolve to address
changing circumstances.

Strategies for Reducing Cost of Quality

A company’s expenses must be kept to a minimum while maximizing product

quality as they have a direct impact on the company’s profitability. By reducing the
prevention, appraisal, and costs associated with quality issues, the company will improve
its overall outcomes. An investment in reducing quality costs also leads to increased
efficiency and improved productivity, which adds to the company’s overall operational
excellence. This often results in customer satisfaction, leading to customer loyalty and a
stronger brand reputation. That is why it is critical for a company to carefully consider the
methods they will employ to reduce the Cost of Quality. The following are instances of
such strategies:

1. Prevention Cost

1.1. Planning: A thorough project planning, quality planning, resource planning helps
the company minimize errors, reduce rework, and avoid costly delays, lowering
the prevention costs associated with quality issues. Let’s say a business or
company developed a detailed plan for each phase of the project after careful
consideration of the processes. As they created step-by-step procedures, the
possibility of further costs for errors and reducing reworks was reduced.
1.2. Risk Assessment: Companies can greatly minimize future costs related to quality
failures by identifying possible issues early in the process and addressing them
before they escalate into something more dangerous. An example of this would be
an extensive risk assessment for a pharmaceutical company during drug
development. Being able to identify the risks early on could save them from future
expenditures associated with quality failures, which could cause mass poisoning if
delivered to the public, culminating in a product recall, which is a request to return
an entire production run of a product, usually over safety concerns.
2. Appraisal Cost
2.1. Test Materials: Using test materials as a strategy to minimize appraisal costs
typically involves using a representative sample or smaller subset of materials to
evaluate the quality or characteristics of a larger batch. This way, one can save time
and money by focusing on just one sample but still have a good sense of the overall
quality.
2.2. Inspection: As a company implements effective quality control measures during
production processes, it allows them to discover the defects of the products and
ensure that they are able to meet the quality standards at each step. It allows them
to avoid an extensive appraisal later on in the process and minimizes the costs
associated with having to identify and address the defects of the products.

3. Internal Failure Costs

3.1. Problem-solving: Investing in an effective problem-solving process helps a
company keep the costs at its minimum, because it addresses the issues as they
occur, preventing these issues from growing into larger, more complicated issues
that may be rather costly from the scraps, rework, etc.
3.2. Retest: Re-testing the product or feature to ensure that it’s functioning properly
helps reduce the expenses associated with the internal failure of the company. For
instance, if a software development company did not implement re-testing
protocols and did not inspect the products thoroughly, moving the products
further along the manufacturing line, it may experience an error that may need
rework, giving rise to costs that could be avoided if a proper re-testing protocol
was done.

4. External Failure Costs

4.1. Late Delivery Penalties: Providing a great service to a customer lessens costs as
well, a delay in deliveries of goods brings customer discontentment allowing
penalties and costs associated with delayed shipment to arise. A real-life scenario
 would be when it was stated in a contract that in case of delayed delivery of any
shipment, the buyer shall agree to postpone the delivery on condition that the
seller agrees to pay a penalty of 5% of the total value of the goods involved in the
late delivery which shall be deducted by paying the bank from the payment.
4.2. Complaints: Consumer satisfaction especially holds importance in a company, as
bringing discontent could cause consumer returns, replacements, and brand
damage, resulting in greater external failure costs. By focusing on product quality,
as well as delivering exceptional customer service and consistently meeting the
consumer’s expectations, the complaints will decrease, resulting in lower external
failure costs.

IV. CONCLUSION:
Quality is an investment, not a cost, as the Cost of Quality (COQ) research has shown.
Although spending is necessary for both preventative and appraisal efforts, doing so
substantially minimizes the impact of both internal and external failures, improving the
bottom line in the process.
This CoQ analysis offers insightful information about areas in need of development. A
sustained priority for enhancing quality procedures and putting preventative measures
into place at a reasonable cost will boost productivity and profitability throughout the
organization.
Lastly, it will be essential to set specific goals and track advancement in critical COQ
measures. Quality management system will be continuously analyzed and improved to
guarantee its efficacy in generating savings in the long run and customer satisfaction.
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