The Cost of Poor Quality
Cost of Poor Quality or COPQ is a financial term generated as a way to determine where companies are their spending money because of the inability of processes to meet requirements. It sums up all of the costs associated with the prevention of problems, appraisal or inspection and the expense of internal and external failures. In the traditional sense, outputs that do not meet requirements are a form of poor quality.
COPQ is associated with the reduction of waste. Waste is really a better term, as it includes poor quality and all other costs that are not integral to the product or service a company provides. Waste does not add value in the eyes of customers, employees, or investors.
COPQ is a symptom of the problems in the company and is measured as a lost of profit from the defects and inefficiencies in our processes.
To understand the cost of poor quality, think of an iceberg. Most of the iceberg is below the water where you cannot see it. The part you can see we call the tangible costs. The invisible part we call the intangible costs.
The tangible quality costs are costs the organization is rather conscious of and may be measuring already. For example costs like inspection, rework, warranty, etc can cost an organization in the range of 4 percent to 10 percent of every sales dollar it receives. If a company makes a billion dollars in revenue, this means there are tangible wastes between 40 and 100 million dollars.
Even worse are the intangible Costs of Poor Quality. These are typically 20 to 35% of sales. If you average the intangible and tangible costs together, it is not uncommon for a company to be spending 25% of their revenue on COPQ or waste. What you may not realize is you have the ability to recapture many of these costs.
In a process, the Cost of Poor Quality often shows up as a “Hidden Operation” (see the rework swim-lane in the process map below). It is called this because in many cases, Management does not know it exists due to the way data is reported about process performance or because we have become so accustomed to doing re-work we don’t think about it, even though we know it is not good.
In almost every process of every company, this “Hidden Operation” model can be found. It can be known by many terms, such as: work around, inspection, defect, re-work, quick fix and many more. Most people think of the manufacturing a physical product when they hear the word scrap, like a hamburger or keyboard. However, what happens if a processor completes a bill review incorrectly? The bill must be re-evaluated or adjusted to make it correct. This is performed by another person in the company (usually a higher-paid person) who must evaluate the bill and make a recommendation on change. What has been scrapped? The time of the people who worked on preparing and completing the initial bill review. That time and their salaries have gone to waste. So, where does the Cost of Poor Quality occur? The truth is every process in every company has elements that can be considered the cost of poor quality. Let’s see if you can spot the apparent defects in the following incident. I’ll read the news article.
At 5:30 AM on June 27,2009, an unoccupied building still under construction in Shanghai city toppled over. The collapse at the Lotus Riverside, a complex of 11 residential buildings in Shanghai, early on Saturday morning killed one construction worker and left hundreds of prospective tenants angrily demanding their money back. China's official news agency said officials were taking "appropriate control measures" against nine people, including the developer, construction contractor and supervisor of the project after it was reported that the company's construction license had expired in 2004.
Preliminary investigations found that the building fell over after workers began excavating an underground garage for the complex, causing a 70-meter section of the flood prevention wall in the nearby Dianpu River to collapse.
What are the obvious costs of poor quality in this example? How about the inspection team that approved the foundation? How about the person who certified that the ground was stable enough to build this building and parking garage in the first place? How about the commission that ensures companies have the proper construction licenses? I’m sure there are a hundred more.
Let’s look at a couple of examples from the world of Medicaid. Companies providing Medicaid support to states routinely pay millions of dollars in fines for not meeting the states numerous requirements. Companies that produce products may recall millions of copies of those products for defects. Both are costs of poor quality.
The bottom line is the cost of poor quality is waste. As a general rule you are trying to assure that any energy, resources, time, equipment and material is adding value to the product or service you are producing. Value is defined when something is changed in form, fit or function in a way that the customer is willing to pay for it, hence the term Customer Value Added.