Case Study in Supply Chain Optimization
The Benefits of Using a CoQ Indicator to Reduce Costs
This case study was developed by a leading materials manufacturer to determine the cost of quality to their company and evaluate the benefits of developing a supply chain optimization program. The CoQ cost model implemented here was developed by a world leading chip manufacturer, and is analogous to the model used by Linx Consulting supply chain optimization expert Kyle Flanigan.
Quotes on the Cost of Quality
Costs do not exist to be calculated; costs exist to be reduced.
— Taiichi Ohno
Cost is more important than quality, but quality is the best way to reduce cost
— Genichi Taguchi
There’s never enough time to do it right, but there’s always enough time to do it over.
– Jack Bergman
What is the cost of quality (CoQ)?
CoQ is any cost that would not have been realized if quality were perfect. In a perfect world, the product would be flawless every time, and there would be no reworking costs. Unfortunately, in the real world, this is rarely the case. It’s when the product doesn’t meet requirements on the first attempt that the costs start to mount. Every time work is redone or a product fails to meet requirements, the cost of quality increases.
Research shows that COPQ can be 15-40% of business costs due to:
- Lost revenue
- Reduced service levels
Can you afford to ignore the cost of quality?
Finding and correcting mistakes can be costly, and as a result, most businesses don’t know their CoQ. Without a clear understanding of what the actual CoQ is, it’s difficult to fully understand the impact quality has on the bottom line.
In the long run, materials suppliers that invest more time and money in the beginning of the process to improve quality are more profitable. The cost to eliminate supplier failure is typically 5x greater than in development or manufacturing. Consequently, the earlier an error is found and corrected, the less it costs. With a little forethought and planning, quality can significantly improve profit margins, reducing failure and rework costs for both supplier and manufacturer.
How can you lower the cost of quality for your company?
To lower the cost of quality, material suppliers should take these steps for each new product:
- Conduct a thorough design review
- Raw material risk mitigation
- Process characterization
Although this process costs more upfront, the benefits of addressing these issues can eliminate costly adjustments later in the process, in addition to increasing profits. Failure to plan can result in loss of $millions for wire defects, dot defects, coherence excursion, and other failures.
The Total Cost of Failure to Meet Supply Chain Expectaions
The "tip of the iceberg" graphic above illustrates the costs that can add up to 20- 40%of business costs, whereas prevention costs average 5-10% of costs.
Case Study Overview
Problem / Opportunity
Supplier doesn’t track how much it costs to prevent, find, and handle failures in a consolidated manner. Understanding these costs requires visibility into the entire value chain and product life cycle.
To have quality cost targets in place based on a standard cost model that:
1) shows the total financial impact of poor quality and;
2) can be applied to any product line.
Any group responsible for the development, manufacturing, and support of a product throughout the product life cycle.
Case Study Implementation
Step 1- Determine total cost of quality
The Total Cost of Quality
CoQ Cost Categories
The total CoQ is the total cost incurred by:
- Preventing non-conformance to requirements
- Appraising a product or service for conformance to requirements
- Failing to meet requirements
- Prevention and appraisal gaps increase failure cost, driving up total cost
- Failure cost is usually least efficient and hardest to forecast
- Prevention and appraisal components can (and should!) be planned and controlled to lower failure cost.
Step 2 - Set goals for CoQ
Once the total CoQ was identified, the company set goals for reducing costs as follows:
Goal = Reduce cost of quality
A marginal cost of quality analysis was developed to determine if the company was operating at the optimal point.
Step3 — Mapping the CoQ to the PLC
The next step was to map the CoQ to the PLC to begin monitoring the costs of quality at each stage of the manufacturing process.
Prevention costs include all activities specifically designed to prevent poor quality in products or services such as:
- New product review
- Quality planning
- Supplier capability surveys
- Process capability evaluations
- Quality improvement team meetings
- Quality improvement projects
- Quality education and training
Appraisal costs include measuring, evaluating or auditing products or services to assure conformance to quality standards and performance requirements such as:
- Incoming and source inspection/test of purchased material
- In-process and final inspection/test
- Product, process or service audits
- Calibration of measuring and test equipment
- Associated supplies and materials
The failure cost includes all costs resulting from products or services not conforming to requirements or customer/user needs. Failure costs are divided into two categories — internal and external, based on whether they occur before or after delivery to the customer.
Internal Failure Examples:
- Material review
External Failure Examples:
- Processing customer complaints
- Customer returns
- Warranty claims
- Product recalls
Cost of Quality =Cp +Ca +Cif +Cef +Caf
- Cp = Cost of Prevention
- Ca = Cost of Appraisal
- Cif = Cost of Internal Failure
- Cef = Cost of External Failure
- Caf = Cost of Administrative Failure
Cost of Prevention
Cost of Prevention is usually the smallest component of CoQ. XYZ supplier has evolving prevention costs, but current prevention costs include:
- Metrology improvements, Gage studies, etc.
- Supply-management meetings with Intel
- Proactive air shipments to manage availability
- Expiring material review
- Sample write-off
Cost of Appraisal
Includes all standard quality costs:
- Equipment depreciation
- All standard quality costs of finished goods and incoming raw material
Cost of Internal Failure
- Cost of adjustments (includes extra QC)
- Cost of re-work for technical reasons
- Cost of scrapped non-conforming finished goods
- Cost of scrapped non-conforming raw materials
Cost of External Failure
- Resources to manage/respond to customer complaints (Engineering, QC, Production, Customer Service, Sales, QA, etc.)
- Write-off of finished goods returned by customer
- Credits given for material disposed of by customer
Cost of Administrative Failure
- Re-work for non-technical reasons
- Material written off for non-technical reasons:
- Forecast error
- Batch / Planning error
- Customer Cancellation
- Human error
CoQ Trend as Absolute $$$
Customer Compensation for Product Performance
CoQ Trends as % of Total Revenue
Return on Quality (ROQ)
The materials supplier created a standard cost model to be applied to all product lines with cost targets for all quality costs to assess impact of quality on profit margins. The cost model was mapped to the PLC and tracked over a two-year period with the following results:
- Customer Compensation for product performance was reduced 6%
- Total cost of quality was reduced 51%
- Appraisal costs were reduced 45%
- Total failure costs were reduced 80%
- External Failure costs were reduced 83%
- Total return on quality was 345%
The Benefits of a CoQ Model
The material supplier identified the following benefits of applying a CoQ model to monitor quality costs:
Links quality to the bottom line
- Spending on quality is necessary to produce, market, and sell a product
- Quality costs are just as relevant as material costs, design costs, and manufacturing costs
- Costs can be proactive or reactive; CoQ can be a lever to drive down total costs through continuous improvement and value-added investments in proactive costs
- Improves visibility and accountability for key CoQ components
Show quality cost trend over time
- Highlight opportunities for improvement
- Evaluate the effectiveness of investments in quality activities
- The effects of quality spending are typically long-term, so there can be a lag between quality “investment” and the downstream benefit
Provide baseline for “what-if” scenarios
- Historical data can be used to establish cause/effect relationships between different quality costs
- Provides a framework for analyzing quality-related issues
Improve your company’s profit margins with a CoQ model
Although materials suppliers are starting to realize the benefits of implementing a CoQ model to lower quality costs and increase profits, many suppliers haven’t addressed this issue. With manufacturers pushing quality into the supply chain, materials suppliers must develop their own programs for supply chain optimization if they want to maximize profits and sales.
Unfortunately, many small and medium suppliers don’t have the resources to set up CoQ model to monitor quality costs, but would like to increase profit margins. If you would like to implement a CoQ model to monitor your company’s quality costs, Linx Consulting can help. Linx supply chain optimization expert Kyle Flanigan has implemented the above CoQ model for various materials manufacturers with excellent results.
Learn more about Linx Supply Chain Optimization Services
Call Kyle Flanigan, Linx supply chain optimization expert, at 503-519-8776 or to learn how a CoQ model can increase your bottom line.