Managing cost of quality

It is estimated that, in a typical organisation, the cost of quality would in be the region of 30 per cent of its sales, if not higher, while ideally the number should be less than half of it, says R. Venkatakrishnan, Director, Value Added Corporate Services P Ltd, Chennai (http://bit.ly/F4TVenkatCA). “The problem is that there is really no validated data set, but past experience does tend to point towards these types of numbers,” he adds, during a recent interaction with Business Line . We continue our conversation on the email.

Excerpts from the interview.

What is cost of quality?

Cost of quality refers to the summation of all costs associated with not delivering a product or service in accordance with the requirements. These requirements can be regulatory, customer specific, or even internal.

Why is it important to measure cost of quality?

In an extremely competitive environment, it is impossible to pass on all increases in costs to customers. The fact is that the customers have become very discerning with greater choices, and, more importantly, availability of information. It then becomes imperative for the company to target all costs that do not add value to its products. In some cases, large organisations make it a condition that vendors agree to pass on reductions, during a period of time, in prices, through cost management. Cost optimisation should be a continuous focus of all companies, and should not be initiated only during difficult periods.

How to measure cost of quality?

There are four main parameters that have to be monitored under two categories. The categories are ‘cost of non-conformance' and ‘cost of conformance.' Costs of non-conformance include costs associated with internal failures and external failures. Conformance costs include costs of appraisal and costs of prevention.

What are the avenues for reducing these costs? How are we to mitigate these costs?

I would recommend that all costs are monitored using the four M approach — men, machines, materials and methods. This approach captures all the elements of costs, barring financial cost, though even that is done indirectly. The various parameters of costs of quality can be monitored under the above four heads, and it would be possible to get a fairly reasonable picture of what the targets should be.

The key issue is one has to constantly keep revisiting the costs periodically, and benchmark the same against the best in class. The moment one stops that, the team tends to get complacent.

Can you give a few examples of successful implementation of measures to control cost of quality?

Starting with the ABC analysis of costs would be the best approach, where ‘A' items could account for approximately 65 per cent of total costs, ‘B' 25 per cent and ‘C' 10 per cent. Invariably, material and labour costs account for a significant part of the costs, and these would be the best starting point.

For instance, I have noticed that revisiting the bill of material and checking out the ideal material consumption norms is very effective. It is critical to get back to the basics and use the zero-base approach, where you have to justify expenditure from the first rupee. Better material specifications, choosing the right vendor, are all an integral part of the exercise. Coming to manpower costs, much higher in the context of service industries, good job definitions go a long way in reducing costs.

To CXOs, what would be your advice on the metrics to regularly monitor?

In addition to constantly monitoring cost of quality, it is critical to monitor capacity utilisations. Capacity utilisation monitoring helps in taking dynamic pricing decisions to ensure that organisational activity is maintained at a healthy level. From a metric perspective, it would be a good idea to monitor ‘overall equipment efficiency', as it considers all the aspects, namely availability, efficiency, and quality.

Any suggestions on disclosure practices relevant to cost of quality?

The existing regulatory mechanism provides for conduct of cost audits in certain industries. There have been some changes notified by the Ministry of Corporate Affairs in April 2011. If these audits could require disclosure on the cost of quality it would go a long way to bring about greater transparency and increase competitiveness. We must also recognise that it would require a fair degree of maturity for industry to be willing to disclose this information, as it would probably sum up the organisation efficiency or probably inefficiencies. We must concede that the existing disclosure requirements, if fully met, are reasonably good and a fair amount of information can be taken from the existing financial statements.

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