1
COST OF QUALITY
Prevention Cost, Appraisal Cost, Internal
Failure Cost and External Failure Cost

2
Definition
• Cost of Quality offers managers a financial method to
evaluate the level of their quality and the costs
associated with different levels of quality.
• The cost is a well-organized and often disputed tool
used to understand the economic consequences of
quality.
• Purchasing manager and clever customers are asking:
“what are the costs related to quality?”
• The definition of COQ varies but, in general, is
considered to be the costs (tangible &intangible)
relating to be the quality characteristics of a product or
service.

3
Difficulties in Capturing the “True
Costs”
Placing a cost figure on quality is difficult and that
accounting is unable to capture the “true” costs of
quality. Some concerns:
• Quality costs do not readily appear in the accounting
journals.
• Large timing delays between quality costs and benefits
create distortions.
• Accounting rules (product & period costs) do not lend
themselves to measuring quality.
• Numerous cost estimates are needed.
• There are hidden costs never captured.
• Matching future costs with historical costs is necessary.

4
The Traditional Cost-of-Quality
Model
The model states that cost can be divided
into two broad categories:
1. Conformance Costs
a. Prevention costs
b. Appraisal costs
2. Non-Conformance Costs
a. Internal failure costs
b. External failure costs

5
Conformance Costs
A. Prevention costs:
• Costs associated with all activities designed to
prevent defects in product or service. These include :
• The direct and indirect costs related to quality
training and education, pilot studies, quality circles,
quality engineering, etc.
• These costs are used to build awareness of the quality
program and to keep the costs of appraisal and failure
to a minimum.
• Prevention costs are all costs incurred in an effort to
“make it right the first time”.

6
Types of Prevention Costs
1. Quality planning and engineering: creation of the overall
quality plan, the inspection plan, the reliability plan, the
data system, all activities of the quality assurance function,
the preparation of manuals and procedures used to
communicate the quality plan, costs auditing the system.
2. New products review: evaluation of new designs,
preparation of tests & experimental programs to evaluate
the performance of new products.
3. Product & process design: costs incurred during the
design of the product or the selection of the production
processes that are intended to improve the overall quality of
the product.

7
Types of Prevention Costs cont.
4. Process control: the cost of process control
techniques, such as control charts, that monitor the
manufacturing process in an effort to reduce variation
and build quality into the product.
5. Burn-in: the cost of pre-shipment operation of the
product to prevent early failures in the field.
6. Training: the cost of developing, preparing,
implementing, operating, and maintaining formal
training programs for quality.
7. Quality data acquisition and analysis: the cost of
running the quality data system to acquire data on
product and process performance. Includes cost of
analyzing these data to identify quality problems.

8
Conformance Costs
B. Appraisal costs
• The costs associated with measuring and
evaluating the product or service quality to ensure
conformance.
• These include the cost of inspection, test or audit
of purchases, manufacturing or process operations
and finished goods or services.
• The direct and indirect costs of the various tests &
inspections to determine the degree of conformity
are included in this category.

9
Types of Appraisal Costs
1. Inspection & test of incoming material:
Costs associated with the inspection and testing of all
vendor-supplied material.
• Receiving inspection & test
• The same at the vendor’s facility
• Periodic audit of the vendor’s quality assurance
system.
2. Product inspection & test:
the cost of checking the conformance of the product
throughout its various stages of manufacturing.
• Final acceptance testing
• Packing and shipping checks
• Salaries of inspectors and supervisors.

10
Types of Appraisal Costs cont.
3. Materials & Services consumed:
The cost of operating a system that keeps the
measuring instruments and equipment in
calibration.
4. Maintaining accuracy of test equipment:
the cost of operating a system that keeps the
measuring instruments and equipment in
calibration.

11
Non-Conformance Costs
These are associated with products or services that do not conform the
customer's requirement. They are often referred to as “failure” costs and
consist of two types.
A. Internal failure costs:
• costs incurred prior to the shipment of the product or
the delivery of the service.
• These costs are associated with defects that are found
prior to customer delivery.
• These include the net cost of scrap, re-inspection and
retest, downtime due to quality problems, opportunity
cost of product classified as seconds, or other product
downgrades.
• These costs would disappear if there were no defects in
the product.

12
Types of Internal Failure Costs
1. Scrap costs: the net loss of labor, material and
overhead (fixed costs) resulting from defective
product that can not economically be repaired or used.
2. Rework: the cost of correcting nonconforming units
so that they meet specifications. Rework costs usually
include additional operations or steps in the
manufacturing process, thus includes extra direct
labor, machine time and supplies costs.
3. Retest Cost: the cost of reinspection and retesting of
products that have undergone rework or other
modification.

13
Types of Internal Failure Costs cont.
4. Downtime costs: the cost of idle production
facilities that result from nonconformance to
requirements.
5. Downgrading cost: the price differential between
the normal selling price and any selling price that
might be obtained for a product that does not meet
the customer’s requirements. Downgrading is
common in the textile, apparel goods, electronics,
and carpet industries.

14
B. External Failure Costs
• The costs of discovered defects occurring after
product shipment or service delivery.
• These costs include warranty charges, customer
complaint adjustments, returned merchandise,
product recalls, allowances, and product liability.
• They also include the direct and indirect costs such
as labor and travel associated with the investigation
of customer complaints, warranty field inspection,
tests and repairs.
• These costs would disappear if every unit of product
conformed to requirements and specifications.

15
Types of External Failure Costs
1. Complaint adjustment: all cost of investigation and
adjustment of justified complaints attribute to the
nonconforming product.
2. Returned product & material: all costs associated with
receipt, handling, and replacement of the nonconforming
product or material returned from the field. Also recalls of
defective product.
3. Warranty charges: all costs involved in service to
customers under warranty contracts. Includes repair and
replacement of product or parts.
4. Liability costs: costs or awards incurred as a result of
product liability litigation.
5. Indirect costs: in addition to direct operating costs of
external failures, there are some indirect costs.
• Customer dissatisfaction with the level of quality
• Loss of good-will; loss of business reputation; loss of future business;
loss of market share.

16
Cost of Quality =
Cost of Prevention + Cost of Appraisal
+Cost of Failure

17
Reducing the Cost of Quality
• The aim of management is to minimize the cost of
quality.
• It makes no difference if this is done by reducing
all three components or by increasing some and
decreasing others enough to lower the total cost.
• To have a significant impact on the total cost; the
cost of failure must be reduced, and the usual
strategy for achieving this objective is to spend
more on prevention.
• “It is always cheaper to do a job right the first time
than to do it over”.

18
The Traditional Cost of Quality
Model
• The study of the relationship of the COQ
categories led to the development of a
significant body of economic literature
offering various models to explain the
interrelationship of the COQ categories.

19
The Original or Classical
COQ model
Costpergoodunitofproduct
Quality of conformance %
Total quality costs
Failure costs
Costs of appraisal plus
prevention
∞∞
1000

20
Definition of COQ model figure
• In this case, the costs of prevention and appraisal are zero with a
100% failure rate.
• The costs of prevention & appraisal rise to infinity as perfection
(no failures) is reached.
• This hypothetical model shows that total quality cost is higher
when quality is low and falls as quality improves.
• According to the model, a company greatly reduce failure costs
by adding relatively low-cost prevention and appraisal
measures.
• As prevention and appraisal expenditures continue to rise, the
rate of improvement begins to diminish until additional
expenditures produce little decrease in failure.
• The model suggests that a relationship exists between
conformance and nonconformance quality costs, with a minimal
total quality cost at the optimal balance.
• Implicit in this model is the trade off of conformance costs for
nonconformance costs to achieve the lowest total quality cost.

21
Behavior of Cost Components During
TQM Implementation
The general behavior of the four quality cost
components for a company starting TQM is as follows:
• Prevention costs remain relatively consistent as the
awareness of TQM is built and maintained.
• Appraisal costs will initially increase as inspection
programs are initiated but should eventually level off.
• Internal failure costs will initially increase as the
inspection programs are implemented, but should the
gradually decrease with learning.
• External failure costs should continue to fall as various
TQM programs are brought on line.