Measuring the Cost of Quality Management

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ECONOMIC CASE FOR QUALITY

Measuring the Cost of Quality For Management
by Gary Cokins

T

he quality movement has used the term cost of quality (COQ) for decades. But few organizations have actually adopted a reliable and repeatable method for measuring and reporting COQ and applied it to improve operations.

Is the administrative effort just not worth the benefits, or is there a deeper problem with the methodology for measuring COQ?

What COQ Should Do
At an operational level, quality management techniques effectively identify waste and accelerate problem solving for tactical issues related to process improvement. For many organizations, quality management initiatives have prevented financial losses from customer defections caused by quality problems or from waste and inefficiencies. At a more strategic level, however, has quality management reached an adequate level of support from senior executives? Unfortunately, the avoidance of reduced profits from quality initiatives is not widely measured or reported by organizational financial accounting systems. As a result, organizations cannot easily quantify the magnitude of benefits in financial terms—and the language of money is how most organizations operate. In short, there has been a disconnect between quality initiatives and bottom-line profits to validate any favorable impact on profitability and costs. QUALITY PROGRESS

In 50 Words Or Less
• Although management prefers to have fact based data and reasonable estimates to evaluate decisions and prioritize spending, financial measurements generally aren’t used to validate quality’s impact on profitability and costs. • Activity based cost/management systems are effective ways to account for the hidden costs of poor quality.

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SEPTEMBER 2006

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ECONOMIC CASE FOR QUALITY

Why Traditional Accounting Fails
One of the obstacles affecting quality management and other initiatives has been the accounting field’s traditional emphasis on external reporting. The initial financial data are captured in a format that does not lend itself to decision making. It is always risky to invest in improving processes when true costs are not well established. This is because management lacks a valid cost base against which to compare the expected benefits from improving or reengineering the process. In The Process-Centered Enterprise, Gabe Pall says: Historically, process management has always suffered from the lack of an obvious and reliable method of measurement that consistently indicates the level of resource consumption (expenses) by the business processes at any given time—an indicator which always interests executive management and is easily understood. The bottom line is that most businesses have no clue about the costs of their processes or their processes’ various outputs.1

2. Management can more reliably assess the different value of processes and how they contribute to the overall performance of the business. The accountant’s traditional general ledger is a wonderful instrument for what it is designed to do: post and summarize transactions into specific account balances. But the cost data in this format (salaries, supplies, depreciation) are structurally deficient for decision support, including measuring COQ. They disclose what was spent but not why or who or for what. Expense data must be transformed into the costs of the processes that traverse across the departmental cost centers reported in a general ledger system—and ultimately transformed into the costs of products, services and customers that uniquely consume the costs of various processes.

Bring Facts, Not Hunches
To some people, it is obvious better management of quality ultimately leads to good performance, which in turn should lead to improved financial health of an organization. These people believe if you simply improve quality, good things, such as happier customers and higher profits, automatically will fall into place. Other...
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