MacroEconomics of Quality

1. MacroEconomics of Quality

2. Issues • Why Estimate Cost of Quality Failures? • Quality Costs are Far Greater than Those that are Readily Identifiable (Iceberg Principle) • Gains to be Made if Cut Measured Quality Losses in Half • How to Reduce Quality Losses • Rule of “Tens” • Eradicate Killer Re’s • Play Offense (Prevention) vs. Defense (Detection) • Sound Quality Practices

3. Why Estimate Cost of Quality Failures • Quantify the Cost of Quality Failures for the Business • Identify magnitude of potential savings • Sensitize Management to the size of the opportunity • Help to re-expose problems we have learned to tolerate • Identify the Highest Loss Areas • Permit Prioritizing the Loss Areas for Corrective Action

4. Economics of Quality: TCE Statistics 1994 • TV Units Sold 5 million • Estimated Revenues $2.5 billion (5 x $500 per set) • Estimated Earnings $125 million (5% of Sales)

5. Economics of Quality: TCE Statistics 1994 • Scrap (Measured) $12 million • Total Cost of Quality $72 - 600 million • (Measured & Hidden) • Cost of Scrap per TV(12/5) $2.40 per unit • Total Cost of Quality $14.40 - $120 • (M+H) per TV Sold • (6/1 to 50/1 Iceberg) • % Total Cost of Quality 3% - 24% • per TV/Selling Price • (14.40/500 -120/500) • # Defects per TV ?

6. Economics of Quality: STB Systems Statistics 1998 • Units Sold 6 million • Estimated Revenues $300 million (6 x $50 per unit) • Estimated Net Earnings $16.2 million (5.4% of Sales)

7. Average • Scrap (Measured) $ 1.875 million $1.875 • Total Cost of Quality $11.25-93.75 million $52.5 (Measured & Hidden) Cost of Scrap per Unit $.3125 per unit $.3125 (1.875/6) • Total Cost of Quality $1.875 - $15.625 $8.75 (M+H) per Unit Sold (6/1 to 50/1 Iceberg) • % Total Cost of Quality 3.75% -31.25% 17.5% per Unit/Selling Price (1.875/50-15.625/50) • # Defects per Unit ???

8. Cost of Quality Failures

9. Direct/Measured Costs: • Scrap/Rework • Service Calls • Warranties/Concessions Indirect/Hidden Costs: • Excess Inventory • Overtime • Reputation/Image ICEBERG PHENOMENON Hidden Costs = 6 to 50 times Measured Costs

10. Cost of Quality Failures Worksheet FAILURE COST CATEGORIES ESTIMATED ANNUAL COSTS $(000) MEASURED COST OF QUALITY • Internal • Waste, Scrap ____________________ • Rework ____________________ • Reinspect ____________________ • External • Warranties ____________________ • Guarantees ____________________ • Concessions ____________________ TOTAL MEASURED __________________

11. HIDDEN COST OF QUALITY • Internal • Troubleshooting and failure analysis __________________ • Evaluation to determine usability of off specification material __________________ • Engineering changes, redesign, buy-offs __________________ • Costs of reviewing quality problems (i.e.,replanning, meetings, expediting, firefighting, reports, etc.) __________________ • Inventory costs on held material __________________ • Overtime because of quality problems __________________ • Late shipment premiums (delayed collections) __________________ • Material handling __________________ • Tool & fixture redesign __________________ • Machine wear __________________ • Fringe benefits on labor __________________ • Loss of productivity due to rework, scrap __________________

12. HIDDEN COST OF QUALITY • External • Loss of market share due to poor quality reputation ____ • Loss of profitability ____ • Loss of bond credit rating ____ • Other • ______________________________________________ _____ • ______________________________________________ _____ • ______________________________________________ _____ • ______________________________________________ Total Hidden ____ Grand Total ____

13. WHAT IF ??? We could cut losses in half? 1/2 x $12,000,000 …………………......$6,000,000 If ICEBERG is between 6/1 to50/1……$36,000,000 to $300,000,000 Total TCE net earnings in 1994 were?

14. WHAT IF??? • We could cut losses in half? • 1/2 x $1,875,000 $937,500 • IF ICEBERG is between 6/1 to 50/1 $5,625,000 to $46,876,000 • Total STB Systems net earnings for 1998 estimated to be $26,250,000 $16.2 million

15. Sales $190 million $300 million Net Earnings (Income) $10.26 million $16.20 million (5.4% of Sales) COQ as of % of Sales 10 - 25% 10 - 25% COQ ($) $19 - 47.5 million $30 - 75 million What if COQ cut in half? $9.5 - 23.75 million $15 - 37.55 million (Savings) ($16.63 million) ($26.25 million) Net Income with Savings $26.89 million $42.45 million Economics of Quality: STB Systems Statistics (1997 vs. 1998) 1997 1998

16. How to Reduce Quality Losses • Rule of “Tens” • Eradicate Killer Re’s…Waste • Play Offense (Prevention) vs. Defense (Detection)

17. RULE OF “TENS” Not doing it right the first time costs ten times as much to find and fix each time errors escape to a subsequent stage of handling. $1 Design Effort =$10 Production Cost =$100 Assy/Test Cost =$1000 Field Cost

18. The Killer Re’s

19. Computing Cost of Quality Internal Failure • Scrap • Rework • Scrap/Rework - Supplier Appraisal • Inspection • Test • Quality audits • Test equipment - initial cost & maintenance External Failure • Cost to customer • Warranty costs • Complaint adjustments • Returned material Prevention • Quality planning • Process planning • Process control • Training Note: The listed categories provides an understanding of the COQ structure. In general, COQ is comprised of costs due to failure, appraisal, and prevention.

20. The Enlightened Perspective Internal & External Failure Appraisal & Prevention Old Belief New Belief 4s 5s 6s Quality

21. Sound Quality Practices • Operational Definitions and Standards (Metrics) • Manage by Fact • “In God we trust. But everyone else must bring data!” • Without good data, everyone is an expert • Focus on Process (Offense) vs Product Results (Defense) • Reduce Variation

22. Questions?