How to Speak to An Accountant: Cost of Poor Quality and Lean

The cliche “so close, yet so far away” applies here: by and large, cost accounting methods still do not capture nor can understand or see the waste that is so evident to practitioners of Lean Management. This is a controversial topic – after all, there is a Lean Accounting movement, which has yet achieved much traction. From a lean fulfillment perspective, costs are much more than just inventory and labor.

In the meantime, while most of industry is wallowing in the dark, how can we help others to see waste and how can that waste be quantified – to be relevant to the accountants, finance professionals, and other EBITDA (ebitda only – nothing else but ebitda – myopic and near-sighted, just ebitda) focused bretheren?

Joseph Juran spoke of this many, many years ago. He argues that there are four categories  in the cost of poor quality (COPQ):

1. External Failure Costs
2. Internal Failure Costs
3. Inspection (Appraisal) Costs
4. Prevention Costs

Now let me explain each of the categories of Cost of Poor Quality.

External Failure Costs

These are costs associated with defects found after the product or service has been delivered to the customer. In other words, the customer discovered the defect. So, these costs might include: customer service contacts, processing customer service complaints, customer returns, warranty claims, product recalls and others.

Internal Failure Costs

These are costs associated with defects of product or service found before the product or service was delivered to the customer. These types of costs include scrap, rework, inventory adjustments (or adjustments of adjustments) and others.

Inspection (Appraisal) Costs

These costs include audits, checks, testing, and other items. In general, these costs include activities to double-check conformance to customer standards.

Prevention Costs

Costs incurred in the prevention of product or service failure are described as Prevention Costs. Examples include: dedicated quality improvement teams, quality education and training, process reviews, etc.

Most Costs are Hidden

Most costs that can be descibed by one of the quality costs categories above are hidden. In other words, they don’t really reveal themselves in costs accounting terms – definitely not as line items – but they are “bunched up” or “rolled up” in a budget. When asked why such and such didn’t make budget, the likely reason is one of the above, but the general manager doesn’t even know it because these costs are hidden – but these costs are very, very real.

Cost of Poor Quality: History

Cost of poor quality (COPQ) or poor quality costs (PQC), are defined as costs that would disappear if systems, processes, and products were perfect.

COPQ was popularized by IBM quality expert H. James Harrington in his 1987 book Poor Quality Costs. COPQ is a refinement of the concept of quality costs. In the 1960s, IBM undertook an effort to study its own quality costs and tailored the concept for its own use. While Feigenbaum’s term quality costs is technically accurate, it’s easy for the uninitiated to jump to the conclusion that better quality products cost more to produce. Harrington adopted the name poor quality costs to emphasize the belief that investment in detection and prevention of product failures is more than offset by the savings in reductions in product failures.