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A Quality Investment
How reducing the cost of quality will pay dividends for years to come
by Neetu Choudhary
Finance is the language of business. All investments must consider the profit they will earn, called the return on investment (ROI). The ROI formula is:
([Return - investment] / Investment) x 100
It’s easy to calculate project and service ROI, but it’s challenging to calculate quality’s ROI. It’s the main reason organizations don’t see financial value in investing in quality until it affects the overall organizational ROI.
Two important factors of business quality are it must be measurable financially and have a relationship to the financial results.
There is a relationship between quality and an organization’s bottom line: good quality reduces expenses and increases sales, while poor quality does the opposite—also known as the cost of quality (CoQ). Online Table 1 shows how an organization’s quality performance affects its bottom line. To understand CoQ’s returns, know that it has three components:
- Preventive costs are associated with efforts taken to prevent defects in the service, product or project. It’s cheaper to prevent defects than to fix them. Examples of preventive costs include quality management system setup, process definition, process repository, process training, quality engineering and statistical process control.
- Appraisal costs, also known as inspection costs, involve the cost of identifying defects or defective product before it’s shipped. This requires a dedicated review team, inspection and testing.
- Failure costs are the most expensive costs, and there are two different types: internal and external.
Internal failure costs are incurred to remove defects from the product or service before it reaches customers. For example, fixing defects, rework and scrapping rejected products.
External failure costs arise when the defective product is shipped to customers, defective projects go live and produce defects in the production environment and low-quality services are delivered. External failure costs include help desk costs incurred to resolve customer issues caused by defective products or services.
Two additional aspects to consider when analyzing quality’s ROI are investment vs. expense, and scope of quality.
Investments involve expenditures that are directly linked to measurable benefits, and a certain ROI is expected. To be considered profitable, the return must exceed the investment’s expenditure over time. In quality, the cost of a preventive action must be calculated and in line with its expected benefit or return. From a financial perspective, a preventive action is more beneficial to an organization than a corrective action.
In terms of the scope of quality, an organization’s CoQ improvement actions must address more than just the product. They also must address processes and systems because improvement actions must focus on preventing mistakes.
Often, organizations see the cost of a project or product as the cost of its development, but the actual cost includes production costs plus failure costs. Organizations can reduce project and product costs by investing in preventive and appraisal costs, which in turn reduce failure costs and overall project and product costs. This difference in reduced failure cost is quality’s ROI (see Online Figure 1).
Neetu Choudhary is a continuous improvement leader with a master’s degree in computer applications. She is an ASQ member, an ASQ-certified Six Sigma Black Belt, ISACA-certified in the governance of enterprise IT, European Foundation for Quality Management-certified assessor, business excellence awards assessor and jury member for various awards.