What it means
Every defect has a price. A faulty part has to be scrapped or reworked, a late delivery may trigger a penalty, and a poor service experience may cost a repeat customer.
The cost of poor quality adds these losses together. It is usually split into two groups.
Internal failure costs arise before the product reaches the customer, such as scrap, rework and re-inspection. External failure costs arise after delivery, such as warranty claims, returns, complaint handling and lost sales.
The wider term cost of quality also includes the money spent on prevention (training, process design, supplier checks) and appraisal (inspection and testing). Companies accept some prevention and appraisal spending in order to reduce failure costs, which is the central trade-off in quality management.
Many of these costs are hidden because they are not recorded in a separate account. Rework time sits in labour costs, scrap sits in materials, and a lost customer never appears at all.
A quality or finance team usually has to build the figure by combining data from several systems. The result is typically shown as a percentage of revenue, and tracking it over time shows whether quality programmes are paying off.
If failure costs fall faster than prevention spending rises, the business is better off. The ideal is to catch defects early, since problems found by the customer are far more expensive than those found on the line.
Be careful not to count the same cost twice. Estimates for intangible effects such as reputation damage are difficult to measure, so they are best shown separately and labelled clearly as estimates.
In practice
Real-world examples
Example 1
A bakery throws away 8% of its daily bread because of inconsistent oven temperatures. The value of the wasted ingredients and labour is counted as internal failure cost and becomes the case for a new oven control system. The owner compares the yearly waste with the price of the equipment and sees a payback of under two years.
Example 2
A software company releases an update with a bug that triggers 1,200 support tickets. The support hours, refunds and engineering time to patch the problem are external failure costs.
Example 3
A hotel chain refunds guests who report cleanliness problems and re-cleans rooms flagged by inspectors. The refunds and extra housekeeping hours show the price of getting room quality wrong the first time. Management uses the monthly total to decide how much to invest in staff training.
Think of it
It is like ignoring a small water leak under your kitchen sink. Fixing the pipe immediately is cheap prevention, but ignoring it leads to rotting floorboards, ruined cabinets, and expensive emergency plumber call-outs.
Formula
Calculation
Cost of poor quality = internal failure costs + external failure costs
Cost of poor quality as a percentage of revenue = cost of poor quality / revenue
A manufacturer with annual revenue of $4,000,000 records scrap of $85,000 and rework of $40,000, so internal failure costs are $85,000 + $40,000 = $125,000. It also records warranty claims of $60,000 and customer returns of $35,000, so external failure costs are $60,000 + $35,000 = $95,000. The cost of poor quality is $125,000 + $95,000 = $220,000, which is $220,000 / $4,000,000 = 5.5% of revenue.Case study
Seen in the real world
Tidewater Components is an illustrative, fictional maker of pumps. The managing director believed quality was good because few customers complained, but the finance team was asked to calculate the cost of poor quality for the first time.
They found $310,000 of scrap and rework on the factory floor and $190,000 of warranty and return costs, a total of $500,000 on revenue of $8,000,000. That was 6.25% of revenue and larger than the whole marketing budget.
The company spent $60,000 on supplier audits and operator training and cut the failure costs by $180,000 the next year. In this illustrative case, putting a dollar figure on poor quality made it a board-level priority.
Watch out
Common mistakes
- Counting only scrap and warranty costs, and missing hidden costs such as rework hours, extra inspection and management time spent on complaints.
- Treating spending on prevention as a cost to be cut, when it is usually cheaper than the failures it avoids.
- Measuring the figure once and never again, which gives no evidence of whether improvements are working.
Questions
People also ask
What is the difference between cost of quality and cost of poor quality?
Cost of quality includes prevention and appraisal spending as well as failure costs, whereas cost of poor quality covers only the failure costs.
How much should a business expect to lose to poor quality?
It varies widely by industry and process, and what matters is the trend and the largest sources of failure within your own operation. Start by ranking the failure types by dollar cost and tackle the biggest first.
Who should measure the cost of poor quality?
Finance and quality teams working together, because finance holds the cost data and quality staff understand where defects arise. Operations managers should then own the actions that reduce it.