22 Sep 2021 20:03 IST

CoQ Methodology: The business guide to financial spending

Keeping a tight rein on quality and process deficiencies can improve company profits substantially.

Among the many ways in which Covid-19 has affected the economy, maintaining revenue consistency amid uncertainties is a major challenge every organisation is facing. The prices of raw materials are on the rise, the overall sentiment on the economy is mixed, and the prospects for interest rates going up is a matter of time. All of which are clear pointers that the profit margins are under enormous pressure.

There is a wide variety of choices for all the products available to the customers these days. With high competition for market share among companies, any increase in the prices might lead to loss of a customer base. Organisations are seeking a balance between maintaining their margins and holding on to their customers.

Here comes Cost of Quality, a methodology used to define and measure what amount of an organisation’s resources are consumed due to lack of quality and where. In other words, CoQ is the cost of failing to produce quality, and being aware of such costs can make a huge difference.

CoQ is broadly classified into four categories:

Graphics by V Visveswaran

  1. Internal failure cost: The cost of medicating the defects found in the product before delivering to the customer.
  2. External failure cost: The cost incurred in addressing the defects found by the customer.
  3. Appraisal cost: All costs associated with inspecting the goods and services to ensure they meet the quality norms.
  4. Prevention cost: The costs incurred with establishing good systems and the cost incurred to prevent the occurrence of damages.

Besides prevention costs, the other costs are results of failing to produce good quality products.

Competing on quality

Quality is the best business plan. When quality of the products gets a hit, the company’s performance, not to speak of the adverse impact on the brand, gets a hit. It is estimated that the average CoQ across sectors varies from 12 per cent to 20 per cent or more of the gross revenue. Which means every small reduction in the CoQ will be of great help to the company earnings. Here are a few examples:

  • In 2006, Dell recalled 4 million laptops due to faulty, overheating of batteries and the cost they had to pay for this was a whopping $400 million.
  • In 2010, Toyota Motor Corporation recalls 10 million cars due to a faulty accelerator pedal. The cost they incurred for the same was $1.2 billion.

What do we infer from these examples? Do we think that not enough prevention cost was spent to mitigate the defects before they reached the customer? Or do we see that they have probably lost more money due to quality failure than they need to invest in maintaining and improving the quality?

Clearly, proper quality checks were absent and efficient systems were not put in place to correct the quality issues that crept in. While spending on quality is important, keeping a track of costs incurred to medicate bad quality products is much more important.

Measuring costs right

Every organisation must consider the costs associated with achieving quality, as their objective is not only to meet customer needs but to do so at the lowest cost.

CoQ has been credited with the ability to impart many strategic benefits to an organisation. It promotes awareness of quality problems and provides motivation to solve them. It is also an effective performance measurement tool and a control mechanism. It facilitates in identifying major loss areas and setting realistic targets to achieve. This information would be key in the preparation of budgets by the companies.

Once the companies measure CoQ and get an idea about which element of CoQ — internal failure cost, external failure cost, prevention cost and appraisal cost — is occupying how much of the total CoQ pie chart, then management can take an informed decision on how best the expenditure needs to be altered to achieve the best results. One can turn customer complaints into customer satisfaction by increasing spending on prevention costs, which in turn will lead to reduced spending on failure costs, and result in overall customer satisfaction.

Not all companies across sectors are aware of this exercise. With the inherent limitations of non-availability of complete data to measure CoQ, very few companies practice keeping a record of the cost incurred on quality. Those that do, surely have a competitive advantage over their peers. So, start now, measure the cost incurred on the quality of your products to improve the quantity of your profits. As management guru Phillip Crosby said: “Quality is free.”
 

 

 

(The writer is CA Article Assistant, RVKS and Associates, Chennai.)