Friday, February 11, 2011

Cost of Mistakes

We are all intelligent and capable people. Occasionally we make dumb mistakes. For example, I enter a check amount incorrectly into my money-tracking program. It costs me a half-hour of looking for it at the end of the month when I need to balance the checking account.

Over my career, I've analysed the Cost of (Poor) Quality for many companies. By far, the categories of expenses that are the greatest are Internal and External Failure. Relatively, miniscule amounts of time and money is spent on Prevention. More is spent on Inspection/Appraisal.

Failure costs are the time and expenses used to fix mistakes: warranty costs, returns, discounts on slightly damaged goods, refunds, customer complaint handling, rework, repair and scrap. Inspection and Appraisal is pretty self-explanatory. Prevention expenses generally are found in training, design reviews, process validations (sometimes captured in Appraisal), etc.

Twenty years ago, a team found in a Fortune 500 accounting department that two-thirds of the activity was Appraisal and Failure. That means for every person doing work, there were two more looking, finding and fixing mistakes. There used to be a lot more discussion about Cost of Quality. Now there's hardly any. Chances are it's still generally 20-30% of a manufacturing company's cost of goods sold (COGS). In health care, for a variety of reasons, estimates have been given that are higher. Despite nearly 40 years of quality improvement efforts, there is a lot of process improvements still needed.

Many times the costs are buried, built into the standards.

Imagine if you could reduce those costs by 10%, which is generally not very hard. The bottom line improves by 1-2% of sales, maybe 20% of net income. That's worth 2-3% increase in sales. It's worth an increase in stock value (enterprise value) by 5% or more (depending on your earnings multiplier).

If you reduced COQ by 20%, now you can double how much your business value will increase.

Simple mistakes add up. You'd be amazed how much it costs you.

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