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Total Quality Management

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Quality costs and total quality

management
a a b
Jens J. Dahlgaard , Kai Kristensen & Gopal K. Kanji
a
The Aarhus School of Business, Aarhus, Denmark
b
Sheffield City Polytechnic, Sheffield, UK
Version of record first published: 28 Jul 2006.

To cite this article: Jens J. Dahlgaard , Kai Kristensen & Gopal K. Kanji (1992): Quality costs
and total quality management, Total Quality Management, 3:3, 211-222

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 TOTAL QUALITY MANAGEMENT, VOL. 3, NO. 3,1992

Quality costs and total quality

management

JENS J. DAHLGAARD', KAIKRISTENSEN' & GOPAL

K. K A N ~ I ~
'The Aarhus School of Business, Aarhus, Denmark & *Shefield City Polytechnic,
Shefield, U K
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Abstract The quality cost in total quality management is one of the most important aspects
of the development of a quality management system. In this article a model of a quality
management system has been developed incorporating the quality cost of the organization.
Finally to evaluate the quality management system of some printing industries a new indirect
method of measuring total quality cost has been introduced to estimate the total cost.

1. Aims of quality management system

T h e aim of the quality management system is to maintain or improve the quality of a firm's
products and services, by fulfilling the satisfaction of consumer expectation. T h e elements
of quality management systems vary from firm to firm, depending on the type and size of
the firm and therefore it can be difficult to evaluate the appropriateness of such systems. An
additional reason for this difficulty is that the total quality management activities of the
firm are sometimes more or less hidden, and not explicitly classified as a quality manage-
ment system. This can be made more clear if quality management systems are defined as
the firm's total activities as follows:

(1) planned quality activities;

(2) preventive and inspective quality activities;
(3) quality improvement activities;
(4) quality information activities;
(5) quality motivating activities.

I t may be argued that (I), (3), (4) and (5) are all examples of preventive activities, so the
ultimate classification of quality management activities can be given below:

(a) preventive quality activities;

(b) inspective quality activities.

As mentioned earlier, the aim of these activities is to increase the satisfaction of the con-
sumer expectation, by way of qualitative improvement of the firm's products and services.
T h e above activities therefore must be justified on the basis of this objective, and failing
which, either they will be counted as superfluous or not a part of the firm's quality
management system.
 212 J. J. DAHLGAARD ETAL.

2. Failure in quality management

I n evaluating quality management systems, it is not adequate only to identify and evaluate
the firm's existing quality management activities, partly because missing activities are not
brought to light. T h e evaluation of quality management systems must therefore be carried
out with a starting point of the potential failures in all departments and functions of the
firm. When these have been accounted for, the existing quality management activities must
be compared and evaluated in relation to the potential failures.
I t is important that the potential failures are determined on the basis of the funda-
mental aim of the quality management system. A failure, for instance, can be described if
the firm's quality of design does not contain the necessary qualities to maintain or improve
customer satisfaction. This failure can be the result of missing activities, inferior consumer
analyses, or inadequate control of the actual product development function. A failure can
also be designated if quality ofproduction fails to live u p to the design quality specified in
the product specifications. There are many failures and their causes can be found in all
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departments and functions.

There are also some 'potential failures' in the post production phase and most of them
are due to failures originated in the sales and service departments. T h e quality of sales
and services is often too poor. 'Failure' must be perceived in the widest sense, since it
can be either looked at as a deficiency in the 'planned' sales/service quality, or inferiorly
'produced' sales/service quality.
I t is therefore necessary that the evaluation of quality management systems must start
with the identification of potential failures and causes thereof, and continue to do so
thereafter. We believe that this is the only way the real effectiveness of existing quality
management activities can be evaluated. In this connection, it is also important to remind
us that the basic classification of quality management activities can be divided into two
parts, i.e. preventive and inspective activities, and the concept of quality cost must be
judged in this context.

3. Quality management activities and quality cost

As mentioned earlier, quality management activities are normally classified according to

the two main groups of activities. They are:
(1) preventive quality activities;
(2) inspective quality activities.
As the name implies, the aim of preventive quality activities is to anticipate and prevent the
emergence of failures, while the aim of inspective activities is to locate and correct failures
which, in spite of the preventive activities, have managed to escape.
T h e use of preventive activities in quality management is vital for a company's com-
petitiveness, and its requirement imposes one of the greatest challenges for the 1990s.
There are many examples where top management are not doing their job and are handing
over their quality responsibility either to the production department or to a so-called
quality department. These departments very often do not practice quality management
and therefore any attempt to introduce preventive quality activities within the company
will be a hopeless task.
A more precise aim of preventive quality activities is to locate and remove the causes of
quality failures throughout the company. However, if top management do not carry out
their responsibilities, then either it is not done at all, or done badly.
 QUALITY COSTS AND TQM 2 13

In recent years D r W. Edward Deming has suggested that 850/, of all quality failures
in western firms is attributable to management, because management has done very little,
or even nothing at all, in this vital area. In practice, instead of using their energies and
resources to introduce preventive quality activities into all the functions of the firm, they
are in fact too busy blaming each other for the failures.
Like all other activities, quality management activities cost money. This cost is called
quality management cost, and is a measurement of a firm's efforts in maintaining and
improving its quality level. T h e quality management cost has a direct effect on the firm's
failure costs. These costs are usually of considerable size and the sizes are inversely
proportional to the quality of the firm's management activities.
Failure costs, which may amount to 10-15% of the turnover, are frequently termed as
'the hidden factory', because often they are of such a size that they could easily finance a
completely new factory. T h e term 'hidden' is used due to the fact that, sometimes, failure
costs are inadequately registered in the firm and, on some occasions, failures are never
discovered. A typical example of this is that when a customer takes delivery of a faulty
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product and then does not complain, instead the customer takes his custom to somewhere
elsewhere. Here, failure costs are equivalent to future loss of profits due to delivery of a
faulty product and the costs in this case are difficult (if not impossible) to estimate.
Here the 'hidden factory', i.e. the above 10-15% of turnover, includes only the more
'traditional failure costs', i.e. the costs involved in correcting the fault, or the costs of
replacing the product entirely. At first sight, these costs seem reasonably easy to calculate.
However, experience has shown that when the level of failures in the firm rises, the result is
chaos. It is therefore necessary that all the employees, including management, will be
involved in preventing the faults in order to avoid any such failures happening in the
future.
Following our discussion of 'quality management costs' and 'failure costs' we will now
concentrate on the concept of 'quality costs'. In fact, the concept of quality costs have
already been described, since they are equal to the sum of 'quality management costs' and
'failure costs'. Cost is often perceived as being a necessary evil, and something which is to
be reduced whenever and wherever possible. As far as quality costs are concerned, it can be
seen from the above discussion that failure costs can be reduced by investing in the quality
management activities. Of those activities the most effective way has proved to be invest-
ment in preventive activities. Apart from a decline in failure costs, there is also an effect on
inspection activities, which gradually become more and more superfluous, and can thereby
be reduced.
Various benefits from the investments in preventive quality management activities
can be seen as follows:
(1) reduction in failures and failure costs;
(2) increase in customer satisfaction;
(3) diminished need for inspection and inspection costs;
(4) rise in productivity;
(5) improved competitiveness and profits;
(6) increased market share.
These benefits are some of the reasons why we often hear the statement: 'Quality is free'.
However, other benefits of the investment in preventive activities will provide the
employees with the knowledge of doing 'things right the first time'. It will change the
company culture, provide more creative employees, and will encourage new ways of
improving quality.
 2 14 J. J. DAHLGAARD ET AL.

Table 1 . A new curegorizariotz of the quality costs

Internal costs External costs Total

Visible costs la. Scraplrepair costs 2. Warranty costs 1+ 2

I b. Prevention/appraisal (complaints)

Invisible costs 3a. Costs due to internal inefficiencies 4. Loss of goodwill 3+4
3b. Preventionlappraisal costs (=loss of future sales)

Total 1+ 3 2+4 1+2+3+4

However, this new Quality Culture will not emerge overnight. Employees at all levels
must be taught, trained, and motivated to understand and apply the fundamentals of quality
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management in their own work place. Experience shows that, if handled corrcctly much
progress can be made during the course of a couple of years. This educational strategy is one
preventive quality management activity which, in a few years, will yield several hundred
percent dividend. A dividend which no other in the Stock Market can boast for their
investment and for this reason alone top management must take the leadership and invest
as early as possible to make these high rates of return to become a reality.
Let us look at further detail on the quality costs. Most of the literature on quality cost
agrees that it is important to measure it, and an increasing number of companies nowadays
are also trying to measure the total quality costs. Although these companies are using the
prevention-appraisal-failure categorization of quality costs (Feigenbaum, 1956), the
registrations of the quality cost is seldom satisfactory. T h e measurements are usually very
poor and insufficient in estimating the company's total quality costs. One of the reasons for
this is that many managers do not understand the concept and definitions of quality costs
(Dale & Plunkett, 1991, p . 4). We also believe that another important reason for this is that
the prevention-appraisal-failure categorization is not sufficient and adequate for measure-
ment of the quality cost of a T Q M company, and requires some modification. We need a
new categorization of quality costs. Table 1, given above, shows such a proposal for a new
categorization of quality costs.
I t is seen that the total quality costs are classified in a 2 x 2 table in which the costs on
the one side are subdivided in internal and external quality costs, while on the other side
they are subdivided into visible and invisible quality costs respectively.
Regarding the classification of quality costs into visible and invisible costs Deming
(1986, p. 98) has pointed out that:
"Deadly diseases afflict most companies in the western world . . .. Cure of the
deadly diseases will require total reconstruction of western management".
According to him one of these 'deadly diseases' is:
"The use of only visible figures, with little or no consideration of figures that are
known or unknowable".
H e further elaborates his example of a deadly disease (op. cit. pp. 121-123) by saying that:
"One cannot be successful on visible figures alone. Now of course, visible figures
are important . . .. But he who runs his company on visible figures alone will
in time have neither company nor figures. Actually, the most important figures
 QUALITY COSTS AND TQM 2 15

that one needs for management are unknown or unknowable but successful
management must nevertheless take account of them".
Some of the Deming's examples of invisible figures include:
(1) T h e multiplying effect on sales that comes from a happy customer, and the
opposite effect from an unhappy customer.
(2) T h e boost in quality and productivity all along the line that comes from success
in improvement of quality at any station upstream.
(3) Improvement of quality and productivity from continual improvement of pro-
cesses, also from elimination of work standards, and from better training or
better supervision.
(4) Improvement of quality and productivity from teamwork between engineers,
production, sales and the customer.
(5) Improvement of quality and productivity from a team composed of a chosen
supplier, the buyer, engineering design, sales, customer, working on a new
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component or redesign of an existing component.

These and other similar examples have given us the idea of the new categorization of
quality costs and the model for construction and evaluation of quality management sys-
tems which is proposed in Section 4. T h e examples mentioned above are very useful for the
understanding of Table 1 and the model in Section 4 because they refer to the results of
missing prevention activities.
Prevention activities, in general, can be characterized by the attribute that a great
proportion of these activities are not formally described in the company's quality manual.
Further a great deal of the company's prevention activities may be unknown to manage-
ment and as a consequence a great proportion, of the total prevention costs are invisible.
However, it is necessary that the management understand this and work systematically
with these invisible quality costs.

4. Construction and evaluation of quality management systems

In order to construct and evaluate quality management systems for the concepts described
in the previous sections, we will first of all develop a model as shown below in Table 2.
The utilization of the model in Table 2 basically depends on the use to which it is
put, i.e. the auditing of quality management systems, or their construction. For further
understanding, auditing is discussed in Section 4.1, and construction in Section 4.2.

4 . 1 . The auditing of quality management systems

'Audit' means examination, and the term 'quality audit' refers to the evaluation or
examination of quality management systems.
In Japan, the 'auditing' of quality management systems is a very important element in
total quality management. 'Audits' are carried out annually, and an important aspect of
this procedure is the firm's managing director who, along with the individual heads of
departments and a 'quality auditor', examines and evaluates the quality management
systems, problems, and results of the various departments. By active participation in the
annual quality audit, top management demonstrates their total commitment to quality. A
total audit like this typically takes about a week to complete.
One of the purposes of auditing the quality management system throughout the year is
to ensure that the system does not become static and can meet the changing demands and
 216 J. J. DAHLGAARD ET AL.

Table 2. A ntodelfor rhe corrsrrucriotr and eval~tariono/ qualiry managenrent sjlsrenrs (deparrtrzr~zrl
/ ~ t z c r i o ~ / p r ~ d ~ ~ c j~) - N o .

Quality management
activities Failure

Potential Inspection/ Failure Failure per

failures Prevention appraisal cost frequency year
PI, pa . P,", I , , 12, . I,#; CI, Hi] C,, ",
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conditions required both by the market and internally. T h e annual quality audit also helps
them to acquire first-hand information about a number of critical problems which was
previously unknown to them, although sometimes top management might be under the
impression that everything in the company was going well. However, after participation
in the annual quality audit, some managers might be able to find the existence of a
number of quality problems. T h e obvious solution to the firm's quality problems is, of
course, to set a quality improving process in motion and to make resources available for its
implementation.
In order to apply the model in Table 2 in connection with the 'auditing' of quality
management systems, first of all, some relevant questions must be asked, from a set of check
lists and then with the help of the answers a model can be developed for the construction of
specific tables for individual department's 'quality status'. This documentation is seen as a
good starting point for further thorough analyses and decision making.
T h e suitable questions that could be asked from the check list on the basis of column 1
of the model are:
(1) Which quality problems/failures have been observed during the past year?
The answer to this indicates the possibilities of potential manifest failures, and
can (in a department j ) be numbered serially, as shown in Fig. 2 (F,j, F,,, ...).
These numbers are now inserted into column 1 of the diagram.
( 2 ) Which additional quality problems/failures may arise when considering the aim
of quality management (i.e. maintaining or improving consumers' satisfaction of
expectation)?
The answer to this indicates the latent, i.e. the hidden possibilities of failure.
They are hidden because either the failure has not occurred, or it has occurred,
but not yet been registered within the firm.
 QUALITY COSTS AND TQM 2 17

It is important to spend as much time as possible discussing these potential failures in

detail in order to discover the real number of failures. T h e seven new quality control tools,
especially the affinity diagram and the matrix diagram, may be well suited for this purpose
(see Mizuno, 1988).
These two questions were asked to groups of employees in a Danish printing com-
pany. T h e groups were established during a 1 day quality seminar held externally to the
company. T h e participants in the groups discussed the two questions and wrote down their
anwers. Some of their answers were the following.
T h e quality of customers' films are often too bad.
T h e quality variation between different jobs is too high.
Too many failures on 'the order bag'.
Too many printing plates with failures from the printing department.
T h e quality of raw material is sometimes too low.
Bad control with output from different departments.
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Bad control with raw material from external suppliers.

Instructions on 'order bag' are not always read correctly.
No check of own work.
Bad communication.

Of course there will be a lot of overlap in the answers, so the first answers are only the
starting point for more questions in order to identify the causes behind. We will not
elaborate on that point in this article but we will assume that 'the ultimate answers' have
been found.
T h e next questions emerge from the possibilities of failure (='the ultimate answers'
to questions (1) and (2)) registered in column 1. Each possible failure raises the following
questions:

(3) Which preventive activities have been introduced to forestall the occurrence of
failure?
(4) Which inspective activities have been introduced to spot failures which have
already occurred?
The answers to these questions are described and numbered as, for example, in Fig. 2. T h e
numbers of these activities are inserted into the scheme as indicated, and we can, by simple
cross-reference, reveal which failures are exposed by which quality management activities.
It is now possible to undertake thefirst simple analysis on the basis of an incomplete
scheme. Here, the cross references will indicate which failures are exposed by preventive
and/or inspective quality management activities. I t provides a good starting point for a
thorough analysis of the type of activities that are lacking at present.
While dealing with quality cost in deeper analysis some people might be confronted
with various cost considerations, which could form the background of the last 3 columns in
Fig. 2. For each of the failures, one or more of the following questions may be relevant.

(5) What is the cost per failure?

( 6 ) How frequently do failures occur?
(7) What are the failure costs per year?
Although, in general, all the above questions are relevant to most of the departments,
nevertheless, some departments might feel that these situations are only relevant to the last
question. T h e main point here is that an estimation of the annual failure costs is made and
 218 J. J. DAHLGAARD E T A L .

with the help of these estimations, failure can be ranked in order of importance. This will
help to determine an order of priority for the quality management plan.
I n the case of latent failurc possibilities, the column indicating the failurc frcquency
cannot be filled out or it is eventually fillcd out with zero ratings. For these failures, the last
but two column of the model will give the only chance of analysing the existing quality
management activities.
As a supplement to the cross referencing of quality management activities employed,
the model can be further furnished with information about the resources used in the new
quality management activities. T h e rationale behind this is that the costs of quality
management must not be allowed to exceed the gains.

4.2. The construction of quality management systems

Here, the model is used for the development of quality management systems especially
when the firm has not introduced any quality management, or for the situations where the
firm is in the process of developing a completely new product and desires to develop and
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implement a quality management system for that product.

I n the latter situation, the modcl is characterized by the fact that all potential failures
are latent. This makes extra large demands on the use of the model and imagination,
creativity and the intuitive problem pcrccption is central to this use.
When the latent failures have becn identified, the next step is to estimate the failure
costs per failure. Here, to cstimate the risk of failures recurring, consideration is given to
alternative preventive and inspective quality management activities which can be intro-
duced in order to reducc the expected annual failure costs. T h e activities chosen arc
thereafter inscrted into the model and cross-referencing carried out as shown in Table 2.
Although the estimates made concerning failure costs and risks are not accurate,
nevertheless, the crucial point here is not so much of the accurate estimates, but to help the
uscrs of the model to think about how to construct a quality management system already in
the product development phase. Wc bclicve that this is the only way that future problems
in the firm can be minimized.
With regard to the use of the model in the situations where the firm has not yet
introduced the quality management system, this will be a compromize between the one
described in Section 4.1 and the one describcd above. T h e firm will presumably have a
number of inspective activities and anumber of manifest failure possibilities in the individ-
ual functions. What is often lacking is a systematic investigation of the consequences of
individual failure possibilities, i.e. an evaluation of the size of the failure costs. Apart from
that, a systematic analysis of required preventive quality managemcnt activities to be
introduced for the individual failure possibilities is also missing. Finally, the modcl pro-
vides the opportunities to evaluate the cxistcnce of latcnt failure possibilities. Table 1
which is still the fundamental model for construction of the specific analytic approach
provides the status of quality management in the individual department and at the same
time it serves as the starting point for all subsequent quality planning. Without such a
scheme, one will find difficulties in asking the right questions, and without the right
questions the company may have a survival problem. Here, thc size of thc 'hidden factory'
will gradually incrcasc and the visiblc factory will disappear. T h e total quality costs as
shown in Table 1 will gradually rob the company's quality profit and equity.

5. An indirect measurement of total quality costs

From our previous discussion it follows that the two most important aspects of a company's
total quality costs are:
 (1) prevention costs;
(2) failure costs.
And they can be characterized due to the fact that a great proportion of the above items are
unknown (invisible) simply because they are neither possible nor suitable (economically)
to register.
In this section a method for indirect measurement of a lower limit of a company's total
quality costs has been proposed. This lower limit is then used to evaluate the effectiveness
of the company's quality management system. T h e method used is as follows:
Let P,, be the ordinary profit in a companyj at time t and let N,, be the number of full
time employees in that company at the same time. Furthermore let the m companies of the
same categories in the market be ranked according to profitability as follows:

If we then define the short term lower limit of the total quality costs for company j as
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then from (2) it is evident that the short term lower limit of the total quality costs can be
calculated for companyj as the difference between the ordinary profit per employee for the
most profitable company in the market (i.e. company m) and the profit per employee for
company j (i.e. the company under discussion) multiplied by the number of employees in
that company. In this way the most profitable company's'hancial result is used as a
benchmark for all the other comparable companies which are competing in the same
market.
An important reason for selecting this method is that it is simple and easy to use. The
method will be demonstrated in the following printing industry example where the method
has been fruitfully applied.
Let us consider a group of printing industries in Denmark which comprises of 205
book printing and offset printing companies. Eighty of those companies have been
analysed using the above method with the following results:

PIn,/N,,,,
= 5998980/30 = 199,966 Dkr (Danish Kroner).

T h e profit per employee varies from the maximum of 199,966 Dkr to a loss per employee of
254,142 Dkr. Of the 80 companies, 24 companies have a negative profit (=loss) per
employee. T h e lower limit of the short term total quality costs varies considerably. Figure
1 shows the relationship between the lower limit of the total quality cost and company size
measured with the number of employees.
I t is seen that the lower limit of the total quality cost increases with the number of
employees and a surprisingly strong linear relationship between the two variables is shown
(r2=0.97). One explanation for that is, that the total profit decreases when the number
of employees grows. This relationship is shown in Fig. 2. This somewhat unexpected
relationship has been found by other researchers in connection with studies of European
organizations. A discussion of the phenomenon can be found in Jacquemin & de Jong
(1977).
It looks as if the companies do not know how to manage the company when the
number of employees grows.
For a particular company in which one of the authors is a member of the board the
lower limit of the total quality costs has been calculated as:
 -
- - -

220 J. J. DAHLGAARD ET AL.

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- 10,000,000 1 I I I
0 50 100 150 200
Employee
Figure 1. The relarion.ihip of lower Itn~itof qua lit^^ cost and rruntber of enzployees.

- 10,000,000 I I I
0 50 100 150 200
Employee
Figure 2. The relurio}rship berweerr the roralprofit and number ofenrployees.

C,, = (199,996 - 35,384)64 = Dkr 10,533,248.

It is interesting to notice that this lower limit is equal to 13'y0 of the company's turnover.
Having obtained reliable information about the visible quality costs it is easy to calculate a
 QUALITY COSTS AND TQM 22 1

Table 3. Threegroups' estimation of the company's total quality costs

Failure Prevention/ Loss of

costs appraisal goodwill
Group (1) costs (2) (3) Total

lower limit of the so called invisible quality costs. Also having information about the
previous and present customers it may be possible to estimate loss of goodwill. In this case
it is also easy to calculate a lower limit of the invisible internal costs.
After further detailed analysis of the remaining companies which had a greater profit
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per employee than company j, it was decided that some of these companies cannot be
suitably compared with company j and a further 'screening' process resulted in the
following adjusted lower limit:
C,, = (109,185 - 35,384)64 = Dkr 4,726,976
which is equal to approximately 6% of the turnover.
We can now compare the above lower limit of the quality cost with the results obtained
by three groups of seven managers each during their brain-storming sessions for the same
company using the following aspects:
( 1 ) internal and external failure costs;
(2) prevention and appraisal costs;
(3) loss of goodwill.
After having constructed the list, the group estimated the costs of each cost item and the
total costs of each cost group. T h e results are shown in Table 3.
At that stage, the three groups did not know the calculated results of the lower limit of
the total quality costs. T h e groups' results shown in Table 3 were calculated from g r o u p
independent discussions and evaluations. T h e results speak for themselves and do not
require any further explanation.

References
DALE,B.G. & PLUNKETT, J . J . (1991) Quality Costing (London, Chapman & Hall).
DEMING,W.E. (1986) Out of the Crisis (Cambridge, MA, MIT, Centre of Advanced Engineering Study).
FEIGENBAUM, A.V. (1956) Total quality control, Harvard Business Review, 34(6), pp. 93-101.
JACQUEMIN,A.P. & DE JONG,H.W. (1977) European Industrial Organisarion (London, Macmillan).
MIZUNO,S. (1988) Management for Quality In~provernent(Cambridge, MA, Productivity Press).
Downloaded by [171.67.34.69] at 06:39 28 February 2013