5. 7
NON-FINANCIAL MEASURES
BIG DECISIONS
—ALLOCATE RESOURCES
FEEDBACK
CEO
CFO
CIO
CUSTOMER INTERNAL
PROCESS
LEARNING + GROWTH
FINANCIAL MEASURES
TRAINING
GET
ATTENTION
Big Picture
Decision Relevance of Financial and Non-Financial
Measures inside the Firm
INVEST
MENT
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
6. 8
Week 7-8 Learning Outcome Summary
Introduction
Quality-Definition
Quality-Measurement
Learning objective 1: Explain the four cost categories in a costs-of-
quality program
Learning objective 2: Develop Nonfinancial measures and methods to
improve quality
Learning objective 3: Use cost of quality measures to make decisions
Learning objective 4: Use financial and nonfinancial measures to
evaluate quality
Time-related Measurement
Learning objective 5: Describe customer-response time and on-time
performance
Learning objective 6: Describe why delay occurs and their costs
Learning objective 7: Use financial and nonfinancial measures of time
Learning objective 8: Theory of Constraints
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
7. 9
Why quality and time?
Quality and time-based competition are often critical parts of any
competitive strategy
Quality based competition
Attributes of quality
1. Design and Conformance quality
who is our customer?
2. Drivers of quality (Casual influences)
How to execute?
Prevention Appraisal Internal failure External failure
SCA
Competitors
Customer
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
8. How important is Quality?
• Needle in Teddy Bear
• Quality and Cost are not Tradeoffs
10
12. Simple Factory Audit in
Asia
Extensive factory audit
(ISO 9001) in China and
Asia
Corporate Social Audits
(SA 8000) in China and
Asia
Pre Production
Inspection
First Article Inspection
Production Monitoring
in China & Asia
During Production
Inspection
Defect Sorting Service
Pre Shipment Inspection
Container Loading
Supervision
Lab Testing & Certification
China Sourcing Academy | 45
2. Three Circle Control Framework
3. Measurement and Verification (e.g. Asia Quality Focus)
14. ALWAYS BE WATCHFUL
Product arrives on time
Product is as ordered
Product works
CAN THEY REPLICATE THE
EXPERIENCE?
Summary
China Sourcing Academy | 35
16. 21
Define it
Product quality dimensions
Design
Conformance
Service quality
Measure it
Financial
Customer
Internal
Learning and Growth
Use it
Competing on Quality
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
17. 22
Quality – the total features and characteristics of a product or a
service made or performed according to specifications to satisfy
customers at the time of purchase and during use
A quality focus reduces costs and increases customer satisfaction
Quality as a Competitive Tool
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
18. 23
Actual
Performance
Design
Specifications
Customer
Satisfaction
Conformance
Quality
Failure
Design
Quality
Failure
1. Design Quality – refers to how closely the characteristics of a product or service
meet the needs and wants of customers
2. Conformance Quality – refers to the performance of a product or service relative to
its design and product specifications
Two Basic Aspects of Quality (Define it!)
Quality and Failure (Define it!)
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
19. 25
Performance
Refers to the efficiency with which a product achieves its intended purpose.
Features
Attributes of a product that supplement a product’s basic performance.
Reliability
The propensity for a product to perform consistently over its useful design life.
Conformance
Numerical dimensions for a product’s performance, such as capacity, speed, size,
durability, color, or the like.
Product Quality Dimensions (Define it!)
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
20. 26
Durability
The degree to which a product tolerates stress or trauma without failing.
Serviceability
Ease of repair.
Aesthetics
Subjective sensory characteristics such as taste, feel, sound, look, and smell.
Perceived Quality
Based on customer opinion. Customers imbue products and services with their
understanding of their goodness.
Product Quality Dimensions (Define it!)
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
21. 28
Service Quality Dimensions (Define it!)
• Tangibles
•Include the physical appearance of the service facility, the equipment,
the personnel, and the communication material.
• Service Reliability
•Differs from product reliability in that it relates to the ability of the service
provider to perform the promised service dependably and accurately.
• Responsiveness
•The willingness of the service provider to be helpful and prompt in providing
service.
• Assurance
•The knowledge and courtesy of employees and their ability to inspire trust
and confidence.
• Empathy
•Caring, individual attention paid to customers by the service firm.
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
22. 29
1. Financial
2. Customer
3. Internal Business Process
4. Learning and Growth
Four Perspectives of the Balanced Scorecard
(Measure it!)
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
23. 30
The Financial Perspective: Cost of Quality (COQ)
(Measure it!)
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
Four Categories of Quality Costs:
1. Prevention Costs – incurred to preclude the production of products that do
not conform to specifications
2. Appraisal Costs – incurred to detect which of the individual units of
products do not conform to specifications
3. Internal Failure Costs – incurred on defective products before they are
shipped to customers
4. External Failure Costs – incurred on defective products after they are
shipped to customers Learning Outcome 1:
Explain the four cost
categories in a costs-of-
quality program
…prevention, appraisal,
internal failure, and external
failure costs
(P. 757)
1
24. What is the reality of the
Cost of Quality Report?
• Nose Job
• Where do the quality costs come from?
31
25. Elements of Costs of Quality Reports (Measure it!)
32
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
The items in Exhibit 19-1 come from all business functions of the value chain, and they
are broader than the internal failure costs of spoilage, rework, and scrap described in
Chapter 18.
26.
27.
28. 36
Example - Photon:
Determining COQ Using Activity-Based Costing (Measure it!)
1. Identify the Chosen Cost Object (Photocopying machines)
2. Identify the Direct Costs of Quality of the Product (Employees such as inspectors and workers
in repair areas who are dedicated to a product line)
3. Select the Activities and Cost-Allocation Bases to Use for Allocating Indirect Costs of Quality to
the Product (Photon indentifies the number of inspection-hours as the cost-allocation base for
the inspection activity)
4. Identify the Indirect Costs of Quality Associated with Each Cost-Allocation Base (e.g.
photocopying machines use 240,000 inspection-hours)
5. Compute the Rate per Unit of Each Cost-Allocation Base (Column 2 of Exhibit 19-2, Panel A,
shows these rates)
6. Compute the Indirect Costs of Quality Allocated to the Product (Quality – related inspection
costs for the photocopying machines are $9,600,000 ($40 per hr * 240,000 inspection-hours))
7. Compute the Total Costs of Quality by Adding All Direct and Indirect Costs of Quality Assigned
to the Product (Photon’s total costs of quality in the COQ report for photocopying machines is
$40.02 million (bottom of column 4, panel A), or 13.3% of current revenues (bottom of column 5)
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
We illustrate the issues in managing quality – computing the cost of quality, identifying quality problem,
and taking actions to improve quality, - using Photon Corporation. Photon makes many products;
however, we’ll focus on Photon’s photocopying machines, which earned an operating income of $24
million on revenues of $300 million in 2013.
29. Example - Photon:
Activity-Based COG Analysis
37
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
Photon makes many products; however, we’ll focus on Photon’s photocopying machines, which
earned an operating income of $24 million on revenues of $300 million in 2013.
44
30. 38
Opportunity Costs as a result from poor quality:
Contribution Margin and Income forgone from lost sales
Lost Production
Lower Prices
Excluded due to estimation difficulties and being unrecorded as to
the financial accounting records
Cost of Quality Exclusions (Measure it!)
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
31. 39
NON-FINANCIAL MEASURES
BIG DECISIONS
—ALLOCATE RESOURCES
FEEDBACK
CEO
CFO
CIO
CUSTOMER INTERNAL
PROCESS
LEARNING + GROWTH
FINANCIAL MEASURES
TRAINING
GET
ATTENTION
Evaluating Strategy
Decision Relevance of Financial and Non-Financial
Measures inside the Firm
INVEST
MENT
32. 40
Example - Osborn, Inc.
Exercise 19-16 – Cost of Quality Analysis (rep old ex)
Osborn, Inc., produces cell phone equipment. Amanda Westerly,
Osborn’s president, decided to devote more resources to the
improvement of product quality after learning that her company
had been ranked fourth in product quality in a 2011 survey of cell
phone users. Osborn’s quality-improvement program has now
been in operation for 2 years, and the cost report shown here has
recently been issued.
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
33. 41
Example - Osborn, Inc.
Exercise 19-16 – Cost of Quality Analysis (rep old ex)
1. For each period, calculate the ratio of each COQ category to
revenues and to total quality costs
2. Based on the results of requirement 1, would you conclude that
Osborn’s quality program has been successful? Prepare a short
report to present your case.
3. Based on the 2011 survey, Amanda Westerly believed that Osborn
had to improve product quality. In making her case to Osborn
management, how might Westerly have estimated the opportunity
cost of not implementing the quality improvement program?
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
34. Example - Osborn, Inc.
19-16. The ratios of each COQ category to revenues and to total quality costs for each period are
as follows: Osborn, Inc. : Semi-annual Costs of Quality Report (in thousands)
6/30/2012 12/31/2012 6/30/2013 12/31/2013
Actual
% of
Revenues
% of Total
Quality
Costs Actual
% of
Revenues
% of Total
Quality Costs Actual
% of
Revenues
% of Total
Quality
Costs Actual
% of
Revenues
% of Total
Quality Costs
(1) (2) = (3) = (4) (5) = (6) = (7) (8) = (9) = (10) (11) = (12) =
(1) ÷
$8,240
(1) ÷
$2,040
(4) ÷
$9,080 (4) ÷ $2,159 (7) ÷ $9,300(7) ÷ $1,605
(10) ÷
$9,020
(10) ÷
$1,271
Prevention costs
Machine maintenance $ 440 $ 440 $ 390 $ 330
Supplier training 20 100 50 40
Design reviews 50 214 210 200
Total prevention costs 510 6.2% 25.0% 754 8.3% 34.9% 650 7.0% 40.5% 570 6.3% 44.9%
Appraisal costs
Incoming inspection 108 123 90 63
Final testing 332 332 293 203
Total appraisal costs 440 5.3% 21.6% 455 5.0% 21.1% 383 4.1% 23.9% 266 3.0% 20.9%
Internal failure costs
Rework 231 202 165 112
Scrap 124 116 71 67
Total internal failure
costs 355 4.3% 17.4% 318 3.5% 14.7% 236 2.5% 14.7% 179 2.0% 14.1%
External failure costs
Warranty repairs 165 85 72 68
Customer returns 570 547 264 188
Total external failure
costs 735 8.9% 36.0% 632 7.0% 29.3% 336 3.6% 20.9% 256 2.8% 20.1%
Total quality costs $2,040 24.7% 100.0% $2,159 23.8% 100.0% $1,605 17.2% 100.0% $1,271 14.1% 100.0%
42
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
35. 43
Example - Osborn, Inc.
Exercise 19-16 – Cost of Quality Analysis
2. Has Osborn’s quality program been successful?
• Total quality costs as a percentage of total revenues have declined
from 24.7% to 14.1%.
• External failure costs, those costs signaling customer dissatisfaction,
have declined from 8.9% of total revenues to 2.8% of total revenues and
from 36% of all quality costs to 20.1% of all quality costs. These declines
in warranty repairs and customer returns should translate into increased
revenues in the future.
• Internal failure costs as a percentage of revenues have been halved
from 4.3% to 2%.
• Appraisal costs have decreased from 5.3% to 3% of revenues.
Preventing defects from occurring in the first place is reducing the
demand for final testing.
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
36. 44
Example - Osborn, Inc.
Exercise 19-16 – Cost of Quality Analysis
2. Has Osborn’s quality program been successful?
• Quality costs have shifted to the area of prevention where problems
are solved before production starts: total prevention costs (maintenance,
supplier training, and design reviews) have risen from 25% to 44.9% of
total quality costs. The $60,000 increase in these costs is more than offset
by decreases in other quality costs.
• Because of improved designs, quality training, and additional pre-
production inspections, scrap and rework costs have almost been halved
while increasing sales by 9.5%.
• Production does not have to spend an inordinate amount of time with
customer service since they are now making the product right the first
time and warranty repairs and customer returns have decreased.
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
37. 45
Example - Osborn, Inc.
Exercise 19-16 – Cost of Quality Analysis
3. How might you estimate the opportunity cost of not
implementing the quality improvement program?
• Sales and market share would continue to decline if the quality
program was not implemented and then calculated the loss in
revenue and contribution margin.
• The company would have to compete on price rather than
quality and calculated the impact of having to lower product prices.
• Opportunity costs are not recorded in accounting systems
because they represent the results of what might have happened if
the company had not improved quality. Nevertheless, opportunity
costs of poor quality can be significant. It is important for Osborn to
take these costs into account when making decisions about quality.
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
38. 46
The Customer Perspective (Measure it!)
Nonfinancial Measures of Customer Satisfaction include:
• Surveys on satisfaction
• Market share
• Number of defective units shipped to customers
• Number of customer complaints
• Product fail rates
• Delivery delays / On-time deliveries
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
Learning Outcome 2:
Develop nonfinancial
measures and methods to
improve quality
…customer satisfaction
measures, internal-business
process measures and
learning-and-growth
measures.(P. 761)
2
39. 47
Three techniques for identifying and analyzing quality
problems:
Control Charts
Pareto Diagrams
Cause-and-Effect Diagrams
Internal Business Perspective (Measure it!)
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
40. Internal Business Perspective -Control Charts
(Measure it!)
Example - Photon’s copier problem
48
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
41. This Pareto diagram shows quality problem with respect to Photon’s photocopying
machines and also indicates how frequently each type of defect occurs.
49
Internal Business Perspective Pareto Diagrams
(Measure it!)
Example - Photon’s copier problem
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
42. Multiple suppliers
Incorrect specification
Variation in purchased
components
Flawed part design
Incorrect
manufacturing
sequence
Inadequate tools
Incorrect speed
Poor
maintenance
Inadequate
supervision
Poor training
New operator
Internal Business Perspective Cause-and-Effect
Diagrams (Measure it!)
Example - Photon’s copier problem
50
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
Human Factors Methods and
Design Factors
Machine-related
Factors
Materials and
Components Factors
43. 51
Percentage of defective products
Average repair time at customer site
Percentage of reworked products
Number of different types of defects found
Number of design and process changes made
Internal Business Perspective Non-financial
Measures (Measure it!)
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
44. 53
Employee turnover ratio
Employee empowerment – number of processes in which
employees have the right to make decisions without consulting
supervisors
Employee satisfaction
Employee training
The Learning and Growth Perspective
Non-financial Measures (Measure it!)
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
45. Application of relevant cost concept in Chapter 11
Example - Photon’s copier problem
Two solutions proposed (p.765)
Electronically inspect and test the frames before production starts.
Redesign and strengthen the frames and their shipping containers to
withstand mishandling during transportation.
See Exhibit 19-6
Estimated incremental costs
Cost savings from less rework, customer support and repairs
Increased contribution margin from higher sales as a result of building
a reputation for quality and performance (Exhibit 19-6, line 14).
54
Relevant costs and Benefits of Evaluating Quality
Improvement
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
Learning Outcome 3:
Use costs of quality measures to
make decisions…identify relevant
incremental costs and benefits
and opportunity costs to evaluate
tradeoffs. (P765)
3
46. Relevant costs and Benefits of Evaluating
Quality Improvement
Exhibit 19-6 Estimated Effects of Quality-Improvement Actions on Costs of Quality for Photocopying Machines at Photon Corporation
Relevant Costs and Benefits of
Further Inspecting Incoming
Frames
Redesigning Frames
Relevant cost Relevant Benefit per
Unit
Quantity Total
Benefits
Quantity Total Benefits
(1) (2) (3) (4) (5) (6)
Additional inspection and testing costs $(400,000)
Additional process engineering costs $(300,000)
Additional design engineering costs $(160,000)
(2)X(3) (2)X(5)
Savings in rework costs $40 per hr 24,000 hrs $960,000 32,000 hrs $1,280,000
Savings in customer-support costs $20 per hr 2,000 hrs 40,000 2,800 hrs 56,000
Savings in transportation costs for repair parts $180 per load 500 loads 90,000 700 loads 126,000
Savings in warranty repair costs $45 per hr 20,000 hrs 900,000 28,000 hrs 1,260,000
Total contribution margin from additional sales $6,000 per copier 250 copiers 1,500,000 300 copiers 1,800,000
Net cost savings and additional contribution margin $3,090,000 $3,862,000
Difference in favor of redesigning frames $772,000
55
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
1. Estimated
incremental costs
3. Increased contribution
margin from higher sales
as a result of building a
reputation for quality and
performance
2. Cost savings from
less rework, customer
support and repairs
47. 56
Advantages of Financial Measures of Quality
(Measure it!)
COQ focuses managers’ attention on the costs of poor quality
COQ measures assist in problem solving by comparing costs and
benefits of different quality-improvement programs and setting
priorities for cost reduction
COQ provides a single, summary measure of quality performance for
evaluating tradeoffs among the costs of prevention, appraisal,
internal failure, and external failure
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
Learning Outcome 4:
Use financial and nonfinancial
measures to evaluate quality
…nonfinancial measures are
leading indicators of future costs of
quality. (P766)
4
48. 57
Advantages of non-financial Measures of Quality
(Measure it!)
Nonfinancial measures of quality are often easy to quantify and
understand
Nonfinancial measures direct attention to physical processes and to
areas that need improvement
Nonfinancial measures provide immediate short-run feedback on
whether quality-improvement efforts have succeeded
Nonfinancial measures are useful indicators of future long-run
performance
Introduction Quality-Definition
Quality-
Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
49. 58
NON-FINANCIAL MEASURES
BIG DECISIONS
—ALLOCATE RESOURCES
FEEDBACK
CEO
CFO
CIO
CUSTOMER INTERNAL
PROCESS
LEARNING + GROWTH
FINANCIAL MEASURES
TRAINING
GET
ATTENTION
Evaluating Strategy
Decision Relevance of Financial and Non-Financial
Measures inside the Firm
INVEST
MENT
50. 59
Summary
Introduction
Quality-Definition
Quality-Measurement
Learning objective 1: Explain the four cost categories in a costs-of-
quality program
Learning objective 2: Develop Nonfinancial measures and methods to
improve quality
Learning objective 3: Use cost of quality measures to make decisions
Learning objective 4: Use financial and nonfinancial measures to
evaluate quality
Time-related Measurement
Learning objective 5: Describe customer-response time and on-time
performance
Learning objective 6: Describe why delay occurs and their costs
Learning objective 7: Use financial and nonfinancial measures of time
Learning objective 8: Theory of Constraints
Introduction Quality-Definition Quality-Measurement
BSC Time-Related
Measures
Theory of ConstraintsTime-related Measures
