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Experts have estimated that Cost of Poor Quality typically amounts to 5-30% of gross sales for manufacturing and service companies. Independent studies reveal that COPQ is costing companies millions of dollars each year and its reduction can transform marginally successful companies into profitable ones.

A manufacturing company had annual sales of $250 million. Its quality department calculated the total cost of repair, rework, scrap, service calls, warranty claims and write-offs from obsolete finished goods. This aggregated cost, called Cost of Poor Quality (COPQ), amounted to 20% of their annual sales. A 20% COPQ implied that during one day of each five-day workweek, the entire company spent its time and effort making scrap, which represented a loss of approximately $ 100,000 per day.

Experts have estimated that Cost of Poor Quality typically amounts to 5-30% of gross sales for manufacturing and service companies. Independent studies reveal that COPQ is costing companies millions of dollars each year and its reduction can transform marginally successful companies into profitable ones. Yet most executives believe that their company's COPQ is less than 5%, or just do not know what it is. All levels of executives recognize that quality is an absolute necessity to survive and succeed in today's business environment. The diagram below provides a framework for calculating COPQ as a percentage of sales.

COPQ Calculation

In a recently published book "Success through Quality", the author estimates that COPQ for an average company is about 20% of sales, with a range as wide as under 1% for companies who have achieved "six sigma", about 15%-25% for companies who are at "four sigma" level and about 25% to 40% of revenue for companies who are at "three sigma" levels. A large fortune 500 communications company calculated its COPQ at 8.6% of sales in 2002 and has set a goal of 5.4% for 2005, which will result in a savings of a little less than $1 Billion per year!

COPQ in a Supply Chain 
The Cost of Poor Quality of individual suppliers participating within a supply chain has a cumulative effect on the COPQ of the OEM shipping the end product - see figure below. As a result, companies are working very proactively with their suppliers to reduce their COPQ. Many OEMs are also implementing supplier charge-backs (also called cost recovery), where a supplier is charged for the additional cost incurred by the OEM due to non-conforming components and materials and late deliveries from suppliers. A charge-back system is an effective way to introduce business discipline and accountability into the supply chain. OEMs use it as a "stick" for their suppliers to drive them to collaboratively identify the root cause of quality problems and to implement corrective actions.

COPQ in a Supply Chain

Reducing Cost of Poor Quality 
Systematic reductions in the Cost of Poor quality can be attained by implementing a Quality Management System (QMS) that provides an integrated and closed loop corrective action process. In a manufacturing organization, when deviations, nonconformance, out of specifications, quality incidents or customer complaints occur, corrective and preventive actions need to be initiated to remedy the problems.

Once a quality problem has been identified, the first step is to initiate an investigation and to properly identify the root cause of the problem. After the root cause has been identified, Corrective Action (CAPA) items are created and routed for approval. When approved, appropriate changes are implemented in the environment and then the CAPA is closed out. These changes may include amendments to a documented procedure, upgrading the skill set of an employee through a training and certification process, or recalibrating the manufacturing equipment. In addition, the system may capture COPQ associated with that non-conformance and use that information to initiate and complete a cost recovery process with a supplier.

It is critical to deploy a closed-loop, integrated quality management system, rather than a set of loosely connected modules from one or more vendors. Integration ensures that the information flows out the corrective action process with a high degree of accuracy and velocity without falling through the cracks. It also ensures that the entire change control process is auditable from end-to-end - a critical requirement to support FDA 21CFR part 11 and the Sarbanes-Oxley Section 404 audit criteria.

Cost of Poor Quality

The QMS system should also be web-based, so that the suppliers can easily participate in the quality management process. The suppliers often use the same plant to manufacture products for multiple OEMs. As a result, they cannot be forced to install different systems for different OEMs at the same plant to support their respective quality needs. Hence the OEM has to rely on process and product quality information from the supplier's quality system. That information usually does not integrate well with the OEM's own systems and is frequently not available in a timely manner. A Web-based QMS allows the OEM to make the application available to the supplier without requiring the supplier to implement the system at their site. As a result, the supplier can provide relevant quality information about the shipment to the OEM even before it ships from the supplier's dock. If there are quality issues with any supplier component, manufacturers can take appropriate preventive action even before it arrives or take it out of the supply chain to reduce their own COPQ. QMS systems that do not support web architecture make it difficult for an OEM, participating in a supply chain, to reduce its effective COPQ.

For a more detailed paper on cost recovery, click here - Supplier Charge-backs 
For more information on MetricStream and its integrated compliance and quality product set, click here 
Please send feedback on this paper or ideas for additional research topics to the author atagupta@metricstream.com

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