Understanding Quality Control Costs in Manufacturing

Quality-related costs impact nearly every part of a manufacturing operation. Scrap, rework, warranty claims, downtime, delayed shipments, and lost production capacity can all affect profitability and operational efficiency. Most manufacturers track the visible costs tied to poor quality, but the larger challenge is understanding the hidden costs that spread across operations over time. Both can have a major impact on the bottom line. To help clients, prospects, and others understand these costs and their effects, BMSS Advisors & CPAs has summarized key details below.

What Are Quality Control Costs?

In manufacturing, the cost of quality (COQ) is the total cost of preventing, identifying, and correcting quality-related issues. These costs happen at various stages of production and can generally be divided into four categories:

• Prevention costs involve stopping quality defects before they occur. Establishing and maintaining a quality management system is often the first and most important step. Other common examples include providing training to employees and conducting preventative maintenance on machines and equipment. 

• Appraisal costs usually involve product inspections, monitoring systems, and quality audits. This is how the plant determines if a product meets quality standards before shipping to the customer and is usually a high-focus area for manufacturers. 

• Internal failure costs occur after a defect affects production but before the product reaches the customer. It includes scrap, rework, downtime, and production delays. It can also include failure analysis to find the cause(s) of the problem. 

• External failure costs occur after the customer receives the product. These costs are often more challenging to track and harder to recover. They include categories like warranty claims, returns, replacement costs, recalls, and issues with customer satisfaction.

The often cited 1-10-100 rule of quality management says it costs $1 to prevent a problem, $10 to identify it during production, and $100 to correct it after the customer receives a faulty product. In other words, the longer a quality problem continues, the higher the cost. 

What Are the Hidden Quality Costs Impacting Profitability? 

Some quality costs are visible and relatively easy to measure. Areas like scrap materials, rework, and returns are often part of quarterly or monthly reports. Downstream costs are more difficult to quantify because they affect multiple departments and processes across the organization.

In fact, a recent report by the American Society for Quality (ASQ) states that up to 90% of quality-related costs are hidden and, therefore, missing from most manufacturing dashboards. This seems to directly connect to another data point from the report: only 31% of manufacturers say they fully understand the impact of quality costs on financial performance. 

Uncovering these costs is becoming even more important to business performance, especially during periods of rising material and labor costs. These numbers can give the business the ability to accurately calculate quality costs by category and then prioritize high-impact improvement efforts.

For example, a business may discover that overtime tied to rework or production delays increases by 20% during the summer months. From there, leadership can investigate the root cause. The issue could involve temperature control systems causing machinery problems. It could involve poor ventilation on the plant floor. Or inspections may happen less frequently because of vacation schedules. There are many possible reasons for the increase, but without an investigation, the cost overrun won’t be addressed. It will only continue to grow and reduce margins over time.

Inventory issues can create a similar chain reaction. A manufacturer may decide to carry additional materials or finished goods because production teams expect a certain amount of scrap or rework. At first, the extra inventory seems like a plausible workaround, but over time, storage costs steadily increase. What looks like a storage problem may actually be a production or supplier quality problem, and that starts to trickle down. Eventually labor costs, scheduling, and throughput are all affected. 

Lost business can be even harder to measure. If a customer isn’t satisfied with a product, they might reduce order volume or request additional plant oversight. In manufacturing, this can have a compounding effect. Reputation often depends on supplier networks and industry relationships. One recurring quality problem may eventually affect future business opportunities in addition to the possibility of losing the contract.

Next Steps for Manufacturers

Even small quality issues add up over time. That’s why many manufacturers look to improve quality through cost-effective measures like preventative maintenance, employee training, and better reporting. Other common steps include:

• Track quality-related costs across departments. Quality is often viewed as an operations issue, but other departments are involved as well. Finance, scheduling, inventory management, and customer service are all a part of QOC. 
• Identify root causes of quality issues. Once the root cause is identified, management can design targeted improvements to be implemented and monitored for effectiveness. 
• Invest in prevention. Quality control is not just the inspection; it starts much earlier with employee training, preventative maintenance, supplier quality management, process controls, and monitoring systems. 
• Look at quality management as part of strategic business planning. Many manufacturers are starting to see quality-related costs as another lever in profitability discussions.

Contact Us Quality control affects more than compliance requirements. Quality-related costs affect profitability across the operation through waste, downtime, inefficiencies, and customer-related expenses. Manufacturers that understand where these costs are occurring will be in a stronger position to reduce unnecessary expenses and improve operational performance over time. If you have questions about the information outlined above or need assistance with another tax or accounting issue, BMSS Advisors & CPAs can help. For additional information call (833) CPA-BMSS or click here to contact us. We look forward to speaking with you soon.