chapter4

In Chapter 1 we raised the question of whether quality is sufficient to win orders in the marketplace. As you will recall, we stated that although quality can still win orders in some markets, in many markets quality has become an order qualifier. This means that high-quality production is an essential ingredient to participation in the market. In Chapter 3 we discussed research showing that quality is still an effective tool in successfully exporting in the international market.

We now discuss quality as a strategy from the perspective of generic strategies. These generic strategies are cost, differentiation, and focus.

One of the generic means of competing is cost. Traditionally, this meant the lowest-priced items in the industry. Many companies compete on cost. For example, Kmart competes on cost. New definitions of cost are expansive, considering the summation of costs over the life of a product. This includes service, maintenance, and operating costs for the product. For example, it is recognized that ink-jet color computer printers are relatively inexpensive to purchase. However, owners of these machines have found that the color cartridges dry up rapidly and that the replacement costs for the cartridges are quite high. As we discuss later, the life-cycle costs for many products may be staggering when environmental costs are considered. In this section we discuss the cost of quality and how quality can help decrease the cost of doing business.

There are two broad categories of cost: costs due to poor quality and costs associated with improving quality. At a minimum, management must understand these costs in order to formulate policy concerning quality improvement. In addition, Taguchi and others have provided insights into the issue of quality costs. As an example, the title of the classic book by Crosby, Quality Is Free, reveals an interest in the costs of quality.

9For a more in-depth discussion of quality-related costs, see Plunkett, J. J., and Dale, B., “A Review of the Literature on Quality-Related Costs,”International Journal of Quality and Reliability Management 4 (1988):247–257; Carson, J. K., “Quality Costing: A Practical Approach,” International Journal of Quality and Reliability Management 3, 1 (1986):54–65; and Foster, S., “An Examination of the Relationship between Conformance and Quality Related Costs,” International Journal of Quality and Reliability Management 13, 4 (1996):50–63.

The PAF paradigm translates quality costs into three broad categories, which are then subdivided into other categories. The three categories are prevention, appraisal, and failure costs (hence the acronym PAF).

Prevention costs are those costs associated with preventing defects and imperfections from occurring. Prevention costs are the most subjective of the three categories of costs. Prevention costs include costs such as training, quality planning, process engineering, and other costs associated with assuring quality beforehand (see Table 4-2).

Two caveats associated with the collection of quality-related costs include (1) there may be some debate as to whether these costs are all related to quality and (2) persons who work in prevention often do not keep accurate records of all costs.

Appraisal costs are associated with the direct costs of measuring quality. These can include a variety of activities such as lab testing, inspection, test equipment and materials, losses because of destructive tests, and costs associated with assessments for ISO 9000:2000 or other awards (see Table 4-3).

These costs have undergone a fundamental change as U.S. companies have progressed in quality. For example, these costs were traditionally uncomplicated to assess because appraisal was performed by a centralized quality control function. The concept of in-process inspection has made it difficult to measure appraisal costs accurately. In addition, appraisal and auditing costs have been impacted by assessment activities associated with ISO 9000:2000 and the Malcolm Baldrige award as companies have undertaken these assessment programs.

Failure costs are roughly categorized into two areas of costs: internal failure costs and external failure costs. Internal failure costs are those associated with on-line failure, whereas external failure costs are associated with product failure after the production process. This includes failure after the customer takes possession of the product (see Table 4-4).

One of the impediments to the collection of quality cost data has been the lack of acceptable accounting standards for these costs. For example, the standard accounting definition for quality is “meeting specifications.” This narrow definition limits organizations desiring to quantify and measure customer requirements as a means of improving service to the customer. A reason for this is that accounting rules require definitions that are not open-ended or open to alternative interpretations.

Problem: Macaluso’s manufacturing company has gathered the following quality-related costs. You are hired as a consultant to evaluate these costs and to make recommendations to management. Compute the ratio of prevention and appraisal costs to failure costs.

Solution: Ratio of appraisal to failure costs:

195,332/2,202,473 = .0887

Ratio of prevention to failure costs:

195,724/2,202,473 = .0889

Ratio of prevention and appraisal to failure costs:

(195,332 + 195,724)/2,202,473 = .1776

Proportion of total quality costs:

Prevention:

195,724/2,593,529 = .0755

Appraisal:

195,332/2,593,529 = .0753

Failure:

2,202,473/2,593,529 = .8492

This analysis shows that failure costs are very high compared with the prevention and appraisal costs. Increasing prevention and appraisal activities (and costs) could result in a significant decrease in failure costs.

The PAF categorization of costs is a useful way of understanding costs. Using the law of diminishing marginal returns, quality costs can be modeled to show the tradeoffs between these costs. This tradeoff model, called the Lundvall-Juran model, is shown inFigure 4-1.

The Lundvall-Juran model is a simple economic model. It states that as expenditures in prevention and appraisal activities increase, quality conformance should increase. For example, the more we spend on training and developing our employees, the more benefit we should get. As conformance improves, failure costs will lessen as well. This is an interesting case because if these statements are true, there should be an economic quality level that minimizes quality-related costs, and this flies in the face of the idea of continuous improvement proposed by Deming and others.

Think of a product you have been desiring for some time that is priced significantly above the average market price for such a product. It might be a very expensive, brand-name stereo receiver or TV that you want because of its special appeal. Chances are that such a product benefits from differentiation. A Harley-Davidson is an example of a product that is priced far above the average price for a motorcycle, yet dealers seem to have trouble keeping enough of them in stock. Differentiation is achieved by a competitor if the consumer perceives the product or service to be unique in an important way. Neiman-Marcus, the retailer, charges many times the prices charged by its competitors for some products. A Rolex watch or Bang & Olufson stereo invests the owner with a certain status that other products do not. These are examples of differentiated products.

In the early 1980s, Japanese automakers differentiated their products based on mileage and quality. The quality aspect allowed Japanese automakers to gain significant market share in the United States. There is evidence that by the early 1990s, U.S. automakers had closed the quality gap sufficiently so that the Japanese could no longer differentiate on quality. This is the case in many markets. It is increasingly difficult to differentiate products based on quality alone. However, there is still much room to differentiate based on service to the customer in many markets.

The third generic strategy is to focus the product. For example, think of a product that is particularly regional or is marketed to a particular segment of the population. This limited customer group or segment of the market is the object of the focus strategy. Chrysler is building high-powered specialty cars, such as the Prowler, that are marketed to a small, affluent segment of the market. As the baby-boom generation ages, many more companies are segmenting products that can be marketed to this age group. For example, more fitness clubs for the elderly are springing up around the country. Such a focus strategy can be very profitable. Consumer Research Incorporated reports that they reduced the number of customers they served by 40% while at the same time doubling profits. They found that by focusing on only their very large clients for advertising services, they were able to get more business with these clients and simultaneously achieve higher service ratings.

The three generic strategies of cost, differentiation, and focus have been identified as important strategic decisions. A company that emphasizes cost will use different approaches to producing quality products than will a company that emphasizes differentiation or focus.

Terry Hill 10 of the London Business School defined a process for setting strategy that is centered on the identification of the order-winning criterion (OWC). Although the OWC is generally associated with manufacturing strategy, the same concept can be applied to service strategy.

10Hill, T., Manufacturing Strategy (Homewood, IL: Irwin, 2000).

Table 4-5 provides an overview of the planning framework defined by Terry Hill. This framework addresses several of the problems occurring in manufacturing. At times, there is a mismatch or misalignment between corporate objectives and decisions and operational subplans. There is a close relationship between the Hill model and generic strategies that we have discussed. First, the organization determines its competitive priorities and defines how it wins orders in the marketplace. For example, if the company wins orders based on focusing on small niche markets, marketing strategies will be developed to market a wide variety of specialized products. At the same time, this agreement on order winners allows the manufacturing people to make process choices and infrastructural decisions that support wide variety. The process choice then might be a flexible manufacturing system using short setup and change-over times.

SOURCE: T. Hill, Manufacturing Strategy (Homewood, IL: Irwin, 2000). Reproduced with permission of The McGraw-Hill Companies.

The key to the Hill model is reaching consensus on the OWC. The process for doing this involves segmenting the business into smaller markets that can each be identified with an order-winning criterion. This provides an understanding of the markets the company is serving. Products are chosen for each market, and marketing provides sales forecasts for the identified markets. Strategic debate then occurs, resulting in the selection of an OWC. From this, manufacturing strategy is formulated.

Prahalad and Hamel 11 have identified the strategic concept of core competence. They describe core competence as consisting of

11Prahalad, C., and Hamel, G., “The Core Competence of the Corporation,” Harvard Business Review (May–June, 1990):79–91.

· communication, involvement, and a deep commitment to working across organizational boundaries. It involves many levels of people and all functions. World class research in, for example, lasers or ceramics can take place in corporate laboratories without having an impact on any of the businesses of the company. The skills that together constitute core competence coalesce around individuals whose efforts are not so narrowly focused that they cannot recognize the opportunities for blending their functional expertise with those of others in new and interesting ways.

· Core competencies do not diminish with use. Unlike physical assets, which do deteriorate over time, competencies are enhanced as they are applied and shared. But competencies still need to be nurtured and protected; knowledge fades if it is not used. Competencies are the glue that binds existing businesses. They are also the engine for new business development. Patterns of diversification and market entry may be guided by them, not just by the attractiveness of markets. (p. 79)

Using the Prahalad and Hamel definition of competency, quality—in and of itself—probably is not a core competency. However, for firms operating in rapidly evolving markets or industries, the ability to change can be more important than the actual changing technology of the moment. Hence organizations producing outstanding products or services with a good understanding of processes are better positioned to operate in the changing market because they can introduce new products rapidly with fewer quality-related holdups. Therefore, core competency is built on the foundation of a long-term commitment to quality and continual process improvement.

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