The True Cost of Supply Chain Quality

By Chris Nahil on September 29, 2020
Chain showing one gear out of place

There’s a pretty shocking disconnect between the actual cost of poor quality (COPQ) and what executive leadership thinks it is. According to the American Society for Quality, COPQ claims between 15% and 40% of revenue; executives put that figure at about 5%.

That puts quality managers in a tough spot. Making the business case for a quality management system is challenging when leadership underestimates the costs—and benefits—of supply chain quality.

You don’t have to look far to find an example of catastrophic supply chain quality failures. Contaminated raw materials used in the manufacture of 43 different Johnson & Johnson children’s products cost the company nearly $1 billion in lost sales, plus millions more in FDA fines and lost production due to shuttered factories, not to mention the incalculable reputational damage as a result of a consumer boycott.

The fact is, manufacturers pay for supply chain quality, whether it’s in terms of negative consequences due to poor quality or making the investment upfront to prevent and avoid problems.

What is supplier quality?

In a nutshell, supplier quality is the ability of supply chain partners to reliably deliver the products and services that satisfy the end-buyer’s needs. ASQ goes a bit further, adding the cost of transactions, ease of communication and problem resolution, and alignment of the supplier’s internal policies (inventory levels, for example) with the manufacturer’s goals to the definition of supplier quality.

In a perfect world, manufacturers could rely on supplier quality throughout the entire supply chain and product lifecycle without a formal supplier quality management program. Unfortunately, this is not a perfect world, and modern supply chains are more intricate, global, and interconnected than ever before.

Transportation delays, cyberattacks, raw material shortages, tougher environmental regulations, and even global economic uncertainty leave manufacturers exposed to new levels of supply chain risk. An organization can have the best quality control processes in the business, but if it doesn’t include robust supplier quality management, there’s a huge potential for expensive problems.

Measuring the cost of supplier quality

The cost of poor quality (COPQ) in the supply chain typically falls in one of three categories.

Appraisal costs are costs associated with measuring and monitoring the quality of purchased materials and services. This includes inspection of received goods, quality audits, and assessing and rating suppliers.

Internal failure costs are those incurred to remedy supplier quality issues before the product reaches the customer. These include the cost of scrapping or reworking defective materials and the waste associated with unnecessary work or poor communication. Other direct internal failure costs include downtime, production delays, backorders, and price downgrades due to quality issues. Failure analysis to determine the cause of the problem also falls under the internal costs umbrella.

External failure costs occur when a defective product is delivered to the customer. These are the most expensive and potentially damaging of all supplier quality costs; remedying quality issues at this stage is generally five times greater than internal failure costs. Direct external costs include product returns, repair and servicing costs, penalties and warranty claims, and complaint investigation.

The indirect costs are more difficult to quantify and include lost opportunities and profits when customers switch brands due to quality issues and damage to the company’s brand and image.

Organizations can take a more proactive approach and focus on the cost of good quality (COGQ). Those that do tend to avoid many of the issues that result from poor supplier quality.

Prevention costs are associated with processes put in place to prevent quality issues as opposed to detecting and correcting them. They include quality and process planning, supplier quality evaluation and audits, and managing supplier relationships.

Although ASQ data shows that only one in three organizations actively tracks the cost of quality, it’s an essential metric for companies that pursue operational excellence. Shaving just a few percentage points off your cost of supplier quality each year can translate into millions of dollars.

Lowering your overall cost of supplier quality

In many organizations, tracking supplier quality is a manual process, making it unnecessarily time-consuming and complex. Integrating supply chain quality into your overall quality management system gives you automated control over and visibility into every element of your supply chain.

This eliminates human error and gives you a closed-loop system of accountability. Once you find the root cause of failure, you can generate a supplier corrective action report and track completion and verification of the corrective action plan. All associated documentation is linked back to the supplier rating system.

The closed-loop system ensures every quality failure is accurately documented and clearly communicated, helping to align your goals and expectations with your suppliers’ performance and quality rating.

This has the added benefit of moving toward a conditional management status with top suppliers who have proven their ability to control their output and no longer need constant monitoring. A relationship built on mutual trust reduces risk and strengthens both parties’ roles in the manufacturing process.

Far from being a cost center, a solid supplier quality management system eliminates waste and non-essential processes throughout the entire supply chain. If you’d like to know more about the ROI of supplier management with ETQ, contact us today for a demo.