Costing and Economics - Essay Example

Prevention Costs: The planned costs incurred by an organization to ensure that errors are not made at any of the various stages during the delivery process of that product or service to a customer. The delivery process may include design, development, production and shipping. Examples of prevention costs include education and training, continuous improvement efforts, quality administration staff, process control, market research, field testing and preventive maintenance. Failure Costs: The costs incurred by a company because the product or service did not meet the requirements and the product had to be fixed or replaced or the service had to be repeated.

These failure costs can be further subdivided in to two groups - Internal or External failures. Internal failures include all the costs resulting from the failures that are found before the product or service reaches the customer. Examples include scrap, rework, extra inventory, repair stations, re-design, salvage, corrective action reports and overtime due to nonconforming product or service. External failures are all the costs incurred by the company resulting when the customer finds the failure.

These external failure costs do not include any of the personal costs of the customer. Examples of these costs include warranty, customer complaint administration, replacement product, recalls, shipping costs, analysis of warranty data, customer follow-up and field service departments. b) Relationship between Failure Costs and Prevention Costs: The following sketch illustrates that actual performance can fall short of customer satisfaction either because of quality of design failure or because of conformance quality failures.

Actual Design CustomerPerformance Specifications Satisfaction Conformance Quality Quality of Design Failure FailureConformance Quality refers to the performance of a product or service relative to its design and product specifications.

For example, if a photocopying machine mishandles paper or breaks down, it fails to satisfy conformance quality. Products not conforming to specifications must be repaired, reworked, or scrapped at an additional cost to the organization. If non conformance errors remain after the product is shipped and the product breaks down at the customer site even greater repair costs as well as the loss of customer good will (often the highest quality cost) may result. Since as outlined above, there exists a strong relationship between prevention costs and failure costs, to ensure that actual performance achieves customer satisfaction companies must first design products to satisfy the customers through quality of designs, and they must then meet design specifications though conformance quality.

Thus it may be seen that there is a direct relationship between the prevention cost and failure costs and if the prevention costs are not taken care of by the company, it may lead to the incurring of additional quality costs in the form of internal or external failure costs.