Question

Required (a) Which costs are relevant to Polley's decision to choose either option 1 or option 2? (b) What qualitative factors is Polley likely to consider in choosing either option 1 or option 2? (c) Explain how the cost-of-quality framework of prevention, appraisal, internal failure and external failure might be applied to operations with environmental pollution, where failures are defined as accidental spillage or leakage of hazardous wastes or as illegal levels of pollutants. On which of the four cost-of-quality categories would you advise Polley to focus her attention?

Answer 1

a) Firstly, the main reason for evaluating both the options is to find out which option is more profitable or feasible in the long run. profitability is determined by costs incurred and revenues generated. So, the two types of costs with respect to this case study are - Relevant Cost and Irrelevant Cost.

Relevant costs are those costs that will differ between the two options. They are crucial in decision making. variable costs are the examples of relevant costs as it will change with each option. Irrelevant costs are those costs which will be incurred in all the available alternatives. These costs will not be affected by future decisions. Unavoidable costs or fixed costs are the examples of irrelevant costs.

The costs which will be relevant to Polley's decision to choose either option 1 or option 2 are :-

• The price and quantity of solvent used in current operations.
• The price and quantity of the new solvent that would be used in option 2.
• The purchase price of the new equipment used in option 1 and 2.
• The cost of removing old equipment and installing new equipment in option 2.
• The purchase price of the filtration equipment used in option 1.
• The salvage value of the current equipment which will be sold in option 2.
• Labor costs for both option 1 and option 2. Labor costs is lower under option 2.
• Training costs of the new equipment in option 2.
• Insurance costs of the equipments and the workers, which is lower in option 2.

The remaining items from the list are irrelevant costs i.e. -

• The purchase price of the current equipment as it is a sunk cost (a cost which has already been incurred and cannot be recovered).
• Polley's salary and fringe benefits will not depend on which option is selected.
• Legal fees and storage and disposal costs will also not change with the change in option.

b) Qualitative factors which is likely to be considered in choosing option 1 or option 2 are :-

• Option 1 would reduce emissions but Option 2 would eliminate current air pollution emissions which will decrease the health risk of the workers.
• There will be lesser risk of violating the OSHA regulations.
• Lesser risk of negative media publicity.
• If environment friendly option 2 is selected, customers maybe attracted to them which in turn will boost the business and eliminate competition with other companies.

​​​​​​​c) The quality cost falls into four categories -

• Prevention Costs - It is the cost which is incurred to to prevent quality problems. Prevention Cost can include employee training, changing from current process of production to some other alternative. Option 2 will totally eliminate air pollution but will have a higher prevention cost when compared to option 1.
• Appraisal Costs - It is the cost which is incurred on activities related to monitoring and inspecting the quality of the product. If Polley incurs this cost, it will lead to regular inspection ensuring that the workers are following the procedures required for equipment selected in option 2.
• Internal Failure Costs - It is the cost which is incurred to rectify the defects detected before the product is delivered to the customer. Internal failures, in this case might be accidental hazardous waste leakage, which will be detected and corrected before the media knows about it.
• External Failure Costs - It is the cost which is incurred to rectify the defects detected by the customers after the product was delivered. In case, there's an external failure the cost to rectify that will be very high. In addition it will also result in loss of customers, goodwill and brand image.

​​​​​​​Polley should focus her attention on Prevention Cost. If the problems are identified in the first stage itself, chances of error will be reduced manifold. There will be ample time to rectify the error.