Question

Exercise: The cost of (poor) quality 10% of the average bank's customers leave per year 21% of these customers leave due to "poor service" The average bank customer yields $121 per year gross profit The average cost to acquire new customers is $150 per year The bank has approximately 200,000 customers American Banking Association Data, 1990 What is (calculate) the cost of quality?

And how does it link to either prevention costs, appraisal costs, internal failure costs, or external failure costs?

Answer 1

No. of customers left per year due to poor service = 200,000 x 10% x 21% = 4,200

Opportunity lost (for lost profit) = 4,200 x $121 = $508,200
Additional cost (to acquire new customers) = 4,200 x $150 = $630,000

So,

Total cost of quality = 508,200 + 630,000 = $1,138,200

The cost of quality consists of four categories of cost – Prevention, Appraisal, Internal failure, and External failure. Prevention refers to the investments for preventing a failure to happen. The appraisal cost refers to the cost of inspection and segregation after any defect is produced but not transferred to the customer end. The internal and external failure costs refer to the cost of repair and rejection of parts at internal customer and external customer end respectively.

Note that in this case, the cost is due to poor service already delivered to the end users i.e. customers and hence it should be classified as an external failure cost.