Understanding Your True Cost of Poor Quality and How to Reduce It

By Jose R. Suarez, Founder & CEO

In today’s competitive apparel and footwear industries, brands regularly focus their efforts on acquiring new customers, increasing distribution networks, and preparing next season’s products. But what about reducing their cost of poor quality?

Despite their success in other areas, companies that do not understand and address their true cost of poor quality face substantial barriers to long-term growth.  What’s more, the cost of not controlling quality could ring in around 20 percent of total sales.

The Underestimated and Compounding Effect of Poor Quality

The cost of poor quality comprises not only the costs resulting from product defects, but also company processes, practices, or functions that generate defects and errors. Poor quality can weaken consumer relationships, damage your brand, and add major operational and financial costs.

Consider the effect of a continued weakness within invoicing and logistics. The error may result in shipments of the wrong product, yielding increased freight costs, chargebacks, and even lost sales.

Similarly, errors in the product development stage may result in a host of additional costs. Suppose first samples are not adequate; additional money must be spent on couriers and redevelopment, with compounding errors leading to production delays, chargebacks, and cancelled orders.

In fact, companies lacking effective quality management often have a cost of poor quality equal to 20 percent of sales or more, according to the American Society for Quality guide.

Identifying the Five Major Categories of Your Product Cost of Poor Quality

To establish and benefit from effective quality management, quality guru Philip Crosbyrecommends that brands first understand and measure their cost of poor quality.

This step, what Crosby refers to as the “awakening,” entails identifying the costs of not conforming to requirements within the supply chain. Namely, companies must recognize the five major categories of the cost of poor quality of a product:

1.     Rework costs

2.     Freight costs

3.     Chargebacks

4.     Product returns (replacement or cancelled orders)

5.     Lost sales (probation or permanent loss of customer)

 

1. Rework Costs

If you ship a defective product, the customer may ask for it to be reworked in your warehouse. For instance, if a garment is incorrectly labeled, you may need to spend $1, $2, or more per piece to open the packages, cut out old labels, print and attach new labels, and ship it back to the customer. Further, if the product itself needs rework, the roundtrip transport and repair costs at a local rework facility can easily exceed $3-$7 per piece.

 

2. Freight Costs

How many of us have supply chains that generate up to 20 percent late shipments, forcing us to incur millions of dollars annually in airfreight to deliver products on time? Even worse, how many of us have suffered from the delivery of a defective product that is the showcase item for our top customer’s key campaign, requiring a rush replacement production order that includes hundreds of thousands of dollars in airfreight? In addition, how frequently do we negatively impact our bottom line by having to invest in additional in-land freight to pick up defective products from disgruntled customers?

Whenever there’s an error, companies face the costs of transferring product back and forth. If you ship the wrong product to a store and the store decides they don’t want it, even if you’re able to ship the goods to someone else, you’re going to lose on that freight cost.

 

3. Chargebacks

In today’s difficult retail environment, where consumers are demanding more value for their purchases, including product quality, retail customers are rightly requesting substantial chargebacks for un-conforming products. It has become commonplace for a seller to receive a claim for $25,000, $50,000, or $100,000 for even the slightest of product variances.

 

4. Product Returns (Replacement or Cancelled Orders)

If a customer chooses not to keep a defective shipment of garments or shoes, at best you may be able to negotiate a quick replacement. At worst, you receive a cancelled order. Should we not keep track of the loss gross margins that defective product returns have on our profitability?

 

5. Lost Sales (Probation or Permanent Loss of Customer)

Finally, a pattern of defective shipments may lead a major retailer to put your brand on probation, lowering your subsequent order volumes. If the retailer represents a significant portion of your sales, the cost of this action can be devastating. Even worse, the retailer may decide to sever the relationship altogether.

The impact this continuous erosion of your topline sales have on the future growth, or even the survivability of your company, could be substantial.

 

The Fallacy of Passing Charges on to Factories

While the true cost of poor quality can be staggering, corporate finance departments often do not capture these costs. Further, even those that do often assume that the costs are of little consequence to their bottom line, as the general philosophy in our industry is that we “simply pass them on to the factories.”

In the world of operational excellence, this is called “fools gold,” as factories will need to “pad” their future costs with those chargebacks to maintain their financial viability. As a result, you will end up paying a higher price per piece, as the factory is assuming there will be future quality claims.

Also, in the current business climate, where consumers reward those brands that are eco-friendly, is it commercially sound to accept that billions of dollars are being wasted on our planet’s limited resources for un-saleable returns sitting in our warehouses or being sold at a discount?

 

The Path Forward: Working with Factories to Eliminate Quality Errors

To successfully reduce the product cost of poor quality, companies must:

·      Accurately keep track of the five major costs incurred because of poor quality

·      Identify key errors throughout their production-chains

·      Implement corrective action plans to significantly reduce such waste from having a corrosive impact on the bottom line

In addition, companies must invest time and money in the hiring of process-minded professionals who can work with their factories to implement effective quality systems.

Ultimately, for brands that achieve the final step of quality management, what Philip Crosby terms “certainty,” remaining errors may drop to 2.5 percent of total sales—the equivalent of millions of dollars in savings for a company and its shareholders.