THE COST OF QUALITY
04/11/21
04/11/21
The cost of quality has traditionally been something of a point of contention for food industry professionals.
At an individual level this might be quite an emotive topic, depending on the department you happen to work in.
Everyone’s individual understanding of ‘the cost of quality’ is different, not only because of the relative value that each person places on ‘quality’ but also as a result of their vantage point.
Now of course this kind of subjectivity is incompatible with an assessment of cost. The word ‘cost’ doesn’t only apply to financial costs, but money is a useful objective reference point, and businesses are generally able to attribute a monetary value to most resources expended.
Just on an accounting basis, it ought to be possible to identify the various costs and benefits associated with quality activities, and form an assessment of whether the costs exceed the benefits (or vise versa) and by how much.
Costs
Benefits
*For all instances of mitigating risk exposure, the cost:benefit analysis would attribute a risk-adjusted value to this point. By way of example, to account for the value of recalls or withdrawals that would have occurred had it not been for quality activities undertaken, one might assume a recall rate of once every 2 years in the absence of quality intervention, and attribute an approximate financial gain incurred as a result of quality activities proportionate to the assumed costs.
**It’s important to understand that company valuations expressed as share prices are based on the expectation of future performance, rather than the present-day performance. Exchange traded funds composed of ESG-driven companies have outperformed the market sectors they represent; but it is not clear if that is as an immediate gain from environmental, social and governance activities, or if this is an indication that investors anticipate superior future performance from ESG-driven companies.
In the short-term, there may be increased costs associated with quality activities corresponding with an increase in company valuation because the relationship between operational costs and share price can be non-intuitive.
With every company being different, the values attributed to each point of cost and benefit will be company-specific, so it is not possible to arrive at an overall valuation of the apparent cost of quality in this article. We do find it interesting to note that the outperformance of ESG-driven companies’ valuations seems to indicate that investors view quality as a net positive, though.
However you calculate the ‘cost of quality’, it’s interesting to pause and think about revenue attribution. If ‘quality’ is seen as a cost, are there revenue-generating functions? A salesperson who closes a £100k contract might claim that they had secured £100k or the business... But all of the activities undertaken in servicing the customer’s order must also be accounted for in revenue attribution calculations.
In order for the business to fulfil the order, the marketing team had to generate the lead, the NPD department had to design the product, the production department had to manufacture the product, and every other activity undertaken in order fulfilment (including quality) must be attributed a portion of the revenue generated as a result of their actions. It doesn’t make sense to attribute the full £100k to the sales function, because the sales function in isolation could never fulfil the order.
As a mental exercise, it can be quite interesting to think about cost models and revenue attribution in a food business setting; but it’s more practically useful for businesses to refer to their company values and allocate resources in the way that best fulfils the objectives of the company.
In conclusion
In principle, it may be possible to ascribe a monetary value to each of the perceived costs and benefits of quality activities in order to determine whether the quality function presents a net cost for food businesses or establish that quality adds value to the bottom line.
The process of doing so is somewhat problematic when you factor in revenue attribution, because any activities that contribute to order fulfilment should be represented in any analysis of revenue generated. Business activities are not simply divided into costs incurred and revenues accrued.
Where quality accreditations may be perceived as a licence to access market opportunities, it is an over-simplification to view the accreditation as a one-time hurdle to be overcome. Customer relations, brand integrity, and forward credibility are all advantages contributing to business success, and they cannot be reduced to a pass/fail outcome.
Any activity undertaken on behalf of a business can be recorded as a cost because resources are always consumed when any activity is performed. This applies to quality activities and sales activities alike. Because of the complexity of the topic, people often find it more palatable to consider some activities to be revenue-generating and some activities to represent costs; so a broader view is usually more helpful.
It is completely rational for any business to try to operate efficiently, reducing costs and increasing revenue proportionately. This incentive to operate efficiently applies to all business activities, regardless of department or function. The systems on Food Portal are designed to enable excellent quality outcomes, with less time and resources expended compared to offline systems or alternative services.
The line between ‘cost’ and ‘investment’ becomes ever-more blurred the closer you look at it… Revenue attribution calculations might label the same activity as a cost or a contributor to revenue generation, depending on the outlook of the person performing the calculation. It is often a good idea to ask, “what would happen to revenue if the activity labelled as a ‘cost’ were discontinued?”
Financial investors (who are arguably the stakeholders furthest removed from individual bias based on department or function), appear to take the view that ‘quality’ is a value-added function, based on the outperformance of ESG-driven company valuations, represented as exchange traded funds composed of ESG-driven companies.
At an individual level this might be quite an emotive topic, depending on the department you happen to work in.
- Account Managers might grit their teeth to see the cost of audits and compliance eat into the profit margins for contracts, especially if compliance costs are treated as an overhead for low volume products.
- Technical and quality personnel might insist that the brand protection and consumer loyalty gained through quality intervention more than outweighs any costs associated with the function.
- Managing Directors and salespeople might view quality accreditations as a barrier to be overcome in order to gain access to customers. Whatever the cost of quality, that’s a necessary licence to enter the market.
- If you’re a financial investor, the actual cost is entirely irrelevant – the interesting thing is the impact that quality programmes have on the company valuation, as well as the predicted future impact. £1 spent on quality today is a bargain if it results in capital appreciation of £10 over the upcoming 3 years.
- Planning Managers might look at quality as a limiting factor on capacity. A factory has an operating capacity of however many units per hour, until you factor in things like downtime for cleaning and equipment maintenance. A variable to be taken into account.
Everyone’s individual understanding of ‘the cost of quality’ is different, not only because of the relative value that each person places on ‘quality’ but also as a result of their vantage point.
Now of course this kind of subjectivity is incompatible with an assessment of cost. The word ‘cost’ doesn’t only apply to financial costs, but money is a useful objective reference point, and businesses are generally able to attribute a monetary value to most resources expended.
Just on an accounting basis, it ought to be possible to identify the various costs and benefits associated with quality activities, and form an assessment of whether the costs exceed the benefits (or vise versa) and by how much.
Costs
- Spending on analytical testing.
- Spending on audits.
- Salaries/wages for quality and technical staff.
- Downtime/opportunity costs for cleaning processes or maintenance work.
- Costs for any memberships to technical or advisory services.
- Time and resources spent implementing quality and compliance systems.
- Time costs where other departments are required to interact with the quality function.
- The costs of sampling and destructive product tests (e.g. taste panel).
- Etc.
Benefits
- Mitigating the company’s risk exposure to recall and withdrawal scenarios. *
- Brand reputation (reducing customer acquisition costs).
- Customer loyalty (improving customer retention).
- Access to large market opportunities such as trade with retailers.
- Access to specific markets based on dietary suitability or religious requirements.
- Competitive advantage where there is a consumer-driven market demand (e.g. Fairtrade).
- Reduction in customer complaints and compensatory pay-outs.
- Mitigating the company’s risk exposure to actions taken by authorities and enforcement agencies.
- Any personal or ethical gains experienced as a result of ‘doing the right thing’.
- Outperformance of ESG-driven share prices (appreciation of the company’s valuation). **
- Efficiency gains through process standardisation.
- Etc.
*For all instances of mitigating risk exposure, the cost:benefit analysis would attribute a risk-adjusted value to this point. By way of example, to account for the value of recalls or withdrawals that would have occurred had it not been for quality activities undertaken, one might assume a recall rate of once every 2 years in the absence of quality intervention, and attribute an approximate financial gain incurred as a result of quality activities proportionate to the assumed costs.
**It’s important to understand that company valuations expressed as share prices are based on the expectation of future performance, rather than the present-day performance. Exchange traded funds composed of ESG-driven companies have outperformed the market sectors they represent; but it is not clear if that is as an immediate gain from environmental, social and governance activities, or if this is an indication that investors anticipate superior future performance from ESG-driven companies.
In the short-term, there may be increased costs associated with quality activities corresponding with an increase in company valuation because the relationship between operational costs and share price can be non-intuitive.
With every company being different, the values attributed to each point of cost and benefit will be company-specific, so it is not possible to arrive at an overall valuation of the apparent cost of quality in this article. We do find it interesting to note that the outperformance of ESG-driven companies’ valuations seems to indicate that investors view quality as a net positive, though.
However you calculate the ‘cost of quality’, it’s interesting to pause and think about revenue attribution. If ‘quality’ is seen as a cost, are there revenue-generating functions? A salesperson who closes a £100k contract might claim that they had secured £100k or the business... But all of the activities undertaken in servicing the customer’s order must also be accounted for in revenue attribution calculations.
In order for the business to fulfil the order, the marketing team had to generate the lead, the NPD department had to design the product, the production department had to manufacture the product, and every other activity undertaken in order fulfilment (including quality) must be attributed a portion of the revenue generated as a result of their actions. It doesn’t make sense to attribute the full £100k to the sales function, because the sales function in isolation could never fulfil the order.
As a mental exercise, it can be quite interesting to think about cost models and revenue attribution in a food business setting; but it’s more practically useful for businesses to refer to their company values and allocate resources in the way that best fulfils the objectives of the company.
In conclusion
In principle, it may be possible to ascribe a monetary value to each of the perceived costs and benefits of quality activities in order to determine whether the quality function presents a net cost for food businesses or establish that quality adds value to the bottom line.
The process of doing so is somewhat problematic when you factor in revenue attribution, because any activities that contribute to order fulfilment should be represented in any analysis of revenue generated. Business activities are not simply divided into costs incurred and revenues accrued.
Where quality accreditations may be perceived as a licence to access market opportunities, it is an over-simplification to view the accreditation as a one-time hurdle to be overcome. Customer relations, brand integrity, and forward credibility are all advantages contributing to business success, and they cannot be reduced to a pass/fail outcome.
Any activity undertaken on behalf of a business can be recorded as a cost because resources are always consumed when any activity is performed. This applies to quality activities and sales activities alike. Because of the complexity of the topic, people often find it more palatable to consider some activities to be revenue-generating and some activities to represent costs; so a broader view is usually more helpful.
It is completely rational for any business to try to operate efficiently, reducing costs and increasing revenue proportionately. This incentive to operate efficiently applies to all business activities, regardless of department or function. The systems on Food Portal are designed to enable excellent quality outcomes, with less time and resources expended compared to offline systems or alternative services.
The line between ‘cost’ and ‘investment’ becomes ever-more blurred the closer you look at it… Revenue attribution calculations might label the same activity as a cost or a contributor to revenue generation, depending on the outlook of the person performing the calculation. It is often a good idea to ask, “what would happen to revenue if the activity labelled as a ‘cost’ were discontinued?”
Financial investors (who are arguably the stakeholders furthest removed from individual bias based on department or function), appear to take the view that ‘quality’ is a value-added function, based on the outperformance of ESG-driven company valuations, represented as exchange traded funds composed of ESG-driven companies.
