Use cost-benefit analysis to determine appropriate measures of quality.
Your company produces and sells widgets with annual sales of $100 million. A recent quality audit revealed that 15% of the widgets manufactured were defective. The following are estimates of the costs associated with passing defective widgets:
Lost Business 2,000,000
Liability Claims 6,000,000
Total Costs $10,000,000
The executive team feels that the costs of passing defective widgets are much too high and that costs associated with defects should not exceed 1% of total sales. To attain this goal, the team wants to implement a quality assurance program using inspections. They have determined that inspections of raw materials, manufacturing processes, and finished products are necessary. The cost of inspecting each production lot at all three of these stages is $500 per lot.
Two million widgets are to be produced in lots of 100 widgets each. Given the cost of inspection the executive team feels that it is not practical to inspect every lot during each phase.
The executive team has asked you to complete the following task.
A. Determine the predicted number of inspections that would be necessary to reach the cost of passing defective widgets not exceeding 1% of total sales. Explain the approach you used to arrive at your answer.
B. Recommend, with rationale, the quality management policy that the company should adopt. Your rationale should include an appropriate application of cost-benefit analysis that fits this situation.