External Failure Costs
External failure costs are a type of quality cost incurred when a product or service fails to meet customer requirements after it has been delivered to the customer. These are the costs associated with defects that are found after the customer receives the product or service.
These costs can be significant and can include:
- Warranty costs: These are the costs of fulfilling the terms of warranties, including the repair or replacement of defective products.
- Product Returns and Recalls: If a product is found to be defective after it has been sold, it may need to be returned or recalled, both of which can be costly processes.
- Complaints and Service Costs: The company may need to set up systems to handle customer complaints related to defective products, and may also need to provide services to help resolve these issues.
- Liability Costs: If a defective product causes harm or damage, the company could face legal action and be held liable for damages.
- Lost Sales and Reputation Damage: Perhaps most significant of all, external failure costs can include the loss of customer goodwill and damage to the company’s reputation, which can lead to lost sales.
Organizations strive to minimize external failure costs by investing in prevention and appraisal costs. Prevention costs are incurred to prevent defects from occurring, such as costs of quality planning, training, and process control. Appraisal costs are incurred to detect defects before products reach customers, such as costs of inspections, testing, and quality audits. By focusing on prevention and detection, companies aim to catch and fix issues before products reach customers, thereby reducing the likelihood and impact of external failures.
Example of External Failure Costs
Let’s consider a hypothetical example of an automobile manufacturing company – let’s call it AutoPro.
AutoPro releases a new model of car that, after a few months in use by customers, reveals a faulty brake system. This fault wasn’t detected during the quality control process at the factory, and now there are thousands of these cars in circulation with customers. The costs that AutoPro incurs due to this fault are considered external failure costs, which might include:
- Warranty costs: AutoPro has to honor the warranty on all the affected cars. They have to replace or repair the faulty brake system for free, incurring the cost of parts and labor.
- Product recalls: To address the brake issue, AutoPro has to issue a recall of all the affected cars. The logistics of this process, including communicating with customers, arranging for the cars to be returned, and managing the workflow, are all costs to the company.
- Customer service costs: The company has to handle a significant increase in customer complaints, which requires more staff in their call centers, more service personnel to manage the complaints, and additional administrative work to document and process the issues.
- Liability costs: If any accidents were caused by the faulty brake system, AutoPro might be sued by customers for damages. They could face significant costs in terms of legal fees and compensation payouts.
- Lost sales and reputation damage: News of the faulty brake system spreads, and potential customers are wary of buying cars from AutoPro. The company experiences a decrease in sales, not just of the affected model but potentially of other models too if the brand’s reputation has been significantly damaged.
As you can see from this example, external failure costs can be significant, and it’s in a company’s best interest to invest in preventing defects and appraising products for quality before they reach the customer.