Reliability and Cost

Reliability engineering relates closely to safety engineering and to system safety, in that they use common methods for their analysis and may require input from each other. Reliability engineering focuses on costs of failure caused by system downtime, cost of spares, repair equipment, personnel, and cost of warranty claims. Safety engineering normally emphasizes not cost, but preserving life and nature, and therefore deals only with particular dangerous system-failure modes.

Cost of Quality

Cost of quality is the sum of various costs as that of appraisal costs, prevention costs, external failure costs, and internal failure costs. It is generally believed that investing in prevention of failure will decrease the cost of quality as failure costs and appraisal costs will be reduced.

Understanding cost of quality helps organizations to develop quality conformance as a useful strategic business tool that improves their product, services & brand image. This is vital in achieving the objectives of a successful organisation.

COQ is primarily used to understand, analyze & improve the quality performance. COQ can be used by shop floor personnel as well as a management measure. It can also be used as a standard measure to study an organisation’s performance vis-à-vis another similar organisation and can be used as a benchmarking indices.

The various costs which constitute cost of quality are

• Appraisal cost is the cost incurred because of inspecting the processes. The cost associated with checking and testing to find out whether it has been done first time right.
• Prevention cost is the cost incurred because of carrying out activities to prevent failures. The cost associated with planning, training and writing procedures associated with doing it first time right.
• External failure cost is the cost incurred because of the failure that occurred when the customer used the product.
• Internal failure cost is the cost incurred because of the failures within the organization.

Examples of the various costs are

• Prevention – Training Programme, Preventive Maintenance
• Appraisal – Depreciation of Test/ Measuring Equipment, Inspection Contracts
• Internal Failure – Scrap, Rework, Downtime, Overtime
• External Failure – Warranty, Allowances, Customer Returns, Customer Complaints, Product Liability, Lawsuits, Lost Sales

Net present value (NPV)

The net present value (NPV) of an amount to be received in future is given by the formula for using the time value of money to appraise the long term projects.

P = A (1 + i)^-n

Where, P is net present value, A is the money that is to be received in ‘n’ years from the present time and ‘i’ is annual rate of interest depicted as a decimal like if i is 10%, then 0.10 is taken to calculate the NPV. This measure is used to select the project with the maximum Net Present Value. The time value of money is already taken into account while calculating NPV. As an example

Assume that Rs. 2400 will be available in five years. What is the NPV of that money if the annual interest rate is given as 9%. Solution – Substitute A as Rs. 2400, n as 5 and i as 0.09 in the formula. We have P = 2400(1 + 0.09) = Rs. 1559.84 Thus, Rs. 1559.84 invested at 9% for five years will be worth Rs. 2400.

Another example, there are 2 projects. Project A has as NPV of Rs. 1,000 and will be completed in 5 years. Project B has a NPV of Rs. 800 and will be completed in 1 year. Which project to select? Solution – Project A will be selected. The fact that project B has a lesser duration than project A does not matter because time is already taken into account in NPV calculations.

Return on investment (ROI)

Usually, ROI is used to estimate the organization’s potential to utilize its resources to produce revenues. It is one of the most common financial measures. It is computed as

ROI = Net income/Total investment x 100%,

Where, net income includes the money that is earned or expected to be earned by the project and money that is saved by avoiding certain costs. Investment refers to the money that is needed to carryout the project. Another ROI approach is to calculate the ‘amortization’ time, i.e., the time in which the organization can get back the money invested on the project. Thus, it is also known as ‘payback period’.

Cost-benefit analysis

Cost-Benefit Analysis is done before the project is initiated. It is conducted in the following way

• List the anticipated benefits of the project.
• State the benefits in financial terms and specify the time limits.
• List the costs involved in undertaking the project.
• Compute whether the benefits exceed costs and decide whether to implement the project or not. At times, the management may decide to implement a project even when the costs exceed the benefits, for instance, projects that provide social benefits, projects that are prestigious to the organization, etc.

Some of the indicators used in cost-benefit analysis are Present Value of benefits (PVB), Present Value of Costs (PVC), NPV (NPV = PVB – PVC), and Benefit-Cost Ratio (BCR).

Benefit- cost ratio (BCR) is calculated using the formula

Benefits (payback or revenue)/costs

BCR can be used as project selection criteria. A project with higher BCR is preferable while selecting projects, as an example

There are 2 projects. Project A has an investment of $ 500,000 and a BCR of 2.5. Project B has an investment of $ 300,000 and a BCR of 1.5. Using the Benefit Cost Ratio criterion, which project to be selected?

Solution – Project A will be selected as project B has a lower investment than project A will not impact the selection.