Billions of dollars continue to be invested in quality management. ISO 9000 now has over 280,000 registrations worldwide with an estimated annual cost in the billions of dollars. How do organizations ensure there is a return on their investment? This is especially hard to answer for service organizations that in many cases have no real idea what a lack of quality is costing them – be it in customer defections, excess costs and staff turnover due to frustration with processes that don’t work.

Every workshop on quality that I give for financial managers I ask the question "do you think that a lack of quality is costing you money – either through lower revenues, higher costs or other reasons?" Every hand in the house goes up. The second question is "OK great – so how much is it costing you?" Few if any hands go up. The tragedy of this exercise is that these are the financial advisors to management – the key people who should be advising where waste is occurring and where profits and return on investment can be increased. But they don’t know what the impact is on their financial capital. Little wonder that poor decisions are often made on how to cut costs. Decisions that often perpetuate loss of morale and decreases in customer satisfaction – the vicious downhill spiral has started. But it can be stopped.

A great deal of attention today is being placed on knowledge management and the value of intellectual capital. Given that intellectual capital is based on the components of human capital (people), customer capital (clients) and organizational capital (processes and capabilities including intangible property), then a lack of quality is also a root cause of depletion of this organizational asset. Statistics show that the "e-based" economy is increasingly based on intangible assets (with many technology organizations having no balance sheet to speak of yet enormous value) – then a lack of quality also depletes our intellectual capital.

Although a key driver for quality improvement can be the perception of increased customer satisfaction, reality often fails to bear this out. In 1997 the Australian Government retracted a previous mandate requiring approved suppliers to have ISO 9000, because it felt that non approved suppliers appeared as capable if not more so, than some who had achieved certification. Over the last number of years, the ACSI (American Customer Satisfaction Index) has failed to make significant improvements on a national basis in spite of the broad based focus on quality management.

No organization, public or private, should ever embark upon a quality management initiative without first defining for himself or herself, how a lack of quality is impacting their organization. If management fails to know what a lack of quality looks like – how will the success of a quality system implementation EVER be able to be either focused on areas of improvement, or evaluated in terms of success – initially or later?

In the book "Grow to be Great (nobody ever shrank to greatness…)" the authors focus on five key areas that successful organizations must focus on to build success. One of these is "flawless execution" in all we do. It must be clear that flawless execution has a great deal to do with eliminating waste and keeping clients happy. At a keynote speech in Indianapolis in May 2000 the President of NOKIA – an extremely successful player in the wireless telecommunications business, made the point that in all aspects of quality in their success, a key core assumption is "…process based thinking." Given that processes are the vehicles of execution, then flawless execution MUST come from flawless processes; and given that processes are the tools of "operationalizing" strategy then success at achieving strategic goals can only come from alignment between strategy and execution through aligned processes.

Thus the goal of a quality management system must be to enhance organizational effectiveness, focusing in the areas of key strategic need. In today’s economy some of the key areas of need are:

• Keeping (and growing) customers based on service that meets and exceeds expectations
• Keeping costs low in a global competitive environment, and
• Creating a work environment where the best people can be well compensated as well as motivated to stay and contribute their intellectual capital.

An absence of quality in these areas will reduce financial and intellectual capital – customers will defect increasing sales and support costs (as well as reputation and loss of brand value in the market). Costs will increase due to dealing with process problems that occur when things do not happen according to the process – and employees (at all levels) will become increasing frustrated through having to try and perform their job with processes that don’t work.

One company who implemented a new order entry system lost 50% of its’ customer service representatives in the space of 12 months because they could not service the customers and "were caught in the middle." This was a loss of over 50 staff – many with years of experience (i.e. an investment in intellectual capital) that would take a long term to replace. What was the loss in terms of replacing the staff?

• Cost of replacement using agencies and internal resources - $5,000 / person (minimum) for a total cost of $250,000
• Cost of loss of customers due to understaffing during replacement process – calls abandoned increased 10% with an average order size loss of $300 approximately $600,000 / week lost revenue
• Defection of customers – not measured but likely to be high
• Loss in productivity from using less experienced replacement staff say 10% year 1 and 5% year 2, equals potential sales loss of potentially $300,000 - $500,000 per week.

Clearly quality is more than just making sure that products meet specifications – it is about the organization meeting specifications of performance. It is the types of cost outlined above that organizations must be able to determine as the costs of poor quality before an improvement program is implemented. This also demonstrates that there are considerable organizational benefits from doing things right.

New tools and measurement systems are required to understand these opportunities. A concept called the "Cost of Quality" has been used by organizations for over 30 years to try and identify the potential impact of an effective quality management system. The problem with this approach was always that traditional costing systems either mis-stated the impact of poor quality or buried it completely within overheads; in the case of many service organizations there never has been an effective way to address costing – this is especially true in the public sector. Alternative methods to identify the "poor quality events" and apply costs to them had to be developed, in many cases creating an "overlay" financial reporting system. Not surprisingly a study by the Quality Cost Committee of the American Society for Quality in 1996 revealed that this process was greatly enhanced by having the involvement and support of the financial function.

Activity Based Costing (ABC) and Balanced Scorecard concepts offer financial managers an opportunity o start thinking about how to report the costs of poor quality. An effective financial manager wants to know both what the processes cost but also what the "optimum" cost should be. The application of "is" and "should" maps often misses the existing impact of poor quality – assuming that the existing process is at least working as designed "step by step" – in many cases an initial incorrect assumption. Poor quality costs are caused by activities that are being carried out over and above what is needed. Given that the core of ABC is the costing of activity and effective ABC system should be able to track both existing "core" process costs as well as additional costs caused by the need to repeat certain steps. For example costing the process of issueing credit notes is fine – and maybe the process could be improved. The key question is "why is the organization doing this?" Elimination of the root cause is the main goal not a more effective process!

Balanced Scorecard allows organizations to focus on the performance of processes in terms of financial as well as non-financial measures. This approach complements the idea of poor quality costs as it seeks to determine opportunities to improve both process performance in terms of time and quality (numbers of defects or repeat activity) as well as the minimization of cost of process through eliminating non value added "poor quality." The approach also supports the linkage of process performance to core drivers of client satisfaction – itself the goal of an effective quality system; clients are satisfied or not by the outputs of processes, so the linkage of key strategic drivers for client satisfaction to the scorecard focuses attention on areas where a quality management system should bring about improvement.

In summary, organization embarking upon a quality management initiative is well advised to identify what the organizational impacts of a lack of quality are. These may be related to depletion of financial or non-financial assets; in addition they should be linked to processes where the output has a direct impact on client satisfaction. Only in this way can the payback of quality management investments be assured.