A hidden effect on inventory costs is the Cost of Quality (CoQ). The CoQ reflects the amount of money spent managing malfunctioning product, damaged goods or stock out due to inconsistent supply
An example:
If you’re shipping 1,000 items on a container that you sell on the market for $5 each
- The container costs $4,000 to ship from your supplier to your warehouse.
- On a specific shipment, 50% of those items malfunction or are damaged and cannot be used.
- As you’re likely out of inventory without those 2,000 products, you’ll lose revenue associated with having that product in stock.
Your CoQ includes:
$2,000 (Container cost to bring in defective product) $5 (x) 500 (Lost revenue from product not in stock) = $2,000 + $2,500=$4,500.
A business spends time managing defective products, placing a new PO, expediting the new PO and managing internal customer complaints as a result of being out of stock. All these activities reflect the amount of resources your business is investing in managing poor quality above and beyond the purchase price. Tracking these costs at the product line (and supplier) supplier level will help illustrate where your pain points and opportunities to improve manifests. In addition, it should be added to the purchase price you’re paying from a supplier and factored into any decision to change suppliers.
For help in identifying your CoQ, reach out to a member of the Forsyth Advisors team.
