Internal Failure Costs – Meaning, Examples and More

Internal failure cost is one of the four types of costs of quality. Three other costs are -preventive costs, appraisal costs, and external failure costs. Internal failure costs, as the word suggests, are the failure costs that are internal to the company. We can also call these costs like the loss to the company.

In simple words, we can say these are the costs that a company incurs on the product before discovering a defect in it and before a product leaves the company. Also, it includes the costs a company incurs to rework the product, remove the defect, and ensure that the defect doesn’t come up again.

A company usually discovers the defect because of its internal inspection processes. Some examples of this type of cost are product reworking cost, throughput lost, and more.

Internal Failure Costs – What Are They?

In the modern era, a product usually has many parts. So, there are more chances of quality defects, both prior to and after the production process. A defect at any stage of the production could create issues for the company in terms of cost and negative response from the market and customers.

This is why a company takes preventive measures to come up with a defect-free product. Still, there are chances of a defective product, and this results in internal failure and other types of quality costs.

What it includes

Talking about internal failure cost, as said above, it is an internal cost that a company incurs before it delivers the product to the customer. It includes the cost that one can relate to the failure, including the cost to make good the defect (defects) that the company discovers before delivering the product to the customer. Primarily, a company incurs such a cost if the output fails to meet the quality standards.

These costs are easier to quantify and could have a substantial impact on profit.

Examples of Internal Failure Costs

Following are examples of internal failure costs:

Scrap

It includes the cost of labor, material, and other overhead costs attributable to the defective product. We consider these costs only when the product is not repairable. Other names for these costs are spoilage, defectives, seconds, and more.

Rework

As the name suggests, this cost includes the cost to rework the faulty product or service to bring it at par with the standard quality standards.

Failure Analysis

It includes the cost, a company incurs to find the cause of the defect. It is the cost of regular sampling and testing, etc.

Supplier Side Cost

This includes the cost, a company incurs due to issue at suppliers’ end. It includes the cost to resolve the issue, scrap, rework cost (if any), and more.

Inspection

As the word says, it is the cost that a company incurs to inspect the output and identify the defective products fully.  

Retesting

As the word suggests, it is the cost to retest the defective product after repairing or reworking them. It ensures that the product meets quality standards.

Modifying Process

If the company finds that the cause of defective products is a faulty production process, it would have to modify the process. The cost to change the production process is also an internal failure cost.

Charging or Modifying Hardware

If the issue is with hardware or any equipment, then the cost of repairing or replacing it will be an internal failure cost.

Updating or Correcting Software

If the production process of a company is software-based, and the defect is because of software, the company will then have to incur the cost to make it good.

Disposing Scrap Product

It is possible that the faulty product or service is not repairable. In such a case, the cost that a company incurs to dispose of it will be an internal failure cost.

Scrapping Indirect Operations

If a company scraps existing operations to rectify defects, then the cost of disposing of them will be an internal failure cost.

Internal Failure Costs

Reworking Support Operations

It is the cost that a company incurs to rework indirect operations, in order, to rectify the defect.

Additional Material Procurement

It is the cost to procure more material to rework or replace defective products.

Change in Selling Price

It is the difference in the selling price (if any) before and after the defect. Generally, the selling price is lesser due to the defect and subsequent re-working.

Loss of Time

It is the cost for the production process remaining idle due to the reworking. Or the production capacity being used for re-working defective goods.

Inventory Cost

It is the cost because of the difference between real (quality approved finished goods) and recorded inventory.

Cost of Non-value-added activities – it includes the cost of non-value-addition activities, such as sorting, inspections, and more.

Other Cost of Quality

Following are the other three categories of Cost of Quality:

Prevention Costs

As the word suggests, prevention costs include the cost a company incurs to prevent the defect from occurring. Primarily, these include the cost to design, implement, and maintain the quality management system.

Appraisal Costs

Appraisal cost includes the cost a company incurs to measure, audit, evaluate components, or the raw materials to ensure they conform to the quality standards and requirements of the company.

External Failure Costs

External failure cost includes the costs that a company incurs to make good the defect after shipping it to the customers.

Final Words

Internal failure costs are unavoidable, but a company can minimize it. A company can minimize these costs by investing in preventive measures. These preventive measures could be investing in enterprise quality management software (EQMS), strict in-process testing and inspection, activity audit, compliance management, and more. Also, a company can invest in real-time data collection software to quickly trace and resolve the defect.



Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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