Quality is Not Free

With all due respect to Phil Crosby, there are no free lunches. Every increase in quality requires an investment of some sort – whether it be internal resources used in problem solving activities, investments in new technology, or process re-engineering.

I think I know what Crosby meant – that the costs associated with improving quality are far lower than the costs a firm incurs as the penalty for poor quality, or put another way, the opportunity cost of doing nothing. But improvements in quality can never be free because every decision a firm makes to allocate its resources in one way or another always involves  costs, whether they be real costs or the opportunity cost of foregoing an alternative use against which those resources could be deployed.

What I am really interested in is not how much costs can be saved from improving quality, but how much additional revenue can be generated. Improvements in quality that are not valued by customers may reduce costs, but they will not create additional revenue. And, cost reduction always has a threshold.

The concept of marginal customers is important here. A marginal customer is a customer that has never bought from your firm before – they have either chosen other suppliers, or chosen not to buy. Marginal customers represent new revenue for a firm, in contrast to inframarginal customers – these are loyal customers who will continue to buy from your firm, even if you maintain your current quality levels. Marginal customers, however, may be induced to buy from your firm if an increase in quality represents additional benefit which they value.

The marginal benefit, or utility, of quality is something that firms should know and be aware of. What is the additional increase in revenue that comes from increasing quality by “one unit”? Often, this may be known from a cost perspective, but rarely from the revenue side.

Looked at this way, quality improvement may be an important differentiator for some firms. A firm that can provide a significantly valuable increase in quality may attract marginal customers and increase its total revenues as well as market share. If the quality improvements can be made with little additional investment, firm profitability may be positively impacted.

The problem with quality improvements is that they are often not sustainable as a competitive differentiator – the methods and technologies employed to improve quality can often be readily imitated by rivals. A competitive convergence then results, where all rivals have increased their quality but the overall profitability of the industry remains the same as before.

Every firm must find its optimal quality level – the level that will maintain inframarginal customers while still attracting marginal buyers. A broad definition of quality must prevail – firms should specify quality from the perspective of customer requirements and fitness for purpose, not just conformance to specifications or freedom from defects.

Stewart Anderson

stewart@andersonlyall.com

http://www.andersonlyall.com

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