Problem 6

Mercury, Inc., produces cell phones at its plant in Texas. In recent years, the companys market share has been eroded by stiff competition from overseas. Price and product quality are the two key areas in which companies compete in this market.

A year ago, the companys cell phones had been ranked low in product quality in a consumer survey. Shocked by this result, Jorge Gomez, Mercurys president, initiated an intense effort to improve product quality. Gomez set up a task force to implement a formal quality improvement program. Included on this task force were representatives from the Engineering, Marketing, Customer Service, Production, and Accounting departments. The broad representation was needed because Gomez believed that this was a companywide program and that all employees should share the responsibility for its success.

After the first meeting of the task force, Holly Elsoe, manager of the Marketing Department, asked John Tran, production manager, what he thought of the proposed program. Tran replied, I have reservations. Quality is too abstract to be attaching costs to it and then to be holding you and me responsible for cost improvements. I like to work with goals that I can see and count! Im nervous about having my annual bonus based on a decrease in quality costs; there are too many variables that we have no control over.

Mercurys quality improvement program has now been in operation for one year. The companys most recent quality cost report is shown below.

Table Summary: Quality cost report with three-line heading for two years: last year and this year. The dollar amounts are in thousands of dollars. The report has sections for prevention costs, appraisal costs, internal failure costs, and external failure costs. Each section is totaled. The last two lines show total quality cost and total production cost.
Mercury, Inc. Quality Cost Report (in thousands)
	Last Year	This Year
Prevention costs:
Machine maintenance	$70	$120
Training suppliers	0	10
Quality circles	0	20
Total prevention cost	70	150
Appraisal costs:
Incoming inspection	20	40
Final testing	80	90
Total appraisal cost	100	130
Internal failure costs:
Rework	50	130
Scrap	40	70
Total internal failure cost	90	200
External failure costs:
Warranty repairs	90	30
Customer returns	320	80
Total external failure cost	410	110
Total quality cost	$670	$590
Total production cost	$4,200	$4,800

As they were reviewing the report, Elsoe asked Tran what he now thought of the quality improvement program. Tran replied. Im relieved that the new quality improvement program hasnt hurt our bonuses, but the program has increased the workload in the Production Department. It is true that customer returns are way down, but the cell phones that were returned by customers to retail outlets were rarely sent back to us for rework.

Required:

1. Expand the companys quality cost report by showing the costs in both years as percentages of both total production cost and total quality cost. Carry all computations to one decimal place. By analyzing the report, determine if Mercury, Inc.s quality improvement program has been successful. List specific evidence to support your answer.
2. Do you expect the improvement program as it progresses to continue to increase the workload in the Production Department?
3. Jorge Gomez believed that the quality improvement program was essential and that Mercury, Inc., could no longer afford to ignore the importance of product quality. Discuss how Mercury, Inc., could measure the cost of not implementing the quality improvement program.