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Product Quality And Profitability

November 16, 2009

“What will you base your purchasing decision on?” “We will give our business to whoever provides the best combination of price, quality and service.” I am certain that sounds like a familiar dialogue to most of you. In fact you probably have played both roles in this conversation numerous times. If this conversation is frequently a part of your business dealings, and particularly if it is part of your customers thinking, it’s time to take a closer look at price, quality and service.

Pricing is a product attribute that can generally be quantified and easily compared. Quality and service, on the other hand, are relative terms that are difficult to measure and compare. Further complicating the problem is the fact that it can be extremely difficult to differentiate between the quality of the actual product and the quality of the service provided by the company selling the product.

One thing we know for sure, if the customers are talking about price, quality and service, these three factors are having a major impact on our profitability and future growth. Since pricing is easily quantified and compared, lets not complicate it, just make sure to do a regular competitive pricing analysis. Since quality and service are difficult to differentiate, lets evaluate them as one. Because they are difficult to quantify, lets establish a simple measure for evaluating them.

No absolute measures exist for determining quality. Statistical analysis of specific items such as rejected parts or customer complaints are useful indices in studying the quality problem. Quality is a relative characteristic, not an absolute one. How is my product or my store or my restaurant doing relative to my competition? That’s the real question. The best source of information in this evaluation is you and your key employees. The secret to obtaining that information is your ability to be candid with yourself.

Perform this exercise. Categorize your business by its major product groups or products. For a restaurant that may mean the five major dishes served for each meal, desserts and beverage service. For an automobile company it would be a listing of all the models manufactured. Beside each product listing put a number which represents that product’s percent of your total sales. The list should total 100%. Have each of your key employees and yourself rate each of the product areas as superior, inferior or average as compared to those of your leading competitors. Remember that we are evaluating quality and service as a combined attribute, so be sure to consider both in your evaluation.

Now compute what percent of your total sales has a superior rating, an inferior rating and an average rating. To determine your company’s quality index, disregard the average ratings and subtract the percent inferior from the percent superior. The quality index, which can range from a theoretical high of 100% to a low of -100%, generally will fall between -25% to +75%.

Remember that however imperfect your computation of quality is, it is important. Quality is important to your customers, research has established a strong link between quality and profit, quality is a relative term and no one is better positioned to evaluate quality in your business than you. Don’t kid yourself on this important evaluation. You will only fool yourself. Be candid!

Those businesses with an index +50% or greater will be classified as having high quality, those with an index below zero as low quality and those in between as average. Research indicates that those businesses with the highest quality evaluations are generally more profitable as measured by return on investment and net profit as a percent of sales.

Surprisingly the relationship between quality and profitability is not a linear one. That is, there is little difference between the profitability of those companies with average or below average quality ratings. Only at the extremes of high and low quality is there a marked differentiation on profitability. The relationship between quality and profitability is a valid one for most all kinds of businesses.

The apparent and obvious conclusion is to do what ever is necessary to improve the quality of the product. That is further reinforced by the stories we hear about an emphasis on quality having immediate bottom line effect. My suspicion is that this immediate impact is probably the elimination of waste rather than a legitimate quality improvement.

Experience with a large number of companies indicates that quality can be improved and if successful in reaching the extreme standards of excellence, enhanced profitability will be the result. However, making substantive changes that impact quality and long term profitability take time and incur real costs. A true pledge to improve quality requires a commitment of time and money. Not everyone succeeds.

While quality and service are difficult to quantify, there is no escaping their impact on profitability. Because it’s your business, make a candid evaluation of the quality and service that you provide.

Joe Driscoll is a management consultant whose column appears regularly in the Monday Herald.

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