Question

List two examples of opportunity costs that may be considered as part of a cost of quality analysis. Why should a company consider opportunity costs when assessing quality performance?

Answer 1

Cost of quality analysis is a methodology that allows a firm to determine the extent to which its resources are used for activities that prevent poor quality or appraises the quality of the firm's products or services and that results from internal and external failures.

Opportunity cost is the cost beared for loss of another opportunity for choosing an opportunity.

Let us see with an example -

There are two alternatives with a company to invest in a project. Both are having different requirements. Project A would take 3 years to make the amount coming from the project equal to all what would be the costs incurred by the company but the items needed in this projects are very difficult to be found and the transportation cost would cost too much.

The market need of the products from project A does not have a long term needs and cannot build a strong market.

If we consider the project B, it would repay its total cost incurred in it in five years. But the products of project has a good market and have long term demands. The items needed in this project are easy to find and incur less transportation cost.

When we analyse both the projects, we find that project B is more feasible as compared to project A, as the cost of the company will be less in project B and the products have good market which will give more profit. The cost of resources is also less in project B than in project A.

So here project B is selected over project A. This shows the opportunity cost as a part of cost of quality analysis.

Opportunity cost should be considered by a company while assessing quality performance because it is important to select the alternative which is more productive and profitable for the organisation as once the money has been invested in a particular alternative it cannot be taken back. The money will get engaged. If that same money would have been engaged in some better alternative where chance for profit was more, or cost incurred by company is les, in that case company will loose an opportunity to work on better project and hence would earn less as compared to what it could have earned.

When economists refer to the opportunity cost of a resource, they mean the value of the next highest valued alternative use of that resource. The word 'opportunity' in opportunity cost is actully redundant. The cost of using something is already the value of the highest valued alternative use. In this case, it virtue is to remind us that the cost of using a resource arises from the value of what it could be used for instead.

Opportunity cost need not to be assessed in monetary terms but rather can be assessed in terms of anything that is of value to the person or persons doing the assessing. Resources spent on risk management could have been spent on more profitable activities.