Failure costs are those incurred by a manufacturer when it produces defective goods. There are two types of failure costs, which are internal and external. Internal failure costs occur before goods are shipped to customers, while external failure costs arise subsequent to shipment. Examples of the two types of costs are:
- Internal failure costs. Includes scrap, rework, and reduced sales prices for reworked goods.
- External failure costs. Includes warranty expenses, legal costs associated with settling customer claims, field service costs, recall costs, cancelled orders, and lost customer goodwill.
External failure costs tend to be substantially higher than internal failure costs, so it makes sense for a manufacturer to expend more effort to ensure that all products leaving the factory adhere to its quality standards.