What are Failure Costs?

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 noted below.

Internal Failure Costs

There are multiple types of internal failure costs, which include the following:

Process failures. A process may be defective, resulting in a reset of the appropriate machinery and the scrapping of all output during this reset process.
Scrap. The production process may generate out-of-spec goods that cannot be reworked. These items must be thrown out.
Rework. The production process may generate out-of-spec goods that can be reworked. The cost of this rework can be quite high.
Reduced resale prices. When goods have been reworked, the seller may be forced to sell them at a reduced price, possibly eliminating the standard profit on these units.

External Failure Costs

External failure costs include warranty expenses, legal costs associated with settling customer claims, field service costs, recall costs, cancelled orders, and lost customer goodwill.

External Failure Costs vs. Internal Failure Costs

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.