What Are Internal Failure Costs? A Detailed Explanation

Internal failure costs represent the financial impact a business incurs when defects or inefficiencies are identified within its operations, specifically before a product or service reaches a customer. These costs are a direct result of failing to meet quality standards during production or service delivery. Businesses track these expenditures to understand where quality improvements can lead to significant cost savings.

Common Categories of Internal Failure Costs

Scrap refers to the costs associated with products or materials that are defective and cannot be repaired or reused, necessitating their disposal. This includes the direct cost of raw materials and any labor or overhead expended on the scrapped item up to the point of its discard. For instance, in manufacturing, an acceptable scrap rate typically falls below 5%, though some precision industries may aim for less than 1%.

Rework or rectification costs involve the expenses incurred to correct defects in products or services, bringing them up to the required specifications. This can include additional labor, materials, and machine time. Rework can add a significant amount, often between 20% and 50%, to a project’s total cost, and in some instances, even up to 200% of the original project cost. For the average manufacturer, scrap and rework combined can account for up to 2.2% of annual revenue.

Re-inspection and re-testing costs arise from the need to re-examine or re-evaluate products or services after rework has been performed. This is done to confirm that the identified defects have been fully resolved and the item now meets all quality criteria. These costs include the labor of quality control personnel.

Downtime, also known as idle time, represents the costs incurred when production or service delivery is halted due to quality-related issues. This leads to unproductive periods for resources like labor and machinery. For example, unplanned downtime costs manufacturers an estimated $50 billion annually, with contamination being a contributing factor.

Failure analysis costs are incurred when investigating the root causes of defects to prevent their recurrence. This involves diagnostic work, testing, and engineering time dedicated to understanding why a failure happened. Material losses encompass the value of materials wasted due to defects, spoilage, or inefficient processes, contributing directly to internal failure costs.

Specific Examples of Internal Failure Costs

Consider a scenario in plastic molding where a machine malfunctions, leading to a batch of incorrectly shaped plastic parts. These parts are unsalvageable and must be discarded, representing a direct scrap cost that includes the raw plastic material and the energy consumed during their faulty production.

In software development, if internal testing reveals a bug in an application before its release, developers must spend additional hours fixing the code. This developer time, which could otherwise be spent on new features, constitutes a rework cost.

After a circuit board undergoes component replacement due to a defect, it must be re-inspected and re-tested to ensure proper functionality. The wages paid to the quality control technician for this repeated inspection process are a re-inspection/re-testing cost.

When a manufacturing line stops for several hours because technicians are troubleshooting a machine that is producing defective items, the wages paid to idle production workers during this stoppage are a downtime cost.

If a prototype product fails internal stress tests, engineers must then dedicate time to analyzing the failure to understand its cause and redesign the component. The salaries and associated overhead for these engineers during this investigative period are considered failure analysis costs. Similarly, during garment production, if fabric is cut incorrectly, making it unusable for the intended design, the cost of that wasted fabric is a material loss.

Differentiating Internal and External Failure Costs

The primary distinction between internal and external failure costs lies in the timing of defect discovery. Internal failure costs are those financial burdens incurred when a defect or non-conformance is identified and addressed before the product or service is delivered to the customer. These costs are contained within the organization’s operational boundaries.

In contrast, external failure costs arise when defects are discovered after the product or service has reached the customer. These costs often carry a higher financial and reputational impact. Examples of external failure costs include expenses related to warranty claims, customer returns, product recalls, and legal liabilities. The loss of customer loyalty or damage to a brand’s reputation, while intangible, also represents a significant external failure cost.