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Quality quandary

Column box-Eagle Watch

A national quality award is part of a larger effort by a government to make its local businesses more competitive in the world economy. The awarding institutions are generally either government departments/ministries or nonprofit organizations with government ties. In many countries, the awarding institutions are consortia of businesses. Candidate companies compete in award-specific assessments of business quality and excellence criteria.

It is widely acknowledged that the national quality award phenomenon grew out of the Total Quality Management (TQM) movement. As explained by the American Society for Quality (ASQ), the history of TQM began as a term coined by the Naval Air Systems Command to describe its Japanese-style management approach to quality improvement. As an umbrella methodology for continually improving the quality of all processes, TQM draws on a knowledge of the principles and practices of the behavioral sciences, the analysis of quantitative and qualitative data, economic theories, and process analysis.

What is the economic rationale behind TQM? As explained by microeconomics textbooks, market signaling is the mechanism through which buyers and sellers deal with the problem of asymmetric information. Market signaling is a process by which sellers send signals to buyers conveying information about product quality. A casual review of the term “quality” yields definitions encompassing both goods and services.

For goods, quality refers to a group of features and characteristics that determine desirability and can be controlled by a manufacturer to meet certain basic requirements. Businesses that produce goods for sale can have a product quality or assurance department that monitors outgoing products for consumer acceptability. 

For services, quality refers to an assessment of how well a delivered service conforms to a client’s expectations. Service business operators can assess the service quality provided to their customers in order to improve their service, quickly identify problems, and better assess client satisfaction.

On a macroeconomic level, national quality awards also serve as market signals. They are given precisely to signal to consumers and investors that local goods and services are of superior quality, which, in turn, could attract more investment and employment opportunities into the domestic economy.

Of course, national quality awards are not given freely. Firms must undergo the necessary training to vie for an award. Training entails costs, and these costs naturally rise as the training becomes more rigorous. Training often demonstrates the characteristics of a so-called merit good—one that is underprovided and underconsumed by a market. The market failure is caused by a divergence between what firms perceive as their own private benefit and what society actually gains. The consumption of merit goods releases positive spillover effects on society, but private firms do not necessarily value them as much as society does. So, because firms tend to privately undervalue merit goods, they end up consuming less of such goods than what is socially optimal.

Why might firms opt to forgo training? There are two possible reasons. One, information might be lacking. Firms do not always know that more training could increase their incomes significantly. Even if owners do recognize that highly-trained firms tend to earn higher incomes in comparison to low-trained firms, they might not always understand that earnings also go up due to marginal increases in training.

Two, it might be difficult for firms to match short-run costs with long-run benefits. Often, firms could easily account for the immediate costs of training, but they cannot readily match these costs with the long-run benefits, especially if there are no objective bases to measure such benefits. Firms might end up underestimating—or, perhaps, even ignoring—the benefits of training, so they opt to forgo such investment.

Interestingly, the ASQ website provides data on training fees. A basic TQM course charges $899 for each nonmember and $799 for each member who opts for a virtual format. For a classroom format, each nonmember is charged $1,729, while each member is charged $1,499.  Since most firms in Southeast Asia are SMEs, they would likely hesitate to avail themselves of TQM training due to the steep prices, so they end up underinvesting in TQM training. Because of such underinvestment in TQM training, national quality awards have not gained much traction in the region.

Governments can intervene to increase the supply of TQM training, which, in turn, would increase the consumption of training. If government subsidies are applied correctly, the socially optimal level of training can be achieved, and this can pave the way for national quality awards to gain more traction. However, there are no guarantees that government intervention will succeed in eliminating market failure. The success of applying subsidies will crucially depend on the ability of governments to accurately estimate the value of positive spillover effects, which is easier said than done.

Dr. Ser Percival K. Peña-Reyes is the Director of the Ateneo Center for Economic Research and Development.

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