External Failure Costs and Internal Failure Costs Explained Easy

In the landscape of project management, understanding the intricacies of cost management is pivotal for driving project success and organizational sustainability. In this article, let's take a closer look at external failure costs and internal failure costs and understand the difference.

Visual PMP Academy
February 15, 2024

In the landscape of project management, understanding the intricacies of cost management is pivotal for driving project success and organizational sustainability.

Among these cost considerations, external failure costs and internal failure costs stand out for their significant impact on a project's financial health and overall quality.

A fascinating statistic from the Project Management Institute (PMI) reveals that poor quality management, including inadequate attention to failure costs, can eat up to 15% of project spending. This underscores the critical importance of managing these costs effectively.

Internal Failure Costs: A Closer Look

Internal failure costs are expenses incurred due to defects identified before a product or service reaches the customer. These costs are internal to the organization and can severely impact the project budget and timeline. Examples of internal failure costs include:

  • Rework: The costs associated with correcting defective work before delivery to the customer.
  • Scrap: Costs related to materials or products that are too defective to be fixed and must be discarded.
  • Downtime: The loss of productivity when teams address defects instead of moving the project forward.
  • Testing and Inspection: Increased costs due to more rigorous testing and inspection to catch defects early.

Managing internal failure costs effectively involves implementing robust quality management systems, continuous process improvement, and fostering quality work throughout the project lifecycle.

Utilizing Six Sigma or Total Quality Management (TQM) methodologies can significantly reduce these costs by preventing defects and inefficiencies at their source.

External Failure Costs: The External Impact

External failure costs occur when defects are discovered after the product or service has been delivered to the customer. These costs can be particularly damaging, not only to a project's budget but also to an organization's reputation and customer relationships. Examples of external failure costs include:

  • Warranty Claims and Returns: Costs associated with honoring warranties or processing returns due to defective products.
  • Liability: Expenses related to legal liability if a product fails and causes harm or damage.
  • Customer Support: Increased costs for supporting customers dealing with defects, including help desks and technical support.
  • Lost Sales: The potential loss of future sales due to damaged reputation and customer dissatisfaction.

Minimizing external failure costs requires focusing on quality control, customer feedback loops, and effective risk management practices.

Engaging customers early and often, utilizing customer satisfaction surveys, and implementing rigorous post-market surveillance can help promptly identify and mitigate these costs.

Strategies for Managing Failure Costs

1. Preventive Measures

Investing in preventative measures is critical to lessen both internal and external failure costs. This includes comprehensive training, quality assurance processes, and regular audits of project processes.

2. Early Detection

Implementing early detection mechanisms, such as phased testing and inspections at various project stages, can help identify defects when they are less costly.

3. Customer Engagement

Regular customer communication can provide early warnings about potential external failure costs, allowing for quicker resolution and mitigation.

4. Continuous Improvement

Embracing a continuous improvement mindset and practices like Kaizen can help systematically reduce failure costs over time.

5. Quality Tools and Methodologies

Leveraging quality tools (e.g., Pareto charts, fishbone diagrams) and methodologies (e.g., Lean, Six Sigma) can aid in identifying root causes of failures and applying practical solutions.

Real-World Application: Internal Failure Costs vs. External Failure Costs

Consider a software development project where internal failure costs might involve expenses related to debugging and reworking code after internal tests reveal numerous bugs.

By implementing agile methodologies and continuous integration/continuous deployment (CI/CD) practices, the team can reduce these costs through early and frequent detection of issues.

On the other hand, external failure costs could manifest as customer complaints and returns after a defective software release.

Establishing a beta testing phase with key customers can serve as an effective strategy for catching and addressing potential failures before a wide-scale rollout, thereby minimizing these costs.


Understanding and managing external failure costs and internal failure costs are crucial for maintaining project quality and financial integrity.

Organizations can mitigate these costs by implementing strategic quality management practices and fostering a culture of continuous improvement, enhancing customer satisfaction, and achieving better project outcomes.

For further insights into managing project costs and improving quality, the PMI offers valuable resources, including standards, certifications, and training programs designed to elevate project management practices.

PMI Quality Management Resources

Ultimately, the goal is to shift the focus from merely reacting to failure costs to proactively preventing them, ensuring projects meet and exceed quality expectations, delivering value to customers and stakeholders alike.


By recognizing the importance of external failure costs and internal failure costs, project managers can take a pivotal step towards achieving this goal, steering their projects toward success and driving organizational growth.

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