Since I wrote The Lean Ratio the other day the comments and opinions have come in fast and furiously. The concept of what is value adding is an important one – at the heart of lean if you believe that lean is all about the elimination of waste and that waste can be defined as everything that does not add value in the eyes of the customers.
In particular, the question of the costs of selling and advertising are a point of contention. Advertising most certainly has value – but it is valuable to the company – not the customer. Same with the cost of selling. As a customer, I could care less how many more you sell and to who. The cost of all that is your problem. You, as the manufacturer, are worried about selling a lot of things and racking up big sales numbers. As the customer, I only care about the one I bought. The point is that because something has value for the company, that does not mean it has value for the customers.
Same thing holds for logistics. The company may need to spend money on it, but as a customer, it holds no value for me. I really don't care if you shipped it 9,000 miles or 900 feet. How far it came does not influence my assessment of the value of the product. Just because an expense is necessary for the company, it does not hold that the expense is value adding in the eyes of the customer.
You may need to spend money on regulatory compliance, but that does not make it value adding in the eyes of the customer. There are lots of things that may be necessary (at least necessary within the business model in which you operate), but necessary and value adding are not the same thing.
The difference is that your necessary – either for business model or for compliance with the law – expenses do not translate into higher prices because they do not make the deal any more attractive for a customer. While some of the commenters pointed out that many costs are necessary, and the business would be in trouble if it did not incur them, the real test is on the flip side. Will spending more on those areas logically result in the ability to command higher prices – sustained higher prices – not just a short term deal?
Will moving the plant further from the customers and increasing logistics costs enable you to raise prices to the customers? If the answer is no then the cost is not value adding because it did not result in a better value proposition for the customer.
Same with advertising. Sure, a slick advertising campaign can drive sales and prices once – but the second time the customer is going to buy or not based on the perception of value resulting from the first purchase. In the long term, all the advertising in the world will not allow a company to command higher prices than the product is worth. This is a harsh reality P&G is now facing. And it is the harsh reality GM has steadfastly refused to face as they were consistently outsold by Toyota, even though they outspent Toyota on advertising by almost 4:1. Wahl Clipper trashed the big guys in the consumer clipper market despite being out-advertised by as much as 8:1. Advertising does not create value – just the temporary illusion of it, at best.
There actually is a companion ratio to the one I described earlier. It is the relationship of value adding expenses to price – usually calculated by (Gross sales/Total Value Adding Expenses = VP).
When you track both of these:
Value Adding Expenses/Total Expenses = VC (or Value to Cost)
Gross Sales/Total Value Adding Expenses = VP (or Value to Price)
You get the whole picture. The lean strategy should be driven by optimizing these two ratios simultaneously. If you choose to convince yourself that advertising is a value adding expense – or like the guy I cited in the previous post, decide to call all payrolls value adding to avoid offending anyone, you will see soon enough that, while you are making the Value to Total Cost ratio look good you are degrading the Value to Price ratio every time you spend more in those areas. The two ratios provide a check on each other, which is why they should be tracked simultaeously.
The bottom line is that it is very important that the discussion be held within every company and that 'value adding' be well defined. Value adding expenses should be reduced very, very carefully because it is too easy to degrade customer value in the process – that is the trap too many companies that run to China fall into. Non-Value Adding expenses, should be cut with near reckless abandon. For that matter, in many companies, they should not be reducing overall expenses at all. Instead they should be shifting expenses from non-value adding activities to ones that genuinely enhance the value of the product and will enable them to command higher prices. That is the real lesson from Toyota's history. Their cars are not cheaper than their competitors – they are a better value. A greater percentage of the money paid goes into the car, while their same-cost competitors are squandering it on administrative nonsense, overblown advertising, global logistics and other waste.