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Adding Cost or Creating Value?

3/4/2004
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I was out on tour this past week, listening to companies' stories as they try to achieve a "lean" transformation.  And I was struck, as I often am, by confusing terminology. The companies I visited thought they were "adding value" but I mostly watched them adding cost.  So let me try to clarify things.

I always use the term "creating value" rather than the more familiar "adding value" because the former is the voice of the customer while the latter is the voice of the accountant.  Companies add up their costs - both bought-in materials and internal spending on capital and labor plus their margins - then subtract the cost of their purchased items to determine how much "value" they have "added".  The problem is that this leaves out the customer, the only one who can determine value.  Often, what a company really means by "adding value" is "adding cost".  Whether the extra cost creates any value is known only to the customer, and many managers never ask!

A quick example, in case I haven't been clear: Let's suppose a company buys some nuts and some bolts and assembles them into a simple product.  These purchased items clearly are costs.  Then lets suppose the company uses a lot of labor to store these parts, take them to the point of assembly, assemble them, rework the defective items, store the assembled goods, hunt for missing items, and then ship them.  Finally, let's suppose that the bought-in items cost 50 units and the selling price for the finished product is 100 units.  Clearly the company must have "added" 50 units of "value".  Right?  Wrong!

From the customer's standpoint this company may only have added fifty units of "cost" including its margin, and created very little value.  The reason is simply that most of the steps consuming the resources - storing the parts, hunting for them, reworking them -  added cost but no value from the perspective of the customer.  Customers actually would have thought the product was more valuable (and been willing to pay more) if these steps had been left out and the product had been delivered faster!

Because products come as a bundle of value and costly waste and because the firms in most industries currently mix the two, customers often have no choice but to purchase the waste along with the value.  But what if some lean thinking firm in your industry  separates value from waste and eliminates the waste?  If that isn't your firm, watch out!

Words aren't a substitute for action, but the wrong words often get in the way of the right actions if managers can't tell the difference between value and cost.  So I hope lean thinkers will sharpen their language to focus on actually creating value, often by eliminating unnecessary costs.

 

Best regards,

Jim

Jim Womack
President and Founder
Lean Enterprise Institute


 

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