Cost Consciousness and Value Adding
Sports teams use data to measure performance and identify opportunities. We in business use data also to measure performance and identify opportunities. Compared to general statistics, cost is different in that it uses money as a common measurement. Reality is operations; cost and profit is the scorecard (and payoff.)
Cost Consciousness-Part 2
Mitch Max continues a series on cost consciousness in business organizations. He reveals different techniques and their advantages in becoming cost conscious.
What Is Value Adding
Alan Stratton responds to a viewer questioning whether rework to avoid a customer return in “Value Adding”. He goes on to suggest a better way to target activities for attention.
In episode 24
Cost Consciousness and Value Adding
Coming up on Performance Management Edge… Cost Consciousness and What is Value Adding.
I’m Alan Stratton and this is the show that helps you get an edge in business. This is the edge you need to get things done, to soar above the masses, and to make more money.
In sports, we love to track scores and statistics. Yet, the real excitement is the game, its ebb and flow, the breakouts, and the human drama. Similarly, in business, numbers, especially financial numbers, are symptoms of underlying operations. The bottom line is the ultimate score.
Similar to sports statisticians, we analyze business statistics. We look for patterns, hot spots, hidden opportunities, and wasted talent. Cost is one major class of business statistics. In this episode, Mitch Max extends his exploration of cost consciousness. He’ll help us use these numbers to our advantage.
Over to you, Mitch.
Hello, and welcome back to our series on creating a Cost Conscious organization. Last time, we discussed that an organization can only become Cost Conscious when it has a strong set of cost analytics to guide its culture in making effective decisions. Today, I’d like to explore this notion of cost analytics in greater detail and give you some ideas for creating better cost reporting.
For most organizations, cost reporting consists of a General Ledger view of expenses where we look at costs by GL account within an organizational unit, and usually compare it to budget or perhaps to a prior period. This reporting generally focuses on ensuring that costs are spent as authorized, but it doesn’t provide sufficient guidance to help the organizational unit spend appropriately. Our goal should be to give the unit manager the tools to understand what the spending relates to, so that manager can use his or her best judgment in resource utilization.
When the unit reports on resource costs – that is, ledger amounts such as staff costs, premises costs, travel costs, and the like – the focus is on what is being consumed. Our goal is to shift the discussion from what to why. Consider this example for the Customer Service department in a distribution company:
First, here is a view of expenses by cost category. All that we know is that we have a set of staff resources focused on Customer Service. If we want to reduce costs by a certain amount, how can the manager tackle this? Reduce systems or occupancy? – hard to control. Cut back on travel? – probably an easy solution but what is the impact? Reduce salaries? – whose job can be cut?
Let’s look at this same data, analyzed by activity:
|Answer Customer Inquiries||149,000||17%|
|Enter Credit Notes||121,000||14%|
|Process Special Orders||83,000||9%|
|Update Price Lists||32,500||4%|
First of all, notice that we’ve sorted this from highest to lowest cost along with the percentage of total. That gives us some focus. If we’re going to manage costs, let’s start with the largest ones. We can see that 20% of our costs are spent on entering orders – that’s a “good” cost. How might we reduce costs? By focusing on the large costs that add less value to customers. For example, Answering Customer Inquiries – at 17% of costs. We need to better understand why customers are inquiring. Is this indicative of errors or problems? This seems likely, given the large cost of issuing Credit Notes. In addition, could we be providing information online about order status that might reduce calls?
What about processing Special Orders? Does the revenue associated with these orders offset the cost of special handling? Are there perhaps other costs that could be automated, now that the costs of the activity are understood – for example, scheduling delivery can be supported by special software programs.
By viewing our costs by activity instead of by resource, we can change the way we think about costs. We can become conscious of why we are using resources, and in that way start to have a better dialog about what resources are really needed. From a planning perspective, this gives us a better handle on the sensitivity of our costs to support changes in new business volume – in this case, the changes in orders. Previously, if our sales group was forecasting a 10% increase in order volume, we might have been inclined to budget a 10% increase in customer service. With this new view, we now have a better understanding of how to support this change with only a small increase in levels, or perhaps – with this new information – even a decrease in costs.
Next time, we will look at other ways to further leverage activity analysis and reporting, to help you on your way to creating a Cost Conscious organization. See you soon!
Thank you Mitch. I only wish that I had this sort of information available to me when I was a financial controller. With a little more analysis, I could have had data driven initiatives to reduce wasted effort and cost. It would have enabled us to grow both our bottom line and our top line: Bottom line by reducing cost judiciously; Top line by freeing up resource to grow revenue.
Let us hear your opinions. Mitch and I would love to hear your experience and comments on either cost consciousness or cost unconsciousness. What has worked for you? Scroll down the page at Performance Management Edge dot com and let us hear from you.
Now for today’s question.
“Often, people refer to an activity as non-value-added. One example is fixing an order before it’s shipped to the customer. Doesn’t this add value, because we’re preventing a return? How do you determine if an activity adds value or not? Is there a better term to use to describe it?”
This question deserves a three part answer: 1) The current example; 2) What is value added; and 3) A better way.
First, managing costs requires honesty and finding underlying causes and their effect. Like peeling an onion, we have to peel back multiple layers to find the juicy goodness. Most “RE” words like repair, rework, signal a repetitive activity. Shouldn’t we be able to do the work correctly the first time? What is value adding? Possibly only the first time the work is performed. Never is the 2nd, 3rd, or 4th time value adding. Therefore, “Fixing an order” is non-value adding. You already did the value adding portion but blew it.
Next, I don’t like the overly simplistic value-adding / non value-adding classification of activities. It all depends on perspective.
I recall my very first Activity-Based Cost implementation and a very long, multiple hour, conversation I had with the purchasing manager on why all purchasing activities had been classified as non value-adding. Didn’t we have to purchase raw materials to make product? Yet, because purchasing did not change or transform the actual product, we had to make all purchasing non value-adding. We did not win friends and influence people with that choice. That conversation has led me to recommend a better way to classify activities.
Which leads me to a better way. Forget the black/white – value / non value-adding classification. Since true value adding depends on perspective, incorporate perspective into your classification scheme. I find greater value in one like this that uses a range of definitions:
- External Customer Value – Anything our external customers would consider value adding without question.
- Internal Customer Value – Any activity our internal customers would consider value adding.
- Business sustaining – Those activities required to sustain business operations: human resources and accounting activities come to mind
- Waste – includes all scrap and rework of any kind.
Actually, we should not over-emphasize activity classification schemes. Across the board, waste, inefficiency, and poor quality abound in all activities, no matter their classification. Only by looking at and attacking true root causes for cost, poor quality, and long cycle time can waste be eliminated and efficiency improved in any or all activities.
Now to our viewers. Do you agree, or Not? How do you classify activities? I’m sure everyone has some sort of feelings whether their work is value adding. Whatever they are, let’s hear your viewpoint. Please share below this video at Performance Management Edge dot com.
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