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June 24, 2010

Value Adding and Value Added

In lean, we are familiar with the concept of “Value Adding” activities – those activities which transform a product, service, information or cash in a way which the customer would be willing to pay for. The purpose of “lean”, of course, is to remove non-value-adding activities (i.e. waste) and, thus, create free capacity which we can use for more value-adding activities which (with the same level of resources) generates more profit.

 

In accounting, we also have the term “Value Added”. This has a specific definition and is the sales value of output less the value of all external inputs. That is to say that “Value Added” is sales income less the cost of bought-in goods and services.

 

The “Value Added” that a business generates comprises three elements – profit (retained or paid in dividends); debt servicing; and the payment of wages, salaries and other employee benefits. Thus “Value Added” is the surplus that the business generates in order to pay the providers of its capital – share capital, debt capital and human capital.

 

In Lean Accounting, we can envisage the concept of “Value Stream Value Added” which would be sales income less the direct cost of bought-in goods and services of the Value Stream. In Lean Accounting we do not apportion or allocate unattributable overheads to Value Streams, so this “Value Stream Value Added” would contain a fourth element. As well as a contribution to the owners of share capital, debt capital and human capital, it also includes a contribution to those corporate overheads which lie outside the Value Stream.

 

This is where the accounting term “Value Added” can support the lean concept of “Adding Value”. By focussing on those activities inside the Value Stream which add value, and by removing non-value adding activities, we increase “Value Stream Value Added”. We remove waste and create capacity to do more value adding activities which enables us to increase sales and, thus, enhance the Value Added of the Value Stream. Because waste is removed by people working together using problem-solving methods, it seems fair that this additional “Value Stream Value Added” created should be shared between the providers of the business’ share capital and the providers of the human capital (i.e. the staff !).

 

Offering incentives based on the incremental “Value Stream Value Added” generated seems like a good way of building trust and driving improvement.

 

Furthermore, if we then go on to analyse how the “Value Stream Value Added” is deployed, we can generate further incentive to improve. In particular we should analyse those corporate overheads which do add value for the business (new product development; market and customer development; and so on), and those which do not. This should boost efforts to establish lean improvement in corporate activities to remove waste and streamline processes, releasing more cash to be shared between the business owners and those who deliver the improvements.

 

So perhaps “Value Stream Value Added” is a measure we should start looking at as well as Value Stream Profit. It could be a useful means of gaining buy-in to improvement activity, helping to focus on processes (not people), and a fair way of sharing the fruits of that improvement.