The Basics of Value Analysis

Value Analysis, or VA, was originally developed by Larry Miles in the 1930’s at General Electric. It’s based on a simple fact: products have design features, elements and aspects that don’t contribute to customer perceptions of value. If that’s true, and it usually is because no product is perfectly optimized, there’s a cost reduction potential that can be mined.

Value Analysis is sometimes called “Value Engineering” because it’s design focused, but the common term is Value Analysis. However, the ideas behind VA are often misunderstood and misapplied. Used incorrectly, VA can lead to serious negative impacts on the products you make and sell.

In the end, VA is a simple idea: how can you change a design to improve value and reduce costs?

The Fundamental Principle

In VA, value is defined as the ratio of Cost to Function:

Inevitably, there’s some waste in this relationship. Finding and reducing the level of waste is what VA is all about. While the general goal is to increase value for your customers, there are some twists and turns that you need to understand.

It’s Design Oriented

VA is always aimed at reducing waste through design changes. Process cost reduction is better approached using lean methods, including reductions in direct & indirect labor and overhead using process mapping and other techniques. VA has been applied to manufacturing operations, but it’s like using a sharp kitchen knife to perform an appendectomy—a skilled surgeon can do it, but there are better tools available that won’t leave an ugly scar. Sometimes, a design change will also impact manufacturing process costs, and that has to be considered. Still, the focus in VA is on product design.

Five Ways Value Can Be Improved

For a simple ratio like the value equation, there are five ways that value can be increased.

First, you can hold function constant and reduce cost in order to improve value.

This classic cost reduction, but in practice it’s terribly difficult to achieve this result. Almost anything that reduces cost affects function. Sometimes a change in vendor for a simple commodity will achieve that, but no two vendors will provide exactly the same thing, no matter what specifications are involved, and function usually doesn’t stay constant. The difference may be small enough, though, that few if any customers even notice.

Second, you can increase function while reducing cost. This is a huge opportunity, but in most cases, this just isn’t possible, because it requires a true “breakthrough” idea.

This can happen, but it’s a rare outcome. It’s certainly welcome, but consider it a bonus if this is outcome results from a VA project.

Third, you can decrease function just a bit while reducing cost proportionally more.

This result is the most common outcome found in most value analysis programs. However, you have to use care when applying this idea. Some functional issues are near and dear to the hearts of your customers, and some aren’t.

Taking value out where customers don’t care much is worth doing, but I often find design engineers have a tough time doing this. They get attached to certain features in a design, or to a level of reliability that is far beyond what customers expect. It’s like buying life insurance. Sure, most people would love to have a policy that pays $10 million if you die—but you don’t really need that much for your family, and you don’t want to pay the premiums for that kind of coverage, either.

The fourth way to improve the value ratio is to hold cost constant and increase the functionality of the product.

Again, this isn’t easy to do. How do you make something work better without affecting the cost? The typical way this can arise is by making several changes that improve the functionality of the product, while the sum of the costs for these changes stays constant. However, this doesn’t really reduce the overall cost of the product, and that’s not consistent with the goal that most VA programs have, which is to reduce product costs. It can, though, yield improved market power. However, I’ve found that most managers that take an interest in VA don’t feel that’s a successful outcome.

The fifth and final way to improve the value ratio is to increase function a large amount and increase cost a small amount.

This, of course, is a cost-effective product improvement. It can provide market power, but it actually increases cost and that’s not usually something that’s desirable when VA is being applied.

What’s the Overall Conclusion?

Only one of these actions is usually consistent with improving value and reducing costs. By decreasing functionality a bit while increasing cost even more, the value ratio can be improved and product cost reduced.

However, there’s another outcome that’s often acceptable, but it doesn’t follow the normal logic of VA. If you decrease the function more than a small amount, but decrease the cost less than the functional change, you’ll reduce the value ratio. If you look at that carefully, it’s often an attractive option. So, this is what you’d see:

In both cases, functionality is reduced.

However, it’s extremely important to have a solid understanding of which functions are affected by the design change, how significantly they are being reduced, and, more to the point, how those functional changes will be perceived by customers.

For example, a twenty-year reliability target for a product that has a three-year warranty is a huge luxury and usually adds great cost that few customers will appreciate. Yes, some customers will find this attractive. But the extra cost is either an expense that you, the manufacturer, will absorb in the form of lower margins—or, if you pass along the cost in the pricing of the product—the other 98% who don’t care will have to accept. Both are negative results that won’t benefit your business.

On the other hand, taking out functionality that customers care about is indeed risky. In VA, this is sometimes called “decontenting” and it nearly always causes problems in the marketplace as customers realize they aren’t getting what they expect and they take their business elsewhere.

There are many examples of “decontenting” that have occurred over the years, and in every case, a business that used this approach to reducing costs suffered negative impacts that far outweighed any short-term financial benefit.

The Net Result: Making VA Work

To apply the VA methodology correctly requires a consistent, structured process and experienced leadership. How to do that is another story for another day, but the overall VA method is one of the most powerful ways to improve the profitability of a manufacturing business.

Five Reasons Cost Reduction Should Be Part of Every Annual Budget

For the past decade, many businesses focused heavily on market share and assumed cost issues could be deferred until a certain scale or size was achieved. The ready availability of venture capital fed that mania, providing “cash burn” and many companies followed that model.

However, even in the chaotic world of startups and unicorns, that proposition is slowly running out of steam.

And—what about most of the world? What about businesses that aren’t trying to become the next Tesla, or Uber, or WeWork?

In particular, what about companies that are trying to make things to sell, and not simply trade on ideas?

Cost reduction is always important, no matter what. And there are great reasons why cost reduction should be a major part of any management plan. So, here are five solid factors that should motivate senior leaders to make cost management part of your budget every year.

1. Cost reduction can have a major impact on capital needs, particularly working capital

Working capital—receivables and inventory in particular—have the highest marginal cost of any capital on a balance sheet. Investors and lenders don’t like to put money into a company if that money will be used for receivables or inventory. There’s a simple reason—those items are not particularly good collateral. So, most of the cash (and cash really is king) used for inventory and receivables comes out of ownership’s equity. And the return on that equity isn’t very good. If ownership can’t get a better return than a credit line would offer, why should owners apply capital to this category of investment?

2. A continual focus on cost reduction can be a powerful competitive tool

If margins improve, there are two non-exclusive options that can be pursued to increase market share and drive future success. One is to lower prices to gain share; this choice can be problematic because a price war may result—and all competitors could suffer. The other is to use the increased margin to develop new products, products that, with the learning gained from previous cost reductions, will have still greater margins. These new products can then become the factor that increases market share and leverage for increase earnings.

3. Repetitive efforts to reduce cost are self-energizing

This means that past efforts provide organizational insights that not only drive future cost reductions, but also power improvements in new products and services. In addition, additional margin can be used to provide both employees and ownership greater rewards—which, if structured properly, can lead to still higher returns.

4. Continual cost reduction will put pressure on competitors

Some competitors, especially those that are just a cog in a larger conglomerate, may even exit your markets because parent companies are keenly tuned to levels of return on equity. This can give you yet another wedge to increase market share. You might even find an attractive acquisition opportunity if a competitor feels sufficient distress from cost pressures.

5. Cost reduction can be a significant contributor to sustainability objectives

Most organizations have a great deal of waste built into their product or process delivery systems, including wasted energy and materials. Eliminating these wastes almost always reduces costs—sometimes from fixed costs, sometimes from variable costs, and more than occasionally from both.

Of course, cost reduction processes don’t come without risk. And it takes time and effort to achieve. It’s a certainty that any effort to reduce cost will have associated risks. Being able to differentiate between “cost reduction for the sake of cost reduction” and coherent, balanced cost reduction efforts is critical.

But that’s another story for another day. Failure Modes & Effects Analysis is a powerful tool that can be applied to manage risk that is inevitable when reducing costs.

The ABC’s of Warranty Reduction

If you want to reduce warranty claims for your products, here are three things you must be aware of before you tackle this challenge.

If you want to reduce warranty claims for your products, there are very few roadmaps available for this kind of effort. I’ve personally been involved in three major multi-year efforts of this type with large corporations, and I’ve learned more than a bit about what does and doesn’t work.

Let’s start by considering three basic ideas you should be aware of if you are asked to lead or participate in a significant attempt to reduce warranty for your company’s product lines. Here they are:

A—YOU WON’T BE POPULAR.

If you are asked to lead or support major warranty reduction activities, don’t expect to be loved for doing so, at least not for some time. In fact, it may take years before your work is appreciated, even by the executives who asked you to take this on.

Why? To start, by highlighting warranty claims and expenses, you will be indirectly criticizing a large number of people and organizations in the business. No matter how you package this, no matter how it’s presented, by focusing on warranty you are focusing on failure. Few will respond positively. Many will be out-and-out hostile. Be prepared. Don’t respond with anger, either; it will make things worse.

You are almost certain to discover that everyone, and I mean everyone, who needs to act to resolve a problem will question your every move. They’ll nit-pick every presentation, debate every metric, and they’ll even question your motives. This will include field personnel who work with customers daily, because they’ll vent their dissatisfaction with the situation to you as the representative of “headquarters” or whatever the central location of the business is called.

B—YOU NEED DATA, DATA, AND MORE DATA.

A company that is suffering from excess warranty claims and costs needs to have data to make anything other than educated guesses about the scope and nature of the issues they face. However, even if a warranty data system exists, you are all but certain to learn several hard lessons about the data that has been collected—or about new data collection methods you initiate.

You will probably learn that a fair amount of the information in any warranty tracking database is riddled with errors. Some are trivial; many are systematic. And more than a bit of the information you can access will be downright misleading. If you can get to the point where you have 70-80% confidence in the accuracy of the data, you are doing very well indeed.

You’ll also need to take a very hard look at the metrics you extract from warranty data. To paraphrase Dr. W. E. Deming, there is no such thing as a warranty metric until you develop an operational definition for each and every metric. And, you will quickly learn that one simple number—something that managers and executives will want to see—will never tell you enough to understand what’s really going on or whether you are making any progress.

You’ll probably have to settle on about a half-dozen metrics to have any real hope of being able to see the big picture, or even a small picture for that matter.

You will also find that obtaining and analyzing returned goods that have failed will be less than revealing. They may also lead to confusion and debate about any analyses that are done. That doesn’t mean you shouldn’t try to understand specific failures, but, in the absence of broad-based metrics, field return analyses aren’t as revealing as you might think.

I’ll discuss these areas in a later posts.

C—IT WILL TAKE LONGER THAN ANY EXECUTIVE IS EXPECTING.

Even when you succeed, your results won’t bring instant financial payback. While a major warranty problem can be created in a very short time, it nearly always takes years to see the full ramifications of corrective action.

When a new or altered product enters the marketplace, warranty issues are unlikely to appear immediately. The worst problems can’t be identified with any confidence for one, two, or even three years after a new product is sold to end customers. Then, it will take more time to understand the cause-and-effect relationships that led to an issue (and there are many pitfalls in doing that).

A change in design and/or production will be needed. Picking and validating the right “fix” takes time and may lead to extensive debate and/or handwringing. You can easily make things worse if you botch this phase of the cycle.

At every point in the supply chain, existing inventory will have to be dealt with, and no one will want to scrap anything unless it’s hopelessly flawed. There will be resistance to rework, too. None of these actions are in anyone’s budget or have been included in their annual performance plans, so expect stiff resistance.

Finally, new-and-improved products have to enter the production stream and be sold. Then it will take the same amount of time needed to see the problem in warranty results to confirm that the corrective action was effective. So, if it took 3 years to see the issue clearly, it would take another 3-4 years to see if you did anything positive.

At the same time, everything produced in the time consumed to see the issue clearly, then formulate a corrective action, and finally get the revised product into the marketplace will continue to add to the warranty mountain you are climbing.

The finance staff won’t be able to book any cost reduction results for a long time. A discounted cash flow based on the costs associated with diagnosis and correction will be unlikely to show a rate of return that excites anyone. This will also test the patience of those who chartered your activities.

Category: Cost Management