Prudent business managers consistently look for ways to increase the bottom line. One means of reducing expenses and thus increasing overall profits is to analyze and evaluate production costs, whether in retail, manufacturing or a service industry. Knowing the difference between value-added costs and nonvalue-added costs can help management find ways of eliminating waste and improving the value-added side.
In economics, value-added costs refer to the direct expenses of producing a product or service and include direct materials and direct labor. Another definition of a value-added cost is an expense that customers find necessary to improve the quality of the product or service. In other words, an added value is something for which customers are willing to pay. Nonvalue-added costs refer to expenses relating to production or providing services that do not add to the final product, or expenses customers do not find necessary to enhance the final product or service delivered.
Well-managed businesses strive to reduce nonvalue-added costs, because these expenses can directly reduce profits. For example, in the manufacturing industry, when equipment breaks down, it can significantly delay production. To fulfill standing obligations, the company may need to expedite the production process, taking on extra costs such as overtime pay for workers or possibly temporary employees to keep production on schedule. Equipment breakdowns then are nonvalue-added costs that can in turn lead to additional nonvalue-added costs such as wait time. Conversely, regular maintenance of essential equipment can be classified as a value-added cost. If equipment works as needed, production stays on schedule.
Just in Time Manufacturing
One method of management manufacturers use in attempting to reduce both value added and nonvalue-added costs include what is called "just in time" manufacturing. JIT manufacturing aims to reduce inventory at each step of the production process. By purchasing materials needed in small quantities and emphasizing preventive maintenance, a company reduces nonvalue-added costs such as storage of inventory and wait time. JIT production stresses quality throughout the work process to reduce and eliminate time spent on rework and delayed delivery to customers, which tack on additional nonvalue-added costs.
Improving Value Added
Often categorizing costs as nonvalue versus value-added for analysis can be a bit problematic. Ideally, total value-added costs amount to subtracting the cost of producing a good or service from the sale price. This business ideal does not make allowances for the often inevitable nonvalue-added costs. Machines do break down. Material supply lines do suffer delays. However, by knowing which expenses are necessary to maintain quality value in a product or service and ones that add no value, initiating improvement programs to cut waste can be developed.
- California State University Bakersfield: Chapter 12 Pricing Decisions and Cost Management
- Drexel University: Activity-Based Management
- MFG Matters: Lean Manufacturing Explained
- Texas A&M University-Kingsville College of Business Administration: Chapter 19
- University of Michigan: Deardoff's Glossary of International Economics
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