Earlier in the One Year, Thirty Minute Challenge (week 11) we examined Experiential Value Creation – the gap between what the customer pays for our product or service and the worth and enjoyment they experience from the purchase. The goal is to widen that gap as much as possible, so the customer’s enjoyment of their purchase far exceeds the monetary investment. In that exercise, we explained the three ways that customers interact with purchases and how to maximize those interactions to create the greatest experiential value. Experiential value creation involves the sometimes-subjective evaluation of customers.
This week’s One Year, Thirty Minute Challenge is the purely objective exercise of economic value creation. Economic Value Creation is the gap between the sales price of our product or service and the cost to produce that product or service.
In economic value creation, we want to push the Sales Price and the Cost as far apart as possible. This is the money we get to keep. It’s fairly easy to track because we know all of the numbers. Successful Experiential Value Creation allows us to push the sales price up. In this week’s exercise, we want to work on pushing the cost down.
Costs fall into two categories – variable and fixed. Variable costs (expressed as cost of goods sold when broken down by sold unit) are those costs that go up and down based on the number of times the product or service is delivered – every cheeseburger sold has a bun, a piece of cheese, a hamburger patty, a squirt of mustard, three pickle slices, a wax paper wrapper and 4 minutes of employee time devoted to frying, dressing, wrapping and delivering the finished product. Every therapy session has 55 minutes of the counselor’s time. The more times the product or service is delivered, the more costs we incur. Fixed costs are those we incur simply by being open. If we serve 2 or 200 customers, they do not change. Rent, utilities, communications, hardware, software, and insurance typically fall into this bucket.
I want to discuss variable costs in the context of the value creation chain.This week’s exercise is devoted primarily to variable costs, but certainly attention should be devoted to reducing fixed costs. We should be regularly checking price vs. value on our office space, insurance, technology and more.
Inputs > Transformation Activities > Outputs
Here are a couple of samples of value creation chains from very different industries.
Economic value creation improves by moving through the value creation chain better, faster and cheaper.
One manifestation of better can be quality – that could be evidenced by fewer defects – i.e. your quality control people find fewer parts that don’t meet your specifications or that need to be reworked. Better could also mean that the raw materials are free from problems. That opens up the entire vendor or supplier discussion – do all of the vendor’s raw materials for your product perform as expected. Is the quality consistent or do they vary wildly from batch to batch? Do you have tools in place to measure vendor performance so you can identify underperforming vendors and defective batches? Do you have initiatives in place that stop or reduce defects in the process? Initiatives that keep your production people from making mistakes? If you’ve visited someone in the hospital lately and been there when the nurse has administered medication, you’ve seen a procedure that makes patient care “better” – the nurse scanned the wristband on the patient’s arm, then scanned a barcode on the medicine he or she was about to administer. That allows the EMR system to alert them if a wrong medication is about to given to the patient. Better might be more effective use of personnel, materials or machinery. In short, “better” can represent exploiting a host of operational opportunities.
The second improvement you can make in the value creation chain is faster. Faster is desirable for several reasons. First, it hastens the moment you get paid. If you can put a product in a customer’s hand quicker, you can be paid quicker. I realize that collecting money, paying for raw materials on terms and credit card processing times all constitute a bunch of moving parts when it comes to money, but suffice it to say, faster is almost always better. Faster on the shop floor means that the same resource can do more work in the same amount of time. If you can automate or organize so that a worker can make 10 widgets in an hour instead of 8, you can significantly increase profitability. Any time you can create more units of output with the same units of input with no degradation in quality, that’s a good thing. Faster also applies in the delivery of raw materials before transportation and delivery after the product is transformed. I know that most of us automatically switch into manufacturing mode when we’re talking about value creation but let me remind you of the value of faster when it comes to stroke treatment. If you can begin the transformation activities (i.e. treatment) faster, the patient’s prognosis improves dramatically, since during a stroke, 1.9 million neurons die every minute. Speed is almost always a competitive advantage.
The final improvement you want to make in the value creation chain is cheaper. This probably seems like a no-brainer and it is. You certainly want to cut the cost of your processes anytime you can. Cheaper can translate into higher margins or in the ability to reduce prices to consumers making your product or service more competitive and hopefully driving more volume. Certainly, improvements in speed as we discussed earlier can cut costs, but there are other opportunities for cheaper as well – more preferable pricing from vendors, cheaper transportation costs before and after the transformation activities and lowering administrative costs (that are typically spread across all produced units).
For this week’s 30-minute exercise, map your value creation chain.
How can inputs be obtained “faster” or “cheaper”. How can you keep a minimal number of inputs on hand (saving on inventory holding costs) while still making sure you never impact the ability to start the value creation process? If the input is a skilled employee, how can you develop them, so they are “better”? How can transformation activities become more streamlined? Be more accurately measured? Require less rework? Be touched by fewer people? How can outputs be delivered to the final customer quicker or in a more convenient way?
Explain the value creation chain to the people involved in each of these steps. Ask them to critically examine their responsibilities in the light of better, faster, and cheaper. Offer them financial incentives when their recommendations for improvement drive more money to the bottom line.