Today's Discussion Topic

by BILL WADDELL

Which of he following is the better managed business - the leadership of which is deserving of the greater reward?

Discuss among yourselves ...

Original: http://www.idatix.com/manufacturing-leadership/todays-discussion-topic/

Comments

[Billy]

Company #2. Even though they are spending $5 more, the're spending it in the right places by adding value to their product (presumabley gaining loyal customers who will continue to support their business) while spending less on processes that don't translate into value for their customers. So even though they don't make as much money per transaction, they are setting themselves up for long term stability

[Bill Waddell]

Brilliant observation Billy! 99 guys out of a 100 on Wall Street would come to the wrong conclusion.

[Matt]

I'm not sure that you can answer this just on these numbers -- even assuming that the companies operate in a similar way and that the numbers are normal for each.

Company 1, for example, may focus more on quality production and produce a better product than 2 -- the cheaper spend may just reflect their relative productive efficiencies.

The higher non-value adding expenses, I agree, are a concern.

[Shmuel Korb]

If we look at these two companies through the lens of the equation "Profit = Price - Cost", then I think these two come out equally. There is not distinction between "Value Adding Expense" and "Non-Value Adding Expenses" in this formula; a cost is a cost regardless of where it shows up on the balance sheet. And just because a particular dollar shows up as a "Value Adding Expense" doesn't give any insight into whether or not that dollar went toward actually creating value for the customer or toward waste. Thus if we treat both companies as monolithic value streams, both sell the same amount of value to their customers for the same amount of input (cost). So it's possible that they are equally managed. Any Lean accountants out there who can weigh in?

[Brian Werneke]

There is just not enough data. While I agree there exists a population with the ignorant mindset that would jump to #1 based only on the bottom line... it would be just as ignorant to jump to #2 based only on "they add more value". I want to see the system - over time - averages, variance, and trajectory. Bottom line: If #1 is a 20 year old company just starting on a transformation, and #2 is a 3 year old start-up that is just beginning to achieve the scale where there is a tendency to start building waste into the systems, I'd put my money on #1 in the back-stretch. Bring me more data.

[T.Miller]

The scenario makes no mention of the companies making the same product, but I will assume it. That being said, Billy 6:47p hits the nail on the head. The difference seems to be spending the money on the right things. If the companies are competitors, #1 could even be manipulating easily affected expenses like direct labor (layoffs) and junk costs like 'Other'(which could be anything from toilet paper to safety equipment cut backs) to make this financial snap shot 'look good.' Based on this, I think that it is not a question of who deserves more reward, but who will attain the most rewards for each particular operation in the long haul. #2, based on the numbers, seems to be the more likely candidate because the numbers are more indicative of long term thinking. This is taking 'Value Adding Expenses' and 'Non-Value Adding Expenses' at face value per Korb 10:31p.

[David Hallsted]

If I was the customer, I would want the product from company #2. $10 more value was spent on the product by company #2 ($60) versus company #1 ($50). That is a 20% better product while costing them on 5% of the sales. That is a 4 to 1 ratio.
Company #2 is brilliant!
Where do I send my resume for company #2?

[Prashant Navalkar]

Given that the decision has to be based on only the data provided, it has to be #2. The extra 5 dollars spent on 'value adding' are exactly that. They are adding value to the end customer. This has to pay off in the long run.

[Joe Molesky]

Both companies deserve a big pat on the back. They both understand their non-value added cost. That is more than I can say for any company that I have worked for. I looked at it and assumed that company #1 just has more work to do, not that they had done a bad job to date. Stay positive, ask why!

[Ed]

Yeah, but...who determines which expenses add value over time? Let's see if the customer agrees with the "value-added" definition over time.

(Kinda splittin' hairs here, Bill -- I see your point).

[Luke Ferrell]

The question seems to presume both organizations' objectives are identical.

[Jeff Hajek]

If you make no assumptions, company 1 is better. The Wall Street guys, in this case, are right. If there are other factors, that of course, could change the analysis.

If you want to make assumptions, though, company 1 could still be better.

Maybe the non-value adding expenses are in HR and are used to enrich jobs which reduces turnover and makes team members more productive, hence the lower value-adding labor costs. Or it could be R&D, which means the company saved money on operations and invested it in its future.

Lower material costs could mean less write-offs due to overproduction.

And who knows what falls into the 'other' bucket.

The bottom line is that given the information here, the only thing we can say with certainty is that for this period, company 1 clearly performed 25% better than compay 2.

[Danie Vermeulen]

The data tells me that the product from #2 is better value for money at the same price ... a 10% more VA cost should mean a better product (possible higher quality / better specification raw material/ possible more features / higher precision)

10% less NVA cost means less waste - i.e. more efficient processes

So, it is very likely that supplier 2's superior product at the same price will attract more customers and put pressure on supplier 1 to reduce price to win or at least retain market share ... not sustainable if supplier 1 decides to reduce their price to defend their position. Indeed the beginning of a slippery slope for supplier 1, because their product will remain inferior to that of supplier 2

[michael bremer]

I'm pretty sure I know where you want to go with this example Bill, but with all due respect I'd have to say it depends. I'm very much against making decisions based on numerics by themselves. I'd like to see the products.

Assuming for the moment these are competitors are there any quality issues, delivery issues, which one is developing new products/services, etc. There are a host of things I'd like to go see or go experience before making a decision based on numbers out of context.

This is part of the problem of leaders making decisions on either set of numbers. They do not tell the whole story. More info is needed. Many, many, many poor decisions have been made by people just looking at the numerics.
Best wishes,
Michael Bremer

[Jimmy]

To get rid of the competition/product part of this equation and take a slightly different spin on this question. What if I was CEO of two different plants making the exact same product. Which plant do I invest money at, which plant do I keep open, which plant do I reward?

[Danie Vermeulen]

Interesting spin Billy ...
Assuming the two plants produce identical quality & spec product it looks like plant 1 runs at lower expense for direct labor, material etc.
Therefore, it could be a good investment to focus on efficiency improvement to reduce the NVA expense for plant 1 ... delivering even higher profit that can be sustained.
(unless plant 1 is an old tired plant and the only way to reduce the higher level of NVA expense will require excessive capex ...)