Explaining Value Added -- Dickeson

It's called Value Added in the Ratio Studies of the Printing Industries of America. Or, you can call it PVA for "Process" Value Added—looking at it from inside the shop. From outside the plant—the customer side—we call it PVA for "Perceived" Value Added.

It's all one and the same. It's the difference between selling price of manufactured products and the cost of the raw materials converted to those products. Strip away selling price, the cost of raw materials, and outside job purchases and what you're left with is Value Added, either as a percentage or as a number.

"Yes, we know all that, Roger. What difference does it make? We look at it once or twice a year—when we get financial statements. You have to buy paper, ink and other stuff for jobs, don't you? Not much you can do about it. Look at those PIA ratios. For more than a dozen years they've been running around 36 percent of selling price for manufactured product—for both top performers and all companies. That means that all printers are paying about the same, doesn't it? Have been for years."

That's mostly true—except for the part about not being able to do much about it. There are things you can, and should, do. Let's think for a moment about it.

First of all, we know that the materials—primarily paper—are about the same for all 800 printers reporting to PIA, don't we? That's the thing we do know about jobs—the dollar cost of materials for the job. It's the breaking point before we shove off into that unknown thicket of "processing" costs that we really can't identify with specific jobs.

Add in Salaries

Those "processing" costs include salaries and wages of the CEO, accounting people, secretaries, estimators, customer service, warehousing, janitorial, sales, supervisors and factory crews. Plus, the "social costs" of those people must be added to their wages and salaries—taxes, insurance, medical, 401(k)s, and the like. That's the bulk of the processing costs. Then we add interest, realty, services, depreciation and taxes. All of these are "processing" costs that can't be added to specific jobs save by assumptions that attribute them all to manufacturing crew labor called job "chargeable" hours.

We find ourselves with two groups of cost: materials and processing of those materials. Material costs we estimate in real dollars by the job. For processing costs we make a set of guesses or assumptions and attribute them to jobs. Those guesses bear only some relationship to the real world. We're adding costs that we know for a job to costs that we predict, and using both of them for estimates.

We're using crew hours that we guess for scheduling. Finally, we're using real dollars of materials actually consumed, plus crew hours actually worked, multiplied by rates we've configured by assumptions for comparisons.

Whew! I'm confused. For estimating, why don't we just stick with the real dollars of materials? You know, when you look back at those ratio values, that's really what were doing to arrive at a price, isn't it? Otherwise why would materials be so consistent as a percentage of manufactured sales over the years?

Let's get back to that point of deflection between materials and processing costs. We can attribute real dollars to materials by job. Once we do that, we can make pricing estimates we can depend on. We can't do so with processing costs. (And aren't we really doing that anyway?) Of course that might put some accountants, estimators and statisticians temporarily out of a job—until they dedicate themselves to supplying information that's really useful to decisions that have to be made.

The fact of the matter is that we really don't need job processing costs at all, do we? They're misleading. They lead us to believe that real costs are going up or down when job processing costs are going up or down. They're convoluted when it comes to price estimating. Besides, we're not really using those estimated processing prices at all, are we? They bear little or no relationship to general ledger income statements.

Taking Stock

We need to estimate materials that are required for a job. That's all. If a customer wants to use low grade stock, the price goes down with the cost of the waste. Higher priced stock bears a greater burden of waste cost and, consequently, a higher price. If we're doing a good job of holding the waste down we can expect to gain more from that job. That's one job cost directly related to job profitability.

When you Target Price a job as a multiple of material costs, the profitability of a job can be forecast much more accurately. Why? It's because you're basing your Target Price on a multiple of real dollars—dollars of materials—instead of real dollars, plus some fictitious assumption of processing costs.

By all means encourage customers to supply the paper. When they do, they're supplying a great part of the Value Added costs. Don't cling to the ancient notion that you're getting more "mark-up" when you supply the paper.

That's plain foolishness. Price is the equivalent of a multiple of the raw materials that you're processing. When the customer supplies the paper he's bearing a major portion of the cost of the job—including the cost of the receivable! Every day that a receivable remains unpaid is a day of lost possible revenue for your company.

My strong suggestion is that you learn your VA or PVA, whatever you want to call it. Watch your actual Value Added weekly. Have it in your head when you go to sleep. Wake up with it. Study your Estimated VA weekly on sales orders captured. Know your weekly break-even point.

You'll come much closer to managing a successful business if you do!

—Roger V. Dickeson

About the Author

Roger Dickeson is a printing productivity consultant based in Tucson, AZ. He can be reached via e-mail: rogervd2@cox.net.