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Manufacturing Value Added
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Best of Gaw Lean Management Articles



During the past decade, the focus of business improvement has in­cluded virtually every aspect of management. Companies have focused on reducing costs and improving quality, which to date has yielded impressive results. While significant efforts are underway, recent stud­ies indicate that management may not be effectively linking business processes to company performance and the value of the company. These processes may be found in every business at every level.


Part of the effort to link processes and company value has resulted from the focus on non-financial performance measures such as the "Bal­anced Scorecard," as proposed by Kaplan and Norton. Measurements of all forms have found their way into business. Some accurately por­tray conditions and allow for intelligent decision-making. Others are extensions of existing accounting systems. Biases in accounting can cause management to make inappropriate decisions because of an in­accurate perception of successful and unsuccessful businesses. Man­agement needs performance models that bridge the gap between mea­surement of historic financial performance and future performance, in order to make better strategic choices.


Businesses are in business for one reason and one reason only—to increase shareholder wealth through increased profit. To do this, man­agers must be able to assess the value of the company, break down the value to the smallest business unit, and assess the value of decision alternatives. They will then be able to build business units and make decisions that will add value to the organization.


How do you measure value? How can value be measured without all the financial distortions? A tool for evaluating the performance of business operations by focusing on value is needed. Value is the result of four factors: investments, cash flow, economic life, and capital cost. Driven by the increased importance of value as a corporate objective, new measures of calibrating the performance of decisions, subsidiar­ies, and strategic business units have been developed. The scientific community as well as the consulting industry have presented "new" value-based performance measures like the Cash Value Added (CVA), Cash Flow Return on Investment (CFROI), Economic Value Added (EVA), and the Q ration or the Market to Book ratio. This development is based on a critique of widely used profit-related performance mea­sures like Return on Investment (ROI), Return on Sales (ROS), Return of Assets (ROA), or Earnings Per Share (EPS). Some of the new mea­sures have been developed very recently. Value-based performance measures combine the financial and capital market theory by continu­ous valuation of decentralized units with strategic and operational con­trolling systems. These new tools are value-based measures that assess the income of a business relative to the capital invested, that adjust for distortions caused by accounting rules and inflation, and that take the riskiness of the business into account.


While managers have been searching for better decision-making tools, virtually every aspect of business is a candidate for improved understanding and measurement. Manufacturing is one of the business units that uses all four of the value factors. As part of the application of the new value-added performance concepts, it became apparent that it is possible to apply the concepts to manufacturing and open new av­enues of understanding and analysis.


Manufacturing Value Added (MfVA) was developed as a result. MfVA is the application of the Cash Value Added (CVA) concept di­rectly to manufacturing. The concept was developed by Erik Ottosson and Fredrik Weissenrieder. It is a value model that periodizes the value calculation and classifies investments into two categories, strategic and nonstrategic investments. Strategic investments are those whose ob­jective is to create new value for the shareholders, such as expansion, while nonstrategic investments are the ones made to maintain the value the strategic investments create. Strategic investments form the base in the MfVA model because value should be derived from a company's ventures, not chairs and tables. That means that all other investments with the purpose of maintaining the original value of the venture must be considered as "costs," such as buying new chairs and tables. 


MfVA creates a unique manufacturing performance index by com­paring equipment investment, equipment life, cash flow, and capital cost. This index can be used to compare internal manufacturing opera­tions, to make product decisions, to determine equipment acquisitions, and to make other equally important decisions. Most importantly, this index uses value drivers (e.g., pricing/discount policies, product mix, distribution/channel selection, quality, customer satisfaction, cycle times, productivity, proprietary products/processes, and receivables/ inventory management) that differ from macro financial measures in that macro financial measures capture what has happened in the past, while value drivers give information and insight about what to do dif­ferently to improve performance in the future.

To Be Continued


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