The Core Philosophy: Adding Value vs. Returning Value

The traditional approach to improve the financial performance of an enterprise, especially during business downturn situations is to cut back on costs. But the real solution lies in continuous improvement in Value Return (VR) per rupee of cost incurred. The cost spenders should consciously assess whether the Rupee they are proposing to spend would improve the company’s VR. In other words, cost spenders should sit in the seat of the customers and decide as a customer, whether they would return the value.

The suppliers of products / services are the trustees of the customers’ money. When a product is bought, the customer returns the value to the supplier. By adding a Rupee to the cost, you are not ‘Adding Value.’ The value is added only when the value is returned by the customer.

The customer may refuse to Return the Value when the Rupee cost incurred has no value to him. Why do certain companies incur losses and are not able to face even domestic competition? Why are certain corporates wary of Global Competition? The reason is simple. Over the years, they have built up costs by sacrificing customers’ interests, all of which the customer would refuse to return, when offered a choice. When there was no choice, the customers were compelled to do that. Had these companies been conscious about the costs passed on to their customers, they would have ensured that their costs are such that they would be acceptable to the customers in a Free Economy. This would have enabled them to face competition in world markets, much before the competition forced them to look at their costs.

Concept of VR and Its Practice

The distinct thing in the case of VR is that it does not simply look at Cost vs Benefit to an enterprise. It goes much beyond that. In case of VR, if a particular level of spending or particular costs do not yield desired benefits, it aims at probing further to improve the VR, even by incurring further spending of costs elsewhere.

Practical Case Illustrations:

1. Advertising Budget: If an Advertisement Budget of a company worth Rs 10 million in a three months period has not boosted the sales, an enterprise adopting VR concept would not cut back on Advertisement costs of the future months, but rather look at the alternative of further boosting the Advertisement Expenses to improve the overall VR.
2. Discounts vs. Free Gifts: When an enterprise offering discounts on the products, costing Rs 50 million a month to improve sales, finds that there is no significant benefit under such a situation, the traditional thinking would be to discontinue discount offers to cut back on costs. However, under the VR concept, the enterprise would be looking at further spending in other cost areas like Free Gifts so as to improve the overall VR.

The VR aims and finally tends to achieve a reduction in the Per Unit Cost, while traditional cost cutting measures aim to bring down costs in aggregate Per Se, which may not ultimately result in the reduction of Per Unit Cost and in some cases, it may rise.

3. Biscuit Packaging Case: A Biscuit manufacturing company in order to cut back on costs, changed over from Glossy Paper and Printing to Ordinary Paper and Printing for its packing. No doubt, the company achieved a reduction in the Aggregate Costs Per Se, but the Sales and Production dropped to such an extent that ultimately, even with a reduction in the packing costs, the per unit cost went up. In other words, the Value Return per Rupee of cost incurred went down affecting the Profit Performance of the company.
   
   In the above situation, the practitioners of the VR concept would have spent more money on the Glossy Packing and Printing, and initiated other additional cost spending measures as may be prudent, which would boost the sales and thereby improve the VR.

Strategic Turnaround Case: Professional Consultancy Firm

Suppose a consultancy firm, practicing in the consultancy services, is plagued with the problem of high marketing overheads and underutilization of other managerial resources. The Value Return, in such a case, gets affected.

What should the firm do?

A traditional C.E.O would resort to Cost Down measures by chopping off the Marketing and Consultancy staff strength and other Marketing Expenses like Advertisement Expenses, Publicity materials, etc. The reduction in Marketing Staff and Expenses would further reduce the revenues disproportionately, and therefore cause a rise in the Per Unit Cost of Service.

However, the C.E.O of the firm strongly believes in the VR concept, and found a solution to increase the VR, rather than cut the costs. The firm’s solution, therefore, was in switching over to ‘MASS CONSULTANCY SERVICES’ in order to boost its VR.

The Model of Mass Consultancy Services:

There are many enterprises in the Medium and Small-Scale Sector which require inputs to systematise various functional activities like Production, Material Procurement, Financial Accounting, Marketing, etc. But these enterprises lack the first step of contact with the right persons to do the job. Also, by nature and by virtue of the very size of the enterprise, they are unwilling to spend significant amounts to streamline the organisational systems. Here lies the scope for ‘Mass Consultancy Services.’ In the ‘Mass Consultancy Services,’ solutions for enterprises are readymade and standard. Each enterprise may therefore adopt it almost immediately, with or without modifications, as they deem necessary, depending upon any special features or circumstances of an enterprise.

So, the Consultancy firm as a measure to provide ‘Mass Consultancy Services,’ may bring out certain standard products. These are such that they are useful to the enterprises in actual business situations for adoption, to systematise various functional activities. They are also educative to the organisational people and hence meet another requirement of such enterprises i.e., ‘Knowledge Transfer,’ thereby catering to the intellectual development of its employees.

Another important factor due to the above advantages is that the enterprises are willing to pay a ‘Premium’ on the product and, at the same time, are able to get ‘Mass Consultancy Services’ at a fraction of the cost, compared to that of Tailor-Made Consultancy Services, since the Consultancy Firm could spread its total cost over a sufficient number of clients. Indeed, it is a Win-Win situation for both the Service Receiver and the Service Provider.

The consultancy firm may bring out the standard products by utilising the current managerial resources, and successfully market its products by utilising the same marketing staff and by moderately increasing the expenses on publicity materials etc., but most importantly, by realising its goal of increasing the Value Return Per Rupee of Cost.

“Value Return, a new concept advocated here, should not be confused with the traditional concepts like Value Engineering, Cost Control, or Cost Reduction.”

Distinguishing VR from Traditional Cost Concepts

“Cost Reduction aims to bring down the Cost Per Unit of a product, either by Value Engineering, or by improvements in processes, methods, environment, systems, procedures, achieving economies of scale, etc.”

A country’s economy would not see recession if the government staff and corporate brains are provoked to think in the direction of making a cost a fully effective one, rather than chopping it off. Chopping a cost off has a chain reaction, triggering reactions like ‘Recession’, whereas achieving cost effectiveness would take markets and the economy forward.

However, it should be distinctively understood that there could be some pockets of ‘Dead Costs’ which are to be got rid of before it stinks.

Additional Business Examples of Enhancing VR:

• Shoe Retail Outlets: A shoe company selling other complementary brands of footwear in their retail outlets to tag on more revenue sources per rupee of retail overhead incurred.
• Pharma Co-Marketing: Pharmaceutical companies taking up co-marketing of products of other pharma companies to optimize field-force and licensing costs.
• Budgeting Role: Every organisational employee shall, at the time of budgeting an expense and its actual spending, ponder over whether the expense will be effective and how to enhance its effectiveness. Approving authorities must play a proactive role here.

Mathematical Computation of Value Return (VR)

VR can be computed for each cost component or sub-components, or total costs of the product or service, or a group of products or services, or an entity as a whole.

Where:

• X = Aggregate Revenue for the relevant product or group of products or the whole entity.
• Y = Aggregate Cost Component of the relevant type for the relevant product or sub-cost components or Total Costs.

Numerical Demonstration: Detergent Soap Manufacturing (October)

• Total Sales Revenue = Rs 30
• Material Cost = Rs 10 → VR of Material Costs = 30 / 10 = 3.0
• Direct Costs = Rs 20 → VR of Direct Costs = 30 / 20 = 1.5
• Total Costs = Rs 25 → VR of Total Costs = 30 / 25 = 1.2

Explained:

• When VR of Material Costs = 3.0, the value returned by the customer is 3 times the material cost, leaving ample margin to cover other operational costs plus profit.
• When VR of Direct Costs = 1.5, the value returned is 1.5 times direct costs, providing margin to cover indirect costs and return.
• When VR of Total Costs = 1.2, the net return after covering all costs is 0.2 (20% surplus).

Normative or Ideal VR

The state of an organization is reflected in its VR:

• Break-even: If an organization breaks even (as an entity or product line), VR = 1.0.
• Profitable: If an entity makes a profit, VR > 1.0.
• Loss-making: If an enterprise incurs losses, VR < 1.0.

In the detergent soap example, if the entity’s required ROI for October is Rs 5 with budgeted costs of Rs 25:

Ideal VR = 1 + (5 / 25) = 1.20

While computing Ideal VR for each individual cost component, the absolute ROI target may be allocated in proportion to each cost component, unless circumstances dictate otherwise.

“VR as a concept is not only very useful for Commercial Enterprises but also for Government Departments, Government Entities and even Professional firms/ N.G.Os.”

Conclusion & Boundary Limitations

VR as a concept is not only very useful for Commercial Enterprises but also for Government Departments, Government Entities and even Professional firms / NGOs. There are several modern instances where VR is practiced unconsciously:

• A TV broadcasting service popping up border banner advertisements without interrupting program content.
• A doctor’s clinic dispensing medicines directly to its own patients.
• A retail petrol station operating a 24x7 convenience store selling FMCG goods.
• Unused land in factories utilized to cultivate agricultural crops until required for plant expansion.

The Boundary Risk: The Postal Service Dilemma

However, if VR is stretched beyond its boundaries, it could result in negative consequences. Consider Postal Services: in attempting to increase VR unconsciously, a multitude of peripheral services—passport applications, Aadhaar card enrolments, financial product sales, retail packaging—were added. This overburdened the core postal infrastructure and impacted its primary service delivery, creating negative side-effects. Nevertheless, adopting this VR strategy did allow postal services to hold their primary postage prices steady for a considerable period.

To conclude, in order to turn business downturn situations to one’s advantage, the Value Return (VR) concept serves as a highly practical, strategic, and sustainable management tool.

Author may be reached at: syam472001@yahoo.co.in and eboard@icai.in