Value added ratio definition
/What is the Value Added Ratio?
The value added ratio (VAR) is the time spent adding value to a product or service, divided by the total time from the receipt of an order to its delivery. A less expansive variation only includes in the denominator the period from the beginning of production or service through delivery. In either case, the VAR is designed to showcase the large proportion of time and money that a company wastes during its servicing of customers. As such, it is a cost-reduction tool that complements constraint analysis.
Example of the Value Added Ratio
The International Plastic Case Company (IPC) manufactures cases for a high-end MP3 player that is assembled and marketed by a Swedish consumer goods company. The value-added steps of the case production process are a few seconds of molding time during a long injection molding batch run, as well as hand trimming and spraying three layers of urethane gloss on the case. Including drying time for the urethane gloss, these steps require six hours per case. Non value-added steps include moving plastic resin pellets to the injection molding machine, wait time at the machine, batch setup time, multiple movements between the molding, trimming, and painting workstations, and the storage interval before a full truckload is available for shipment. Thus, non value-added time is one week, which results in a VAR of 6 hours divided by 168 hours, or 3.6%.
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The VAR percentage in the example is typical, and would be considered quite respectable in some industries. A world-class manufacturing company, such as Toyota, rarely exceeds a VAR of 20%. Clearly, a detailed analysis of the processes underlying a VAR calculation can be used to pinpoint a considerable amount of wasted time in the production process, which can then lead to much greater inventory turnover and higher order fulfillment speeds.
How to Use the Value Added Ratio
We can apply the VAR to the effectiveness of the accounting function by dividing the time spent on business risk management and decision support by the total time worked by all accounting staff. This is an excellent way to determine the effectiveness of the department in supporting strategic company activities (rather than the usual transaction processing functions).
Alternatively, we can include incremental changes in VAR in a capital expenditure request form. By doing so, applicants can show how an investment will change the value added amount of a process. However, since capital expenditures are not usually needed to improve the VAR, it can be used to deny capital expenditures.
If the VAR is used as a principal management metric, then watch out for a shift to outsourced administrative and production processes. Managers will simply avoid the metric by shifting work away from the company, where it can only be measured with the active cooperation of suppliers.
In short, the value added ratio is a useful analysis tool that focuses on the effectiveness of time spent.
Advantages of the Value Added Ratio
There are many good reasons to use the value added ratio, including the following items:
Highlights process efficiency. The ratio reveals the proportion of time spent on activities that directly add value, helping to identify and eliminate waste in production or service processes.
Supports continuous improvement. The ratio encourages teams to streamline processes and adopt lean manufacturing or service practices by focusing on increasing value-added activities.
Enhances customer satisfaction. By reducing non-value-added time (like waiting, rework, and unnecessary movements), businesses can speed up delivery times and improve customer experiences.
Drives cost reduction. Identifying and minimizing non-value-added activities leads to lower production costs and more efficient use of resources.
Facilitates performance benchmarking. The ratio provides a clear metric to compare internal processes or benchmark against industry standards, helping identify areas for improvement.
Supports lean and six sigma initiatives. The ratio aligns well with lean and Six Sigma methodologies by focusing on eliminating waste and enhancing process efficiency.
Boosts profitability. A higher VAR typically means lower costs and faster delivery times, which can lead to better margins and profitability.
Encourages strategic focus. The ratio helps companies focus on what truly matters to customers, ensuring that resources and efforts align with customer expectations.
In summary, the VAR is a powerful tool for reducing waste, improving efficiency, and driving profitability while keeping a strong focus on customer value.