In the world of activity based costing (ABC), a value-added analysis will often divide the production cycle into high value-added and low value-added activities. A high value-added activity significantly adds value to the product and is usually essential to the production cycle. Typical high value-added activities include, but are not limited to, designing and processing the product. Low value-added activities add little value to the product but consume a disproportionate amount of resources, whether they be time, money, space, etc. Typical low value activities include reworking, restoring, moving inventory, etc. Obviously the goal is to minimize the amount of low value-added activities during the production and revenue cycles. (Notice that many of the low value-added activity names begin with re: rework, repair, restore, redo, etc.)
What about quality control (QC)? Is it a high or low value-added activity? Many textbooks take the approach QC is a low value activity. I believe the answer to that question depends on the vision and mission of the organization. Activity based costing (ABC) and management are inextricably linked with the vision and mission of the organization. Put another way if the vision and mission is to provide a high quality, superior product perhaps QC is in fact a high value-added activity. The prevalence of Six Sigma and other such programs show many companies place a very high premium on QC.
Years ago I worked for a manufacturer of herbal and natural products. The industry was filled with some less than reputable companies. They were regulated by the FDA not as drug manufacturers but as food companies. Consequently, standards were much lower in the herbal industry than in the pharmaceutical industry. Companies would routinely just grind up the organic material (roots, bark, leaves, etc.) used in the manufacture of natural products and sell this as a herbal supplement. There was absolutely no way any of these would provide an efficacious dosage of the supplement. No claims of potency were put forth for these types of products but consumers were under the impression these could work.
The company I worked for saw itself differently. Our mission and our vision was to provide herbal supplements whose efficacy would be supported by science. We hired the equivalent of a small college chemistry faculty to design extraction processes that would result in scientifically determined dosages and delivery systems. Product design is definitely a high value-added activity so this group was definitely a high value-added function.
The company went beyond this. The same group of scientists also performed quality control (QC). The high-end of the industry demanded and we were more than happy to provide our customers with a certificate of analysis for each batch sold. This certificate provided key data such as the batch number, the date of manufacture, and most importantly, the level of potency and efficacious material in the batch. We believed this to be so important that the enterprise resource planning and production system would not allow raw material to be received without it being tested and shipping documents could not be printed out without the laboratory concluding QC checks and providing the certificate of analysis. The QC process was so integral to the vision and mission of the organization it was deemed to be ipso facto a high value-added activity and was treated as such. It was thought to be a competitive weapon, placing our company in the high quality market niche which management believed we could dominate. As time went on the company developed a Quality Assurance (QA) program and became ISO qualified. All of this was quite an achievement for a company that had modest amounts of revenue.
This insistence on producing a superior product came at a price though. Science is expensive and overhead soared when the QC and QA programs were in full stride. The cash flow needed to purchase equipment and the depreciation charges were often crushing. I remember how excited the lab personnel were when the company purchased a phenomenally expensive piece of equipment called a nuclear magnetic resonator (NMR). Not only was the equipment expensive but it had to be located in a special room so it didn’t deactivate the credit cards of everyone on premises. Sadly, this overhead was allocated rather than traced to individual products as ABC would require.
On a related issue, many ABC texts designate packaging as a low-value activity. Again, one has to look at the vision and mission of the organization. Our finished product was shipped to customers in a fifty-five gallon steel drum. Sterile packaging was a key consideration since our products would often end up in further production or in an encapsulation process by our customer. The final product would be purchased in a drug store and consumed by the public. Once again, the mission and vision of the organization seemed to dictate packaging was also a high value-added activity.
In summary, the vision and mission of the organization can heavily influence what is defined as a high or low value-added activity. The activity based management and costing would then follow suit.
Mark Koscinski CPA D.Litt. 