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SKILL SET
Analyse techniques for driving profitability and adding
value for the customer.

TOPIC
The Value Chain

Course learning objective

After completing this course, you should be able to analyse the elements of, and the linkages
within, the value chain to enhance product profitability and create value for the customer.

Introduction

The value chain is a model used to consider the full range of activities required for an
organisation to deliver a product or service. First, the following five primary activities that focus
on the systems managing the process of converting inputs into outputs for customers are
considered:

● Inbound logistics
● Operations
● Outbound logistics
● Marketing and sales
● After-sales service

The objective of this analysis is to ensure that the value created by these five primary activities is
greater than the costs incurred in operating them.

In addition to the primary activities, the following four support activities can assist with multiple
primary activities:

● Procurement
● Technology
● Human resource management

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● Firm infrastructure

These may be considered as the ‘overheads’ of an organisation but are essential for the primary
activities to operate effectively. For example, it is important to have good staff recruitment and
retention and sound IT systems and technology support in all primary activities.

Once the primary and support activities have been identified and classified into sub-activities that
add value to the organisation, connections between these activities are analysed and
opportunities to increase value in each area are sought.

Overall, the value chain provides a framework for an organisation to identify actions to add value
and improve the links between the primary and support activities while eliminating activities that
do not add value. The objective of a highly functioning value chain is to gain competitive
advantage to maximise the ‘margin’ (profit) that the organisation generates.

Value chain

A valuable model used to evaluate the operations of an organisation is the value chain. The value
chain can be used to consider the full range of activities required for an organisation to deliver a
product or service with a goal to ensure that the value added by these activities is greater than
the costs incurred, therefore maximising the profits generated.

Click the video to begin viewing or click Transcript below.

Value chain

The value chain was created by Michael Porter, a renowned Harvard Business School professor,
who understood how to think of an organisation as comprised of many systems designed to
convert inputs to outputs in an efficient manner. If an organisation is able to do that well, it will be
successful in creating value that customers desire. In turn, this will drive profitability and enable
the organisation to gain competitive advantage.

The value chain is shown in the following diagram.

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The value chain includes primary and support activities.

These activities represent a linked group of value-adding activities, from placing an order with a
supplier, through the manufacturing process, to delivery to the customer, and after-sales service.

Evaluating the primary activities in a value chain helps an organisation review how it operates to
determine opportunities to add value. This might involve reviewing its suppliers, considering
alternative distribution channels, or analysing more effective methods of marketing. For a
manufacturing organisation, examples include the following:
Inbound logistics (purchasing raw materials that are delivered by the supplier)
Operations (using those raw materials to manufacture a product)
Outbound logistics (delivering the completed products to a customer)
Marketing and sales (advertising and marketing methods used to increase product
awareness in the market)
After-sales service (managing customer needs after the sale including servicing and
maintenance and customer queries)

The value chain aims to identify links between the primary activities. For example, excessive
costs incurred for after-sales service may be reduced by changing the supplier of raw materials
or improving its internal manufacturing processes to reduce product failure.

The support activities aim is to support the primary activities. Each of the following support
activities (with examples) can assist with multiple primary activities:
Procurement — Comprising the purchasing systems for the organisation
Technology — Comprising the IT operations and support systems, investment in equipment
and machinery and research and development
Human resource management — Comprising the recruitment and training of employees for
all primary and secondary activities
Firm infrastructure — General and strategic management systems and the accounting and
legal functions

It is important to understand how an organisation creates value to the customer through its
activities. The value chain is about adding value (either actual or perceived) to the customer. An

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organisation needs to identify what the customer values, and then configure its activities to serve
customers more effectively than competitors.

In addition, coordinating the elements of the value chain enables an organisation to improve
customer satisfaction, in terms of quality, delivery, and cost-effectiveness. Linkages connect
activities. These linkages might be with suppliers or customers or within the organisation itself.

Value chain analysis recognises that interdependence exists between the activities, where the
performance of one activity affects the performance of another. Co-ordination of the linkages can
achieve efficient outcomes, reducing costs and enhancing differentiation strategies (that is,
giving an organisation a competitive advantage by being different).

One method to achieve an effective value chain is to view each activity in the chain as a customer
of the previous activity. For example, the outbound logistics activity is a ‘customer’ of the
operations activity. If the product manufactured is not easily delivered, then the feedback from
outbound logistics is useful to enhance the manufacturing process of the product to enable
better delivery. Value chain analysis attempts to coordinate the linkages throughout the chain and
increase the satisfaction at each stage — particularly that of the final external customers. This
serves to ensure that the value added by the activities exceeds the costs incurred and, therefore,
increases the overall profit margin that the organisation generates.

Scenario

You are the finance manager of Vite Online, and you report to the finance director, Audrey Smart.
Vite Online is a medium-sized listed entity, based in Europe. It takes orders online and delivers
groceries to customers. Vite Online serves more than 650,000 customers and has been growing
its customer and distribution base since it was founded 12 years ago.

Vite Online offers a vertically integrated supply model by which groceries are sourced directly
from suppliers, stored in large central distribution centres, and then delivered directly to
customers without using retail outlets. The organisation owns delivery vehicles that are used to
transport groceries from the central distribution centres to its customers. This allows more
control over distribution to customers and maintains high standards of service.

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Vite Online has always tried to provide the very best customer service for online grocery delivery.
The retailer offers a wide range of products that includes many prestige brands, fresh produce,
deli products, and own-brand recipes.

There is strong competition, mostly from large retailers with many stores that offer home delivery
or in-store pick-up. Recently, a large international online retailer that had always concentrated on
general retail goods launched an online grocery delivery service.

The following extract from the annual report of Vite Online states:

Our business model has been based on using innovation and investment in
technology to differentiate our online service from our rivals. We seek to provide
our customers with the best online interface available and provide a wide range of
groceries, including fresh produce. We are committed to give the very best
customer service and delivering the highest quality produce.

Scenario (continued)

Audrey sends you an extract of the minutes from the most recent executive directors’ meeting.

Minutes of the directors meeting

Date: 8 December 20XX

Time: 14:30–16:30

Attendees: Chief executive, CFO, and chief operating officer (COO)

Agenda: Review of competition and customer loyalty

Chief executive: Our strategy to date has been to offer the best online grocery service
available, and we have been successful at generating a reputation for our high-quality service.
However, the new global online retailer poses a threat to the loyalty of our customer base.

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Many of our customers are likely to have already purchased home goods from this competitor
and now may consider switching to order their groceries from them as well.

COO: We are good at what we do, but we need to identify areas in which we may improve and
strengthen customer loyalty by focussing on those activities that maintain customer loyalty
and build on the value of our service. We need to understand what our customers value in our
service, what differentiates us from our competitors, and what ways we can provide better
customer value for an equivalent or lower cost.

CFO: In the past, we have focussed on evaluating the value added by our operations once we
have purchased goods from our suppliers and up to the point of delivery to our customers. I
think this approach is too narrow. We should extend our focus to review the drivers of the
purchase price by working with our suppliers, identifying the links between our activities
through our operations, and closely weighing the consequences of our customers’ actions. We
should review how we coordinate our activities from supply through to delivery to the
customer, focussing on providing better value to our customers.

Agreed action:
CFO to coordinate the following:

● Understand what our customers value most about our service that differentiates
us from our competitors.
● Investigate ways to improve customer value for an equivalent or lower cost.
● Review how we coordinate our activities, from supply through to delivery to the
customer, focussing on providing better value to our customers.

Later that day, Audrey sends you an email to discuss the action points raised by the executive
directors.

Email from Audrey

To: Financial manager

From: Audrey Smart, Finance director
Subject: Re: Director’s meeting

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There are so many activities involved in satisfying our customers. We need a systematic way
to analyse what we do and understand where value is created. By identifying what our
customers value, we can then configure the work that we do (our activities) to serve
customers more effectively than our competitors.

The value chain model can be used to perform this analysis. We should consider the sequence
of our primary activities from procuring inputs and taking delivery through to delivery of goods
to our customers and after-sales service along with the support activities that are vital to
ensure our primary activities operate effectively.

I would like you to use the value chain as a basis to classify our activities and ensure we are
able to address the points raised at the directors meeting.

Regards,
Audrey

Knowledge check

Group items by dragging them into their corresponding boxes.

Question
Classify each of the following activities to the appropriate primary activity of Vite Online.

Solution

Hand packing orders – For delivery to customer

On-time delivery to customer of goods – Managing delivery

Consumer research – Identifying buying preferences of customers

Online customer ordering process – To process the sale to the customer

Customer call centre – Receiving calls from customers relating to goods delivered

Instant refunds – Offered for damaged goods or missing items on delivery

Inventory control and re-ordering – Automated re-order system for receiving goods

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Receiving supplies – Handling goods received

Tight control of sell-by dates – Controlling process for final product

Regulation of refrigerators – Controlling quality of final product

Inbound logistics Operations Outbound logistics

Marketing and sales After-sales service

Submit

Knowledge check feedback

Primary activities are analysed in sequence.

Inbound logistics
Receiving supplies, handling and storing inputs (goods received), and the automated inventory
control system for re-ordering goods.
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Operations
Converting resource inputs into final product (processes involved) — Processes ensure that
goods are delivered to customers before sell-by dates expire (particularly important for fresh
produce) and that goods are kept at the right temperatures by regulating refrigerators.

Outbound logistics
Packaging and distribution to customer — Orders are hand packed into bags for delivery avoiding
damage to soft items caused by machine packing processes. To attain high customer service,
steps are taken to ensure that deliveries are on time.

Marketing and sales

Informing customers about products, persuading customers to buy (advertising and promotions)
— Consumer research enables the organisation to understand the customers’ buying activities
and informs customers of services and goods provided. Sales are made online. Maintaining and
enhancing the online customer order system is a central focus of Vite Online.

After-sales service
Services provided to customers after goods have been delivered — Customers can call the
customer call centre to discuss deliveries and register complaints; and instant refunds are
offered for any damaged or missing items.

Knowledge check

Group items by dragging them into their corresponding boxes.

Question
Classify the support activities of the company. Sort each activity listed below to the
appropriate category. Allocate TWO activities per category.

Solution

Establishing relationships with new suppliers Credit control Strategic planning

Developing automatic re-order facility Rewarding personnel

Improving customer online website Developing close ties with suppliers

Training drivers to give customer service

Procurement Technology development

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Human resource
management

Firm infrastructure

Submit

Knowledge check feedback

Procurement
Acquiring resource inputs such as purchasing goods from suppliers and managing relationships
with suppliers — Developing close ties with suppliers and establishing relationships with new
suppliers can foster trust to share information regarding expected demand and costs which
assists planning and decision making for both parties.

Technology development
Improving processes and services provided through the use of enhanced technology — Improving
the website benefits the customer through easier access; the automated inventory reorder
system enables quick, flexible responses to demand.

Human resource management

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Covers all aspects of recruitment, training, developing, and rewarding staff — Training drivers in
customer service and offering reward incentives for good performance encourages staff to offer
customers high-quality service.

Firm infrastructure
Central control of operations including strategic planning, credit control, and finance.

Knowledge check

Select the choice(s) that best answers the question below.

Question
Vite Online is pursuing a goal of offering the best online grocery service to customers by
providing a wide range of high-quality goods. The goods are delivered in premium
condition directly to customers. This differentiates its service from other online grocery
retailers.

Which two of the following activities are strategically important to this retailer?

Solution

A. Instant refunds for missing items.

B. Offer small range of goods and fresh produce.

C. High investment in technology to provide a premium online experience

for the customer.

D. No customer call centre facility available.

Submit

Feedback

A Correct: Refunds for missing items is an activity for giving customer value that
. differentiates Vite Online from competitors by attempting to provide superior customer
service.

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B Incorrect: This is a low-cost strategy where the range of goods is kept to a minimum to
. enable bulk discounts and lower costs.

C Correct: Investment in technology is an activity for giving customer value that

. differentiates Vite Online from competitors by attempting to provide a superior customer
experience and unmatched customer service.

D Incorrect: Vite Online is pursuing a high quality and service strategy. ‘No customer call
. centre facility’ is not pursuing superior customer service and would be considered a low-
cost strategy.

Scenario (continued)
The following day you receive a telephone call from Audrey.

Looking at these activities, it is clear they are interdependent of one another (for
instance, ordering supplies of fresh goods to meet demand but not creating waste
with unsold goods before the expiry dates are exceeded). We need to think of our
operation as a group of linked value-creating activities from procuring supplies to
delivery and after-sales care of the customer. Please review the following proposed
technology development activities and think about how, by coordinating the
linkages, we can attempt to lower costs and enhance our differentiation strategy of
providing a high-quality service.

Vite Online is considering the following significant technology upgrades:

● Implementing an enhanced point of sale system to update inventory control

● Linking sales data to suppliers through EDI (internet-based software)
● Using a web-based customer call centre for customers to report missing items and
damaged goods
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It is hoped that the proposed technology upgrades will better link activities in sales and after-
sales service with other activities. For example, by linking sales data to suppliers through EDI
software, more value is created to benefit the supplier, Vite Online, and the final customer. This
enables higher performance and greater competitive advantage for Vite Online.

Knowledge check

Match items by dragging and dropping each item into the corresponding box.

Question
Identify how new information generated in one activity links to another primary or support
activity to provide feedback on the activity performed.

Match each proposed technology development with the appropriate activity it would
influence.

Activity Proposed technology development

Outbound logistics Point of sale information used to update

inventory control. This links sales to

Inbound logistics

Procurement

Linking sales data to suppliers through EDI

(internet-based software). This links sales to

Using web-based customer call centre to report

missing items or damaged goods. This links
after-sales service to

Submit

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Knowledge check feedback

Point of sale information used to update inventory control. This links sales to
Inbound logistics.
Inventory control has instant feedback on sales to manage stock levels efficiently.

Linking sales data to suppliers through EDI (internet-based software). This links sales to
Procurement.
By sharing information with suppliers, they can receive sales information instantly, which helps
them respond more quickly to changes in demand; this, in turn, helps to maintain continuous
supply and avoid overstocking and costs associated with waste.

Using web-based customer call centre to report missing items or damaged goods. This links
after-sales service to
Outbound logistics.
Instant feedback from the customer of missing items or damaged goods can inform outbound
logistics to prevent incidences in the future which enhance customer service.

Knowledge check

Match items by dragging and dropping each item into the corresponding box.

Question
It is hoped that — by linking sales data to suppliers through EDI software — benefits are
derived by the supplier, Vite Online, and the final customer.

Identify how the customer benefits by linking sales data to suppliers by using the EDI
software. Match each description regarding a benefit to suppliers and Vite Online to the
appropriate benefit to the customer.

Benefit to supplier and Vite Online Benefit to customer

Suppliers have the ability to plan in advance to Reduction in missing products and multiple
match supply to demand reducing wasted substitutions in customer orders
produce and gain possible cost savings. This
creates for a possible reduction in costs for
Vite Online as supplier produces less wasted
produce.

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A supplier’s time to process orders is quicker Improved quality of fresh produce as it arrives
than before, gaining possible cost savings. faster from supplier.
Vite Online can maintain lower levels of
inventory and gain possible cost savings.

A supplier can respond to demand changes of

the retailers’ customers without having to wait
Less waste disposed in landfill sites which is
for orders to be processed. This allows Vite
harmful to the environment
Online to ensure that products are available to
supply to customers.

Submit

Knowledge check feedback

Reduction in missing products and multiple substitutions in customer orders

A supplier can respond to demand changes of the retailers’ customers without having to wait for
orders to be processed. This allows Vite Online to ensure that products are available to supply to
customers.

As information is directly fed through the EDI software, suppliers can respond in real time. This
should ensure that required products are supplied to Vite Online and can be sold to the customer,
reducing the possibility of missing items and the need for substitutions in orders. The close
relationship developed between the supplier and Vite Online may also foster trust and enable
more information to be shared to the benefit of both parties.

Improved quality of fresh produce as it arrives faster from supplier

A supplier’s time to process orders is quicker than before, gaining possible cost savings. Vite
Online can maintain lower levels of inventory and gain possible cost savings.

Suppliers save time on task, which could lead to reduction in prices or improved profitability. Vite
Online may be able to maintain lower inventory levels because the supplier is quicker to process
orders and may be able to operate just-in-time systems. Vite Online may benefit from lower
inventory costs for storage, which could lead to reduction in prices for the customer or improved
profitability. The customer may benefit from improved quality of fresh produce delivered as the
process of ordering is quicker than before.

Less waste disposed in landfill sites which is harmful to the environment

Suppliers have the ability to plan in advance to match supply to demand reducing wasted
produce and gain possible cost savings. This creates for a possible reduction in costs for Vite

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Online as supplier produces less wasted produce.

Matching supply to demand could lead to reductions in prices or improved profitability for
suppliers. Vite Online may be able to purchase supplies at a lower cost, which could lead to
reductions in prices for the customer or improved profitability. The customer would benefit from
improvements to the environment as less waste is sent to landfill sites. Vite Online would hope to
gain competitive advantage as the customer perceives value in the improved service and may be
more loyal and/or possibly pay more for the service provided.

Scenario summary

The use of value chain analysis has allowed Vite Online to consider its primary and support
activities as a whole in response to the entry of a new competitor into the market. By analysing
its customer needs and identifying connections between activities, opportunities to improve its
performance, maintain its market share, and enhance its profits have been identified.

Conclusion
Analysing an organisation’s activities using the value chain developed by Michael Porter can
provide insight into how the activities are connected, how they are performed, and opportunities
to perform them in a way that adds more value. The primary and support activities are shown in
the following diagram:

The value chain

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The value chain is a linked group of value-adding activities, from placing an order with a supplier,
through the manufacturing process, to delivery to the customer, and after-sales service. Each
activity is examined to determine whether there are any actions to improve the activity — either by
reducing costs associated with that activity or enhancing value for the final customer. The
decisions are guided by factors that the customer values.

Coordinating the elements of the value chain by identifying and exploiting links between the
activities enables an organisation to improve customer satisfaction, in terms of quality, delivery,
and cost-effectiveness. If the cost of inbound logistics is reduced by purchasing low quality and
cheaper inputs, other activities may be adversely affected (for example, after-sales service
experiencing more returns and repairs to poor quality products). Therefore, the entire value chain
needs to be considered, to ensure that the whole business model is operating efficiently.

By viewing each activity in the chain as a customer of the previous activity, useful feedback is
generated at each link and should ensure end-customer satisfaction. Value chain analysis
attempts to coordinate linkages throughout the value chain and increase the overall profit margin
generated by the organisation.

TOPIC
Functional analysis

Course learning objective

After completing this course, you should be able to apply functional analysis to products
to optimise the balance between product functions, the perceived value to the customer, and
cost.

Introduction

Functional analysis is a method that focusses on the functions of a product or service as the cost
object. Functional analysis is concerned with improving profits by identifying functions that are
important to customers and establishing alternative methods of fulfilling these functions. This
might involve attempting to reduce costs of existing functions or aim to improve products or
services, by adding new features in a cost-effective way that are attractive to customers, leading
to increased profits.

For example, a new or existing product or service can be analysed to determine how to reduce
costs without affecting its selling price or whether there are additional features that can be added
that would increase costs (although with a larger increase in selling price).

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To achieve functional analysis, a team is assembled consisting of members from the marketing,
design, and manufacturing teams. It also includes members from any other relevant departments
and the accounting team. The functions of the product or service valued by the customer are
determined and assessed, alternatives are considered, and recommendations are put forward for
potential improvements.

Functional analysis
Functional analysis is an in-depth analysis of the relationship between product functions, their
perceived value to the customer, and the cost of providing each function. Functional analysis
aims to increase profits by identifying the functions that customers value and establishing
alternative approaches to achieve them. This may involve reducing costs or cost effectively
adding new features that are attractive to customers so that the product or service becomes
more profitable.

Functional analysis can be applied to overheads and the organisation’s structure and strategy as
well as its products and services.

The steps involved in functional analysis are described below.

Click the arrows to advance the slides.

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Once implemented, the changes made should be reviewed and evaluated to determine their
success. This exercise can also be helpful in improving future functional analysis exercises.

Scenario

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You are the finance manager at Jonas Group, reporting to CFO, Adam Stamp. Jonas Group is a
medium-sized listed entity, based in Europe, which manufactures power generation equipment.
The organisation has been established for more than 20 years, and its products are designed and
engineered in Europe and distributed worldwide.

One of Jonas Group’s most successful products is a portable power generator, model number
PPG 1500. It was developed several years ago and is used by domestic customers for camping
trips, boating, and outside domestic tasks. The product is produced in high volumes and is a best
seller for Jonas Group. Recently, a competitor launched a new design of their portable power
generator that is sold for a lower price than the Jonas Group product and has received favourable
reviews for its design features. The manufacturing process for the PPG 1500 involves complex
design and high costs of production involving significant investment in processing machinery.

It is thought that the complex design, high volumes, and costs of production make it an ideal
candidate on which to perform a functional analysis. It is estimated that 80% of the costs of
producing this product are committed during the planning and design stage, and it is difficult to
alter production costs once manufacturing has started.

You have been assigned to the new product functionality team to develop products that meet
customers’ expectations for quality and functionality while minimising costs. Your role on the
team is to advise on how to undertake the functional analysis, provide costing and pricing
analysis for the new proposals, and contribute towards the development of the product.

You receive the following email from Adam Stamp.

Click the folder to learn more.

Email from Adam

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To: Finance manager

From: Adam Stamp
Subject: Product development team

Good morning,

It seems appropriate to pursue a product re-design of product PPG 1500 to improve value to
the customer while pursuing cost reduction measures in the design phase.

I propose that we consider undertaking functional analysis. By applying this approach, we can
identify methods to improve the product by adding features in a cost-effective manner before
production commences and costs are committed. We are hoping to make our product more
attractive to the customer, resulting in an increase in sales, and identify ways to reduce costs.

We may need to explain the concept of functional analysis to the rest of the product
functionality team, so I would like you to prepare some notes to circulate before the next
meeting.

Kind regards,
Adam

Knowledge check

Match items by dragging and dropping each item into the corresponding box.

Question
Complete the following exercise to clarify what is meant by functional analysis, to be
circulated to members of the product functionality team.

Functional analysis is an analysis of the relationships between production

functions, their perceived value to the customer, and the cost provision.

Drag the following descriptions to the matching functional analysis component.

Description Component

This reflects what a customer would be Product functions

prepared to pay for each element.

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The product is broken down into elements and

attributes such as quality, style, or reliability.
Perceived value to the customer

This represents the amount incurred in

implementing the element.

Cost provision

Submit

Knowledge check feedback

Functional analysis is an analysis of the relationships between product functions, their perceived
value to the customer and cost provision.

The product is broken down into elements and attributes such as quality, style, or reliability,
known as product functions. A price or value is determined for each element (that is, what a
customer would be prepared to pay), known as the perceived value to the customer.

A maximum target cost for each element is established in line with the perceived value to the
customer and the organisation’s desired profit margins. This is known as the target cost. If the
expected costs of incorporating this element exceed the maximum target cost, then these
elements should be eliminated or modified until the cost provision is within the target cost
benchmark.

Scenario (continued)

The team completes the first two steps of functional analysis for the portable power generator
(PPG 1500) by
1. identifying the PPG 1500 as the product to undergo functional analysis that features high
volumes, complex design, and high production costs; and
2. compiling a multifunctional team from the appropriate departments of purchasing, product
engineering, design, management accounting, marketing and sales, and production.

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The meeting invite notes that the remaining steps are on the agenda for the next team meeting
for which you send the following meeting agenda:

Team meeting

The meeting details are outlined in the following attachments.

Agenda
Project: Improve PPG 1500

Attachment: Explanation of functional analysis

Functional analysis is an in-depth analysis of the relationship between product functions, their
perceived value to the customer, and the cost of providing each function. Functional analysis
aims to increase profits by identifying the functions that customers value and establishing
alternative approaches to achieve them. This may involve reducing costs or cost effectively
adding new features that are attractive to customers so that the product or service becomes
more profitable.

Attachment: Financial analysis steps

The steps involved in functional analysis are as follows:

1. Select the product, service, or overhead for analysis.

2. Select the functional analysis team. This consists of members from multiple
departments.
3. Gather detailed information both internally and externally of the organisation on the
marketing, design, manufacturing, and technology available.
4. Define the functions of the object. Functions should be identified as to whether they are
basic or secondary in terms of the importance of the function.
5. Draw a functional matrix or family tree that describes individual functions and their
costs. A visual representation is usually valuable.
6. Evaluate functions by first identifying the perceived value of each function to the
customer. The target cost of providing this function (also known as the ‘derived cost’)
is then established using the desired profit margin and compared to the expected
cost incurred in creating this perceived value. This process should highlight any
functions in which the expected cost incurred exceeds the target cost. These functions
may need to be eliminated or modified.
7. Suggest alternatives that might include new production processes or using standard
components. Consider whether these are likely to be economic and fit with the overall

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business strategy (such as being a premium or low-cost product).

8. Choose alternatives for manufacturing. Assess them and select themost appropriate
option.
9. Review actual results by undertaking a post-completion audit and report to senior
management.

The meeting is held in the office of Freja Lund, the production manager. Representatives from
each of the functional teams are present at the meeting.

Freja: Many thanks to our finance manager for the notes explaining functional analysis and an
outline of the steps to be taken. I would like to plan how we implement these steps for PPG 1500.

Please work through the steps according to your department’s expertise. Identify the appropriate
processes to achieve these steps. I would like each team member to coordinate with the finance
manager, who can advise on appropriate action plans.

We will meet again to discuss action plans and progress next week. The meeting is adjourned.

Action plans

In response, team members have identified action plans to gather information to define the
functions of the product.

Each department has identified a suggested technique to gather information to define functions
of the product in preparation for the creation of a functionality matrix, fulfilling steps three to five
of the functional analysis process.

The selected techniques by department are as follows:

Marketing department: Questionnaires — Current customers of the product are asked to
identify important elements and attributes.
Purchasing department: Telephone interviews — Suppliers are asked for alternative
components that could deliver same functionality.

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Design department: Face-to-face interviews — Product testing experts are asked opinions
on product functionality, reliability, and quality.

The next step is to evaluate the functions from the customer’s perspective to determine which
functions the customer places value on.

Knowledge check

Select one choice that best answers the question below.

Question
Advise the marketing department which plan of action would not be appropriate to
determine the price or value, from a customer’s viewpoint, for a particular element of
functionality, to complete step six of the functional analysis process.

Solution

A. Use customer feedback to determine price or value for a particular

element of functionality.

B. Ask production team how much they would be prepared to pay for a
particular element.

C. Compare to competitors’ selling prices.

D. Ask customers how much they would be prepared to pay for a particular
element.

Submit

Feedback

A Incorrect. Feedback from customers provides a good source of information relating to

. the value placed on functions of the product.

B Correct. Price or value is determined for each element of functionality from the
. customer’s viewpoint, the production team may have different viewpoint, therefore this
action is unsuitable.
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C Incorrect. Competitor prices influence customer choice and provide an appropriate

. action for the marketing department.

D Incorrect. Feedback from customers provides a good source of information to

. determine an appropriate price.

Scenario (continued)

Action plans are circulated to all team members ahead of the upcoming team meeting.
You receive an email from Andrea Hutchins, the marketing department’s representative on the
product functionality team.

Email from Andrea

To: Finance manager

From: Andrea Hutchins, Marketing department
Subject: Customer price or value feedback

Good morning,

I apologise in advance because I am unable to attend the meeting. In my absence, please

discuss the results from the customer feedback on functionality.

With respect to steps three through six of the functional analysis process, customer feedback
indicates that several product attributes or functionalities are not ranked highly by customers,
while others have not.

Attached is the customer feedback ratings using a scale from 1–5 (with 5 being high
importance).

Kind regards,
Andrea

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Attachment: Customer feedback ratings

Customer-desired attribute Start Engine Power Total

motor running output €
system

Low noise 1 4 -

Low weight 1 5 -

Low maintenance 3 5 5

Easy to assemble - 1 -

Immediate start 5 - 5

Actual customer price/ value (Euros) 200 860 240 1,300

Target cost derived from customer 150 645 180 975

price/value (Euros)

Expected cost (Euros) 150 680 175 1,005

Team meeting
The next day, you attend the team meeting, in the office of Freja Lund, the production manager.

The team leads in attendance present the outcomes of their information gathering. You present
the customer feedback findings provided by Andrea from marketing, highlighting those attributes
and functionalities that are the most and least valued by the customer. You have added cost
information to accompany Andrea’s analysis of the customer-desired attributes.

Freja: We need to decide which of these design attributes or functions should be enhanced (or
developed) by a re-design of PPG 1500, and determine if we should eliminate any from the

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design. In addition, there may be other steps that we could take to find alternative solutions to our
re-design issues. Remember, we are looking for an improved, cost-effective design for this
product.

Start motor

Customers place a low value on low noise and low weight for the start motor. That’s good
because costs of production to improve these attributes are high. Conversely, customers
place a high value on the immediate start functionality. Customers place a moderate value on
maintenance costs, and we don’t believe maintenance costs ore overly burdensome to our
customers. Upgrading the immediate start functionality requires lesser expensive upgrades to
the electrical components relative to what would be required to lower the noise and weight.
The perceived value placed on the start motor part of the product by the customer is €200,
and the expected cost of production (after improving the immediate start functionality) is the
same as the maximum target cost, based on the current level of perceived value.

Engine running system

Customers place a high value on low weight, low noise, and low maintenance costs for the
engine running system, but the costs to make improvements to the unique, in-house
components associated with these attributes are high. However, standard components have
recently become available that are the equivalent of the unique in-house components and may
be a lower cost alternative. Customers do not place a high value on the ease of assembly. The
perceived value placed on the engine running system part of the product is €860. The
expected cost of production (if improvement were made to lower weight, noise, and
maintenance costs) is estimated to be €680 which is higher than the maximum target cost
that would keep us in line with the desired profit margins. The expected cost is based on
making enhancements to the components made in-house.

Power output

Customers place a high value on immediate start and low maintenance requirements for the
power output. The electronic components required to improve the immediate start
functionality are somewhat more than the electronic components we use now. But, the costs
of upgrading the applicable manufacturing materials to lower the maintenance costs have
become more economical in the last few years. The perceived value placed on the power
output part of the product is €240, and the expected cost of production (including the
improvements made to lower the maintenance costs) is estimated to be €175 which is just
below the maximum target cost.

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We need to consider the appropriate actions to take with regard to these functions.

Knowledge check

Match items by dragging and dropping each item into the corresponding box.

Question
Advise the product functionality team on appropriate actions for the functional product re-
design. Match the following actions to the appropriate re-design issue.

Product re-design issue Action

Engine running system — Noise and weight Proceed with making the design enhancements
to this functionality

Power output — Maintenance costs

Start motor — Immediate start functionality

Do not proceed with making enhancements to

these attributes, but continue the cost analysis
focussed on a switch to standard components
rather than in-house components

Proceed with making the design changes to

enhance this attribute

Submit

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Knowledge check feedback

Immediate start functionality for the start motor

Proceed with making enhancements to this functionality.
Customers highly value this functionality, and the expected costs are equal to the target costs.

Lower weight and noise for engine running system

Do not proceed with making enhancements to these attributes but continue the cost analysis
focussed on a switch to standard components rather than in-house components.
Standard components are likely going to be a lower cost alternative (over unique components
made in-house) so it’s probable that, with a switch to standard components, the expected costs
to make design enhancements to lower the weight and noise will keep production costs lower
than target costs.

Maintenance costs of power output

Proceed with making the design changes to enhance this attribute.
Customers highly value this functionality, and the expected production costs (after implementing
these design changes) are less than the target costs.

Scenario (continued)
The following day you receive an email from Freja Lund.

Email from Freja Lund

To: Finance manager

From: Freja Lund, Production manager
Subject: Next stages of functional analysis

Good morning,

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Many thanks for all your help with the functional analysis of PPG 1500. Things are progressing
well. Once we have conducted investigations with our suppliers in relation to sourcing
standard components in lieu of the specialised components that we are making internally for
the engine running system, we can wrap up all but the post-completion audit — the last step in
our functional analysis.

The post-completion audit will hopefully identify any improvements to the functional analysis
process for future analyses and determine whether any other departments should be involved
in the process.

Great work so far! The functional analysis is detailed but valuable, and we have taken some
positive steps forward. We should implement this regularly for existing products and
immediately if a particular issue emerges.

Here’s to our future success!

Kind regards,
Freja

Conclusion
Functional analysis is a method that focusses on the functions of a product or service as the cost
object. Functional analysis is concerned with improving profits by identifying functions that are
important to customers and establishing alternative methods of fulfilling these functions. This
might involve attempting to reduce costs of existing functions or aim to improve products or
services by adding new features in a cost-effective way that are attractive to customers leading
to increased profits.

To achieve functional analysis, a functional analysis team is put in place, with members from
different departments of the organisation. The functions of the product or service are determined
and assessed, alternatives are considered, and recommendations are put forward for
improvements.

Over time, the changes should be reviewed and evaluated to judge their success and decide if
further action is necessary.

TOPIC
Value analysis and value engineering

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Course learning objective

After completing this course, you should be able to apply value analysis and value engineering to
create higher value for customers at a lower cost.

Introduction
Traditionally, management accounting involved analysing and, where possible, reducing costs.
However, this approach does not consider the potential effect of cost reductions on customer
satisfaction.

Value analysis evaluates existing products, services, and activities and provides a focus on
elements that add value to the customer with an objective to decrease costs without reducing
value to the customer. Value analysis is defined as ‘the systematic interdisciplinary examination
of factors affecting the cost of an existing product or service, to devise means of achieving the
specified purpose most economically at the required standard of quality and reliability’.

Value engineering comprises the evaluation of new products, services, and activities or the
redesign of existing ones by performing the same type of analysis. Value engineering is defined
as ‘the (re) design of an activity, product or service so that value to the customer is enhanced
while costs are reduced or at least increased by less than the resulting price increase’.

Four aspects of value should be considered in the analysis:

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Value analysis and engineering seek to achieve the best combination of these four factors. The
factors are interlinked. For example, manufacturing a product using cheaper material benefits the
production cost; however, it may adversely affect the usefulness and lifespan of the product, and
therefore negatively affect the esteem value. It may also cause reputational damage in the long-
term for the organisation. Therefore, it is important to involve many functions of the organisation
to determine the potential effects of any changes on the value of a product, service, or activity in
order to recommend the most appropriate action.

Value analysis and engineering

Many organisations strive to improve and progress. Maintaining the status quo is a dangerous
strategy as there are likely to be existing competitors that challenge them through advancements
in technology or new entrants into the market.

A focus on the importance of factors that customers perceive to add value to the product or
service is a good approach to making improvements to an organisation’s products or services.
Value analysis is a planned, scientific approach to cost reduction that reviews the composition of
an existing product, service, or activity, and its production design so that modifications and
improvements can be made that do not reduce the value of the product or service to the
customer or user.

There are four aspects of value:

Click each folder to learn more.

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The cost incurred to produce the product, service, or activity.

The price that customers are prepared to pay for the product, service, or activity.

The prestige or status attached to the product, service, or activity by the customer; for
example, premium products often have high esteem value.

The features and usefulness of the product, service, or activity; its ability to perform its
specific intended purpose.

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The cost and use of the product should be clear, but the exchange and esteem value need to be
determined in combination with customer input. Customer feedback is likely to be obtained in
order to establish these values.

The following steps may be implemented to conduct value analysis:

1. Select the product, service, or activity for analysis.
2. Obtain and record information. Identify the uses and purpose of the product, service, or
activity; determine if it fulfils these uses; identify alternatives; and establish the cost of
these options.
3. Analyse the information and evaluate the product. Evaluate any cost savings that can be
made without loss of use or esteem value. The savings must at least exceed any loss in
value suffered, so customers are compensated for the loss of use or esteem value in the
form of a lower price. There should be consideration if all the features and functions of the
product, service, or activity are necessary.
4. Consider alternatives. A range of options may be available, including ideas for eliminating
unnecessary parts, adding valued features, or standardising certain components or
functions.
5. Recommend the preferred option for management approval.
6. Implement and review the changes. In light of the recommendations, modifications to the
product, service, or activity are made, followed by an assessment of their success for use in
future value analysis reviews.

Value engineering involves a similar process to value analysis; however, it applies to new
products, services, and activities, or the redesign of an existing product, service, or activity so that
value is enhanced and costs are reduced, or are less than the resulting price increase. The steps
applied for value engineering are the same as for value analysis.

Scenario

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You are the finance manager at Jonas Group, reporting to the CFO. Jonas Group is a medium-
sized listed entity, based in Europe, which manufactures power generation equipment. The
organisation has been established for more than 20 years. Products are designed and engineered
in Europe and distributed worldwide.

Working with its board of directors, the senior leadership team at Jonas Group has launched a
new strategy that it has communicated to the management team in the memo that follows:

Memo to management team — Jonas Group

The need to create higher value for customers at a lower cost

Due to increasing global competition and ever-changing market conditions, it is vitally
important to be responsive to customer needs and expectations. Jonas Group is committed
to increasing efficiency and effectiveness in pursuit of increased customer satisfaction.

To keep Jonas Group at the industry forefront, we are making operational changes that ensure
our competitiveness for years to come. Cost minimisation or cost reduction is no longer a
sufficient strategy to obtain competitive advantage. In addition to lowering costs, we need to
focus on ways to create higher value in our products. The new operation strategy for
manufacturing is designed around balancing cost, quality, and functionality.

To meet the demands of this new strategy, we are putting together a multi-functional team
(involving customers, engineers, designers, accountants, and sales people) to develop
products that match our philosophy to maximise customer satisfaction with product quality
and functionality while minimising costs.

Following the announcement in the memo to the management team, the board appointed a
consultancy service to produce a report recommending actions to pursue the new strategy.

The consultancy service recommended that the following two products be selected for review
with the aim of creating higher value for customers in a cost-effective manner.

Re-design hybrid fuel power generator — Hybrid PPG 1100

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It is proposed to re-design the existing diesel generator for use on farms, building sites, and
offices. The new hybrid fuel system allows the generator to use both diesel and biofuel to
generate power. It is hoped that the new design offers customers a more environmentally
conscious method of generating power. The re-design concentrates on improving value to the
customer while pursuing cost reduction measures in the design phase.

It is thought that the complex design of this product, high volumes, and costs of production make
it an ideal candidate for review and development. It is estimated that 80% of the production costs
occur during the planning and design stage, and it is difficult to alter production costs once
manufacturing has started.

Food truck power generator — TPG 230

This product was launched several years ago. It is produced in high volumes and is a best seller
for Jonas Group. It is used by food trucks, pizza vans, and market stall vendors. Recently, a
competitor launched a new design of its food truck power generator which has received
favourable reviews and is available for a lower price. A cost reduction approach is proposed to
review the processes required to manufacture this product without reducing the value of the
product to the customer.

Scenario (continued)

You have been assigned to the new multifunctional team to conduct value analysis and value
engineering for the two products identified by the consultancy service. You continue to report to
the CFO, Adam Stamp, while working with the new product development team.

As an advisor on the product development team, you are required to advise on the following:
How to undertake an appropriate analysis method
How to provide costing and pricing analysis for new proposals
How to contribute toward the development of products

Adam sends you the following email regarding your role on the product development team.

Email from Adam

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To: Finance manager

From: Adam Stamp, CFO
Subject: Product development team

Good morning,
The new strategy is placing emphasis on providing higher value in our products to increase
customer satisfaction while reducing costs.

Value is a very broad term and may be assigned different meanings. We must define what we
mean by offering value to our customers. If we look at our existing food truck power generator
(TPG 230), we can examine the different types of value that this product offers to illustrate the
different types of value to the rest of the product development team.

Please draft a brief note considering the four aspects of value to circulate to the other
members of the product development team.

Thank you,
Adam

Knowledge check

Match items by dragging and dropping each item into the corresponding box.

Question
Match the following examples of value for the food truck power generator TPG230 to the
correct category by type.

Examples of value Types of value

Stand-alone power generators that can be Cost value

used by trucks and mobile units when there is
no available connection to main energy supply

Range of colours and finishes available

Exchange value
Sales price

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Production costs such as direct materials

Esteem value

Use value

Submit

Knowledge check feedback

Cost value
Production costs such as direct materials
Costs involved in the production of a product or providing a service

Exchange value
Sales price
Equivalent to the sales price or market value of a product or service

Esteem value
Range of colours and finishes available
Properties of a product or service that do not increase its performance but make it more
attractive to induce customers to purchase the product. Esteem value is considered the prestige
a customer attaches to a product or service.

Use value
Stand-alone power generators that can be used by trucks and mobile units when there is no
available connection to main energy supply
Attributes of a product that are essential for its performance and may be necessary for the
safety, reliability, and control of its operation

Scenario (continued)

You send the details to Adam and he replies with the following message.

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Thank you for the notes relating to the different types of value. We need to
distinguish between two types of activity — those that customers perceive as
adding value through increased usefulness or improved efficiencies, and those
perceived as non-value-adding. Customers are not prepared to pay for elements
that do not add value. Identifying non-value-adding activities gives us scope to
reduce costs because these can be removed without lowering the value to
customers. Can you provide examples and explanations of value-adding and non-
value-adding activities?

In response to Adam’s request, you summarise the following activities that are considered value-
adding and non-value-adding activities for the existing product TPG 230:

Value-adding activities Non-value-adding activities

Extending range of colours and finishes Carriage of work-in-progress from one production
available process to the next

Improving fuel efficiency Inspection of incoming materials

Reducing noise and vibration Discarding scrap materials

Value-adding activities
An activity is viewed as adding value if it provides a function or feature that the customer is
prepared to pay for, such as improved efficiency or appearance. An activity only adds value if the
value added exceeds the cost of providing it. Value is added if customers perceive an increase in
value that they are prepared to pay more for, or costs are reduced without sacrificing quality or
efficiency.

Non-value-adding activities
An activity that does not improve quality or efficiency, add usefulness, enhance appearance, or
provide any features that add to customer satisfaction is considered non-value-adding. The value
the customer attaches to the product or service is not affected if these activities and related

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costs are reduced or completely eliminated. Therefore, non-value-adding activities should be

highlighted with the greatest potential for cost reduction resulting in the lowest impact on
customer satisfaction.

Later that day you receive another email from Adam.

Email from Adam

To: Finance manager

From: Adam Stamp
Subject: Procedures for product development team

Hi,

I have discussed the project with senior management, and we have agreed that value analysis
should be conducted for TPG230 as an existing product, and value engineering for Hybrid
PPG1100 which is being redesigned. As the process is the same for both methods and the
products for analysis have been selected, the product development team should now focus on
conducting the required analysis. The next stages involve the following:

Identify the purpose of each product; identify any alternative features; and determine how
much these options would cost.

Identify any cost savings that can be made without loss of use or esteem value. We should
consider if all the parts are needed. Can the parts be obtained or created at a lower cost? Can
standardised parts be used? Does the value provided by each feature justify its cost?

Consider the alternatives in more detail. A range of options should be devised, including ideas
for eliminating unnecessary parts or standardising certain components or features.

Compare the costs (and other aspects of value) of each option and choose the lowest cost
alternative.

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These steps allow appropriate recommendations to be made to the board on the most
suitable actions to take.

I have sent this information to all members of the new product development team.

Regards,
Adam

Scenario (continued)

Later that day, you are invited to a meeting to discuss the product development project. The
details of the meeting are outlined in the invite:

Meeting agenda
Plan to implement steps for the value engineering of the hybrid fuel portable power generator,
Hybrid PPG 1100; and value analysis of the food truck power generator, TPG 230.

Meeting attachments accompanied with the invite

Attachment 1 - Explanation of the aspects of value
Attachment 2 - Steps to be taken to implement product development review

Meeting attachments

Attachment 1

Explanation of the aspects of value (Attachment 1)

There are four aspects of value:

Cost — the cost incurred to produce the product, service, or activity
Exchange — the price that customers are prepared to pay for the product, service, or
activity
Esteem — the prestige or status attached to the product, service, or activity by the
customer
Use — the features and usefulness of the product, service, or activity

Attachment 2

Steps involved in a product development review

1. Select the product, service, or activity for analysis.

2. Obtain and record information.

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3. Analyse the information and evaluate the product.

4. Consider alternatives.
5. Recommend the preferred option for management approval.
6. Implement and review the changes.

The meeting is held in the office of Freja Lund, the production manager. Representatives from
accounting, purchasing, engineering, design, marketing, and production are present at this
meeting. The following is an excerpt from the meeting.

Team meeting

Freja: Welcome everyone to the project, and thanks to our new finance manager for the notes
explaining the concepts involved and an outline of the next stages which everyone has now seen.
We need a plan to implement these steps for each product. We are going to start with the
redesign of Hybrid PPG 1100.

According to your department expertise, conduct the appropriate processes to complete the
value engineering exercise for PPG 1100. I would like each team member to coordinate with the
finance manager, who can advise on appropriate action plans and clarify any points concerning
the concepts involved.

A further meeting is scheduled to discuss action plans and progress next week. The meeting
adjourns.

The team decides to start by concentrating on answering the following questions in relation to
Hybrid PPG 1100:
What tasks does the product perform?
Does it succeed in performing these tasks?
Are there any alternative approaches to perform the same tasks?

The team gathers information from all members and uses customer survey data compiled by the
marketing department regarding the tasks performed by the Hybrid PPG 1100 and considers the
alternatives to perform these tasks.

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The possible alternatives for the new design are linked to its current corresponding task as
follows.

Current tasks performed Alternatives to perform tasks

Fast diesel start engine Use biofuel start engine

Ability to generate power using biofuels Extend range of biofuels that can be used to include
and diesel recycled oils

Power generation running time — 35 Extend power generation running time by adding
hours storage batteries

To fulfil the remaining steps of the process in order to present a recommendation to the board,
the marketing department conducts a survey to establish if customers perceive that value is
added to the product if these alternatives are introduced.

Improved use value — use value is improved if the customer perceives that performance or
features necessary for safety, reliability, and control of operations have been improved.
Reduced use value — use value may be reduced if the customer perceives that performance
or features necessary for safety, reliability, and control of operations have diminished.

All options offer improvements to use value and have disadvantages which reduce aspects of
use value. Decisions regarding implementing these new options would need to consider how use
value is perceived to have improved overall and whether the advantages outweigh the
disadvantages. This has been summarised in the following table:

Current tasks Considered Improves use Reduces use Effect on costs

performed alternatives to value value
perform tasks

Fast diesel Use biofuel start Creates a small Takes longer to New technology
start engine engine reduction in CO2 start the engine required adding
emissions 50% to costs of
the engine
starter

Ability to Extend range of Gives more options Requires more Adds 5% to the
generate biofuels that can to customers cleaning between cost of filters
power using be used to include depending on fuel different oils and cleaning
recycled oils used fluid

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Current tasks Considered Improves use Reduces use Effect on costs

performed alternatives to value value
perform tasks
biofuels and source available
diesel and market prices

Power Extend power Extends the Increases the Adds additional

generation generation amount of time size and weight cost to storage
running time — running time by power can be of the product batteries
35 hours adding storage generated if no making it more
batteries other power source difficult to
is available transport

Knowledge check

Group items by dragging them into their corresponding boxes.

Question
The following summary shows the information gathered by the customer survey:
Use a biofuel engine starter — customers do not perceive that the added value from
a small reduction in CO2 emissions exceeds the loss in value from a slower start
engine and the increase in cost.
Extend the range of biofuels that can be used to include recycled oils — customers
perceive that the increase in value from an increased range of biofuels exceeds the
increase in cost and loss of value attached to the increased cleaning time required.
Extend the power generation running time by adding storage batteries — 25% of
customers are prepared to pay the additional cost for this feature. The remaining
customers would prefer to keep the current design.

Based on this information, establish whether these alternatives should be introduced in

the design of the new product.

Advise the team by sorting each alternative to the appropriate category in the following
table.

Solution

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Use biofuel start engine

Extend power generation running time by adding storage batteries

Extend range of biofuels that can be used to include recycled oils

Do not adopt Adopt for all models Adopt as an optional extra

Submit

Knowledge check feedback

The analysis should seek to redesign the product so that value to the customer is enhanced and
costs are reduced (or at least increased by less than the resulting price increase).

An activity can add value only if the value added exceeds the cost of providing it. Value is added if
customers perceive an increase in value that they are prepared to pay more for, or costs are
reduced without sacrificing quality or efficiency.

Do not adopt
Use biofuel start engine
This new design feature increases costs significantly, and customers do not perceive that any
increase in value exceeds the loss of value and the increase in costs — implying they would not
be prepared to pay for this new feature.

Adopt for all models

Extend range of biofuels that can be used to include recycled oils
This new design feature incurs a small additional cost and additional cleaning time for the
customer; however, customers perceive that the increase in value exceeds the costs and loss of
value for additional cleaning — implying the customer would be prepared to pay for this feature.
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Adopt as an optional extra

Extend power generation running time by adding storage batteries
Only 25% of customers perceive that the added value from this feature exceeds the increased
cost and loss of value from increased size and weight — implying only 25% of customers would
pay for this feature. It is proposed to develop these batteries as an optional extra for customers
who would be prepared to pay more to have this feature.

Scenario (continued)
After the successful completion of value engineering for Hybrid PPG 1100, the product
development team focuses on the value analysis of TPG230. You receive an email from Shawna
Reid, the purchasing department’s representative on the product development team.

Email from Shawna

To: Product development team

From: Shawna Reid, Purchasing department
Subject: Food truck power generator — TPG 230 purchasing options

Good morning all,

I have investigated product TPG230 to determine whether any cost reductions could be
achieved in our purchases. I have compiled the following information:

Colour range
We have been using the same supplier of paints for more than 10 years. We have approached
a new supplier that can supply the same range of colours for 10% less than our current
supplier.

New engine parts available

We have received new product information from one of our suppliers regarding different
engine parts that cost 20% less than our current parts. I have asked the production engineers

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to test these parts because there are concerns that the new parts may increase noise and
vibration while the engine is running.

Use standard components

One of our suppliers has suggested replacing some of our components with standard
components that we already use in other products. This would enable us to reduce costs for
component parts by 15% because we could obtain bulk order discounts.

Regards,
Shawna

The next day, you attend the second team meeting in the office of Freja Lund, the production
manager. The following is an excerpt of the meeting.

Team meeting

Freja: Thank you for attending today. I hope all of you have read the information from the
purchasing department. I also received information from the marketing team this morning.
I have the following comments to add:

Colour range
There is no impact on the customer by changing supplier.

New engine parts available

The production engineers have conducted tests on the new engine parts and concluded that the
generator engine would be noisier and vibrate more if the cheaper parts are used.

The marketing team has stated that customers place a high value on our low-noise and low-
vibration functionality and do not perceive that the reduction in costs would compensate for the
loss in value.

Use standard components

The production engineers have tested these standard components and do not envisage any loss
in efficiency or quality of operation if we were to replace our current components with them.

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Remove some parts in design

The engineering design team has identified some parts that could be removed if we use the
standard components suggested. The removal of these parts does not affect the quality of
performance or reduce the esteem value of the product. The advantage of removing these parts
is a cost reduction of 5% and a weight reduction of 10%.

The marketing team has identified that customers place a high value on lighter weight because it
makes the product it easier to transport.

We need to decide if we should consider making these changes to our current purchases for
product TPG 230. Remember we are trying to retain or improve the value and quality of the
product at a reduced cost.

Scenario (continued)
The team has asked you to assist with these decisions. You decide to analyse the effect on use
or esteem value to the customer and the effect on cost to prepare your recommendations for
implementing changes to purchases. The outcome of your analysis is as follows:

Changes in esteem value and costs

Improved esteem value

Remove some parts. Removing some parts improves the use value to customers because
this action reduces the weight of the product by 10% which customers perceive as adding
value. This results in a 5% reduction in the cost of current parts.

No change in esteem value

Change supplier for paint. The change in supplier does not affect esteem value because the
same range of colours is available to customers. This leads to a 10% reduction in the cost
of paint.
Use standard components.Using standard components does not affect use or esteem
value. This results in a 15% reduction on component parts.

Reduced esteem value

New engine parts. Using new engine parts reduces use value as noise and vibration
increase if these new parts are used. Customers value the current low-noise and low-
vibration. This action leads to a 20% cost reduction over the current engine parts.

Knowledge check

Group items by dragging them into their corresponding boxes.

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Question
Recommend whether these changes to purchases should be implemented by sorting
each option to the appropriate category.

Solution

Remove some parts Change supplier for paint New engine parts

Use standard components

Recommended Not recommended

Submit

Knowledge check feedback

Recommended
Change supplier for paint. This option is recommended because it achieves a reduction in
cost but does not reduce value.
Use standard components. This option is recommended because costs are reduced with no
loss to value.
Remove some parts. This option is recommended because costs are reduced, and use
value is improved.

Not recommended
New engine parts. This option is not recommended because customers perceive a
decrease in value, and the reduction in cost does not compensate for the value loss.

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Scenario (continued)

The recommendations arising from the value analysis and value engineering exercise need to be
summarised to present to the board.

The objective of the exercise was to identify methods to reduce the cost of producing the Hybrid
PPG 1100 and TPG 230, without adversely affecting customer satisfaction and continuing to
meet the required quality, efficiency, and reliability standards expected by customers.

The suggested recommendations arising from the value engineering exercise in redesigning
Hybrid PPG 1100 are as follows:
Extend the range of biofuels that can be used to include recycled oils by adapting the
design of the product.
Offer additional storage batteries as an optional extra that can be added for those
customers who perceive this feature to be important and are prepared to pay a higher price
to cover the cost.

The suggested recommendations arising from the value analysis exercise in evaluating TPG 230
are as follows:
Change the paint supplier to achieve cost savings in a non-value-adding activity that does
not affect the customer.
Use standard components in production to both reduce the purchase cost and allow the
removal of unnecessary parts to reduce the weight of the product, which is a desirable
attribute for customers.
Remove parts to both improve the use value to customers with the 10% weight reduction
and to achieve a 5% cost reduction.

The product development team has been able to achieve cost savings without adversely
affecting customer satisfaction, and in some instances has increased customer value using this
customer-focused analysis method.

Conclusion
Value analysis is conducted for existing products. It attempts to identify cost reductions without
sacrificing aspects of value such as performance and quality. It seeks to retain or improve the
value of the product to the customer at a reduced cost. Four aspects of value are considered in
the analysis — cost, exchange, esteem, and use.

Value engineering is applied to new products, services, and activities or the redesign of existing
products, services, and activities, to identify cost reductions and value enhancements before
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production commences. The techniques applied for value engineering are the same as value
analysis.

Value analysis and value engineering require coordination from all aspects of design through to
sales and marketing; with a team representing different functions within an organisation working
together on the process. For this reason, value analysis and value engineering need to be fully
supported by senior management to experience success in this type of analysis.

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