Using Value Stream Costing for Root Cause Analysis

Value Stream Costing (VSC) is often misunderstood when it’s introduced into a business.

First reactions to VSC often are based on incorrect or incomplete beliefs about VSC.  The purpose of value stream costing is to get all employees focused on the root causes “actual costs”. Because VSC is so different from analyzing product costs, employees believe falsely that a VSC-based income statement is not GAAP compliant.  This is based on the false belief that standard costing must be used for GAAP-compliant financial reports. Another typical reaction is “These numbers can’t be right!” because the numbers look different from what they are used to. The result is a lot of stress.  It’s just human nature.

So, when I am helping a company introduce VSC, I consciously make myself aware of that these reactions may occur and look for ways to reduce this stress.

In my experience, what really helps is training.  The Lean company introducing VSC will get on board faster, once they understand two key facts about VSC, namely:

  1. It’s the best way to identify the root causes of your costs.
  2. All we are doing with VSC is applying standard Lean problem solving methodology (Plan-Do-Check-Act) to managing the costs of the business.

Once I get people to understand these facts, I invariably see the lights go on in peoples’ minds and feel the stress go down.

Here’s how you can understand this:

Let’s start with a fact that binds everyone together. Every company has a goal to be a low-cost producer.  Many companies, however, struggle with reducing costs in an effective manner.  For example, we can mostly agree that a management edict like “10% across the board cuts” is not effective way. Nor is strictly adhering to an annual budget going to work, because it is impossible to predict everything in an annual budget.

Now, let’s consider how Traditional companies differ in their approach from Lean companies.

Traditional (non-Lean) companies have problems cutting costs because they are going about cost analysis in the wrong way, looking at the wrong indicators, and not understanding what’s really driving their costs.

Lean companies understand that the most effective way understand costs, is to analyze any variability using root cause analysis. Once they identify the root cause, then they take corrective action to eliminate it. Eliminate the root cause, eliminate the variability. This is how Lean companies eliminate waste from processes.

Lean companies recognize there are two primary root causes of costs in a value stream (whether it is a production value stream or an office value stream). One root cause is the amount of production capacity required (people, machines, and facilities) to meet demand. The other primary root cause is the amount of variability in the value stream processes, such as quality problems, lack of flow, too much inventory and other wastes. And these two root causes are related because the more waste that exists in a value stream creates need for more capacity.

VSC makes the path to understanding how to improve costs more direct. It puts real power in the hands of the value stream manager because he or she gets critical actual cost information faster.

I like to use the following diagram as a handy way to contrast the two approaches.

CompareApproaches

VSC reports actual spending; a value stream manager can identify the decisions or events which were the root causes of the spending. Countermeasures go into effect quicker, and costs go down.

VSC is a much easier and more direct method for managing costs than any form of product costing. The traditional product costing process requires subjective allocations of fixed costs to products. It is quite difficult for a value stream manager to understand these allocations and they are useless to get to the actual root cause of the cost.  Please note: knowing the allocation method used is not the same as knowing the root cause.

So when introducing VSC into your company, first have a discussion on these topics:

  • Is your company meeting its cost management objectives?
  • What are the weaknesses of your current cost management/analysis system?

Then you can see Value Stream Costing as a method to achieve your Lean goals.