Examples of using VPA information to improve business performance:
Issue: A major customer is pushing for price concessions and extended payment terms while promising an increase in purchase volume.
VPA: The aggregate profit for this customer is total sales dollars minus the aggregate cost of all of its value points. A profit amount is reported after each of the 4 value point cost sets are subtracted. The variable cost of capital reflects the actual receivables collection experience with this customer. This customer’s P&L profit tiers show that the first 3 value point cost sets are recovered but there is a loss after subtracting the 4th cost (the cost of capital for fixed assets). In other words, the total cost of capital (target ROI) is not being earned by this customer with its current product mix, price level and payment practice. The customer's proposal can be accepted provided there is unused capacity available to handle it. Fixed asset capacity expansion would not be warranted to support higher volume from this customer under its proposed price and payment terms.
Issue: A review of the company's entire product line for price changes and possible product eliminations.
VPA: All products are ranked in descending order by profit dollars generated after subtracting total economic cost. Those with positive profit dollars are candidates for price reductions if demand is considered elastic – more volume can increase ROI and economic value. Those with negative profit dollars are candidates for price increases or elimination, particularly those that do not recover the variable cash cost and the variable cost of capital.
GROWTH CAPITAL EXPENDITURES
Issue: A specific production machine on the shop floor is now fully utilized and the purchase of second machine has been proposed.
VPA: The value points of all products currently using that machine are analyzed to see if each is earning the firm's cost of capital. Findings show that 30% of the current machine usage is for value points with sales revenue below total economic cost. In other words, the machine has 100% physical capacity utilization but only 70% economic utilization. Price increases to those value points with economic losses are considered as an alternative to a capacity increase. Any decrease in the volume of loss value points can free existing machine capacity for growth in higher profit value points. The VPA insight: there may be an opportunity to redeploy an existing investment to a higher value use.
Issue: The product engineering team wants to identify cost reduction projects for the next fiscal year.
VPA: Applying projected market demand to the current value point performance for each product will point to those products where cost and/or investment reduction will produce the greatest economic value improvement.