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‘Utility divided by cost’ encompasses literally everything we need to know

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William A. Levinson

Lean

Why We Should Replace the Term ‘Quality’ With ‘Value’

‘Utility divided by cost’ encompasses literally everything we need to know

Published: Wednesday, September 29, 2021 - 11:03

This article contends that we should replace “quality” with “value” to address an enormous array of previously unaddressed risks and opportunities. Poor quality is only one of the Toyota Production System’s seven wastes, and it is rarely the most costly one because it is also the only waste to draw attention followed by corrective and preventive action. The other wastes can hide in plain view for literally hundreds of years (as proven by brick laying) and are present 100 percent of the time as they are built into the job. Even the Toyota Production System’s seven wastes do not encompass all potential wastes.

It might even be instructive to say “value management” instead of “quality management,” and “value engineering” instead of “quality engineering.” The U.S. General Services Administration already defines value engineering as “... achieving essential functions at the lowest life cycle cost consistent with required performance, quality, reliability, and safety.” Investopedia defines value as the “ratio of function to cost.” This article will define it as the ratio of utility (i.e., what we can do with the product or service) to its overall cost.

Value = Utility/Cost

The power of names

There is a scene in Ursula Le Guin’s A Wizard of Earthsea in which the protagonist, who has fled from a terrible entity that he unleashed by using a spell he didn’t really understand, confronts a dragon. The dragon knows his predicament and offers to tell him the true name of his adversary. Le Guin, the daughter of an anthropologist, knew that there are, in fact, many societies which believe that knowledge of somebody’s or something’s true name gives one the power to control it. The Scandinavian tale Lord of the Gallows recounts how Odin hung on the world ash tree for nine days to learn 18 powerful runes: “I know a fourteenth: if I so desire, I can tell men the names of the gods and the elves one by one—few fools can do this!”

There is, as with many other myths and legends, a considerable element of truth behind this belief. The power to name a thing does not convey any supernatural power over it, but it can convey an entire idea with a single word or very short phrase as shown by these examples.

Little things

General Carl von Clausewitz1 defined friction as “...the force that makes the apparently easy so difficult.... countless minor incidents—the kind you can never really foresee—combine to lower the general level of performance, so that one always falls short of the intended goal.”

Henry Ford2 wrote later, “It is the little things that are hard to see—the awkward little methods of doing things that have grown up and which no one notices. And since manufacturing is solely a matter of detail, these little things develop, when added together, into very big things.”

James Halpin3 wrote, “They [chronic inefficiencies] turned out to be the little things that get under a worker’s skin but are never quite important enough to make him come to management for a change.”

Benjamin Franklin described the same principle more than 200 years ago: “Beware of little expenses. A small leak will sink a great ship.”

All are saying essentially the same thing. The cumulative effect of seemingly minor annoyances and inefficiencies can undermine an organization’s performance, and perhaps fatally. When we put a name, such as friction, on these seemingly minor annoyances, and teach our stakeholders all that the name implies—and Ford, Clausewitz, and Halpin needed no more than two sentences each to do it—we gain power over it.

Paint parts, not air

Shigeo Shingo’s “paint parts, not air,” and “grease parts, not scrap,” teach with four-word phrases the principle that consumables such as paint and grease that go other than where they are needed, e.g., in a spray booth where much of the paint misses the parts entirely, are complete wastes of money and possible environmental problems as well. My observation “baptize converts, not parts,” applies the same principle to rinse tanks that immerse the parts in water to generate dilute chemical waste that is harder to treat than concentrated waste. Many etching and plating operations use spray rinse tanks to address this specific issue. “Light the streets, not the sky” applies the same principle to light pollution and the associated waste of energy.

Missed opportunities

The famous Russian field marshal Aleksandr V. Suvorov used unterkunft (literally, lodging or accommodations) to describe dropped balls and missed opportunities. “Although you were the victor, you stopped and sat down in Unterkunft and indecision. Having shot up the enemy, you should have chased him.”4 The Russian Army as led by Suvorov contained a wide array of these words and short phrases that everybody understood. Suvorov fought 63 battles including some against Napoleon’s future marshals, of which he lost none.

These are but three examples of single words or very short phrases that, while they confer no magical powers, create an easily shared language that encompasses entire principles and concepts. We can similarly use “value” to encompass not only quality but also lean principles as well as education of the American consumer to demand value for his or her money.

Value = Utility divided by cost

There are several dictionary definitions of value, but “utility divided by cost” provides a working definition that encompasses literally everything we need to know. Quality is still in the equation because a product or service that lacks quality, i.e., does not meet the customer’s needs, has no utility and therefore no value regardless of the denominator.

The denominator consists, in turn, of the cost of the time, materials, and energy necessary to create the product or service, along with waste. Attention to this tells us most of what we need to know about the ISO 14001 and ISO 50001 standards for environmental and energy management systems respectively. Any material we purchase that does not emerge from our process as a saleable product is waste, regardless of whether it is an environmental aspect. Henry Ford looked for ways to use everything—as but one example, waste wood became Kingsford charcoal and other wood distillation products—even though he could have legally thrown into the nearest river whatever wouldn’t go up his smokestacks. Any energy we purchase beyond that necessary to create the product or service is similarly waste.

Insurance, extended warranties, and gambling

There are some situations, such as actuarial and gambling applications, in which utility can be quantified in terms of money. Insurance is a form of gambling in which one places a bet, in the form of a premium, that he or she will suffer some kind of loss, i.e., a bet he or she does not want to win.

If we exclude “coverage vs. catastrophic loss,” the value is always less than one. The only reason to purchase insurance is therefore for protection against a loss one cannot easily afford to absorb, which is why, as shown below, extended warranties are almost universally wastes of money.

Now suppose the insurance company runs frequent radio, television, and other ads. In this case, the premium must cover not just the payouts but also the insurer’s profit, administrative costs, and advertising costs. A lot of advertising could therefore be symptomatic of waste for which the customer should not be willing to pay.

This leads in turn to extended warranties, which are an almost complete waste of money. The formula for the utility (probability of loss times cost of loss) is the same, but the probability of the loss is very low because the extended warranty covers the lowest failure rate. Remember that the manufacturer’s warranty covers defects that cause infant mortality, and the extended warranty does not extend into the wearout or old-age period, where the failure rate increases. Dave Ramsey5 says of extended warranties for automobiles, “In fact, about half of what you pay goes to the salesperson’s commission,” which means the value of the extended warranty is well under 50 percent. Extended warranties are equally worthless for consumer electronics, noting also that the purpose of insurance is to cover something one cannot easily afford to replace. It is one matter to pay $500 a year to insure a $100,000 house and another to pay $10 or $20 for an extended warranty on a $200 item.

The corresponding application in a casino or state lottery is:

Since the chance of winning times the payout is always less than the wager, the value is less than one in the absence of entertainment value. This is how casinos and state lotteries make money.

Waste motion example

Frank Gilbreth’s introduction of a nonstooping scaffold to deliver bricks at waist level, as opposed to requiring the workers to pick up each brick from the ground, is an excellent way to illustrate value, but in this case the cost consists of a worker’s time. Masons could lay only 125 bricks per hour with the latter method, but the nonstooping scaffold allowed them to lay 350 per hour. The utility (numerator) of 125 bricks incorporated into a wall does not change, but the value of those laid with the nonstooping scaffold is clearly much greater.

Consumer product examples

A major problem with the personal finances of many Americans involves a complete failure to understand value. Suppose for example that 100 pills cost $6 for the original brand name and $5 for the store brand or generic brand, which is chemically identical to the original. Generic brands tend to appear as soon as the patent expires for the original. As the quality and function of both products are identical, the value of the generic version is 100 divided by 5, while that of the brand name version is 100 divided by 6. The mathematical conclusion is obvious, but the presence of the nongeneric versions show that many consumers purchase them anyway. This is also true of many other products such as detergents and cleaners, where the store brand is chemically identical to the well-known brand name but costs less. The utility (numerator) is identical, but the denominator of the store brand is much less.

Now consider the value of a clothing item or shoe whose utility consists solely of comfort, durability, and basic appearance. Sellers mark up items enormously for famous brand names and celebrity endorsements, which is why I will not buy anything with a celebrity’s name on it. While the workers who make the items certainly deserve to get paid, and the manufacturer is entitled to a profit (cost of capital), the cost of the celebrity endorsement or famous label is complete waste.

This is especially true when the garments are made by cheap offshore labor. An upscale store sells “imported” ripped jeans—the kind that you could probably not give to the Salvation Army—for upward of $200. If it was “imported” from a place like Italy or France, which are known for the quality of their garments, it would say so. As it does not name the country, the People’s Republic of China or a similar low-wage and low-quality venue is the most likely source. Anybody who really wants to buy clothing that looks like rags can get almost identical items from Walmart for less than $20.

Supply chain examples

The Covid-19 pandemic has created a shortage of registered nurses, who can now earn as much as $5,000 a week.6 There are, however, situations in which traveling nursing agencies charge $165 to $170 an hour, of which the nurse gets only $70 to $90. I am not sure what kind of utility these agencies add to make them worth 50 percent of the nurse’s compensation. The nurse and the hospital (with the latter’s costs being passed on to insurers and patients) therefore seem to be paying $75 to $100 per nurse-hour to agencies that appear to do little more than connect nurses with hospitals that need them.

Mylan’s former CEO, Heather Bresch, complained similarly7 that the high cost of the EpiPen automatic epinephrine injector ($608 in 2016) was partially because of “...four or five hands that the product touches and companies that it goes through before it ever gets to that patient at the counter.” She added that, of the $608 for a two-injector package, Mylan got only $274. Although I am by no means familiar with Mylan’s supply chain, my first question cocnerns what utility these “four or five hands” added to the transaction to make them worth $334 from the pockets of patients and Mylan’s investors and employees. Henry Ford8 wrote of this sort of thing, “...everything and everybody must produce or get out,” and his first move would have probably been to find ways to get high-priced and nonutility-adding intermediaries out.

Cost of living example

“Reuters cited Google employees who could take pay cuts of up to 25 percent if they chose to work remotely, leaving San Francisco for an area such as Lake Tahoe,”9 which makes perfect sense. A query on BestPlaces finds that the cost of living index in San Francisco is 244 vs. 140.9 for South Lake Tahoe. The value ratio of $75,000 in South Lake Tahoe vs. $100,000 in San Francisco is therefore:

The worker gets 30 percent more goods and services for 25 percent less pay, or maybe even more because the $25,000 difference is no longer subject to California’s and the federal government’s progressive income taxes. Customers and the employer can meanwhile share the $25,000 a year that was previously squandered on San Francisco living costs. My personal inclination as a business customer would, in fact, be to immediately question the desirability of purchasing from a supplier located in a high-cost venue such as Los Angeles, San Francisco, or New York. The price of the goods or services must cover not only the compensation (in the form of genuine utility) to which the supplier’s workers and investors are entitled but also the excessive costs of the venue in question.

Ford (1922, op. cit.) pointed this out roughly 100 years ago. “And finally, the overhead expense of living or doing business in the great cities is becoming so large as to be unbearable. It places so great a tax upon life that there is no surplus over to live on.... The modern city has been prodigal, it is today bankrupt, and tomorrow it will cease to be.” Working from home, distance education and online conferences now give us the ability to put these words into practice to the benefit of every relevant interested party (customers, workers, and investors) involved.

Summary

The definition of value as utility divided by cost offers a simple and easily understood tool for personal as well as workplace decisions. Any cost, whether for wasted time, wasted materials, wasted energy, designer labels, celebrity endorsements, high costs of living, or nonvalue-adding intermediaries, that does not contribute to utility does not belong in the product, service, or process. Business and individual customers can and should demand utility for their money, and demand that anything that does not produce get out of the transaction.

References
1. Clausewitz, Carl von. On War. Translated by M. Howard and P. Paret. Princeton University Press, 1976.
2. Ford, Henry, and Crowther, Samuel. Moving Forward. Doubleday, Doran, & Co., 1930.
3. Halpin, James F. Zero Defects. McGraw-Hill, 1966.
4. Longworth, Philip. The Art of Victory: The Life and Achievements of Field Marshal Suvorov (1729-1800). Holt, Rinehart, and Winston, 1965.
5. Ramsey, Dave. “Just Say ‘No’ to Extended Warranties.” Ramsey Solutions, 2021.
6. Hollingworth, Heather, and Kunzelman, Michael. “U.S. Hospital Hit with Nurse Staffing Crisis amid Covid.” Associated Press, 2021.
7. Mangan, Dan, and Balakrishnan, Anita. “Mylan CEO Bresch: ‘No one’s more frustrated than me’ about EpiPen price furor.” CNBC, 2016.
8. Ford, Henry, and Crowther, Samuel. My Life and Work. Doubleday, Page & Co., 1922.
9. Romaine, Jenna. “Google employees who work from home could take pay cut.” The Hill, 2021.

Discuss

About The Author

William A. Levinson’s picture

William A. Levinson

William A. Levinson, P.E., FASQ, CQE, CMQOE is the principal of Levinson Productivity Systems P.C. and the author of the book The Expanded and Annotated My Life and Work: Henry Ford’s Universal Code for World-Class Success (Productivity Press, 2013).

Comments

Value and David Garvin

Thanks for the column William. I was hoping to see David Garvin's Eight Dimensions of Quality, published in Harvard Business Review in 1987. The column mentioned three of them. Here is the link to the HBR article: Competing on the Eight Dimensions of Quality (hbr.org) When we published The Improvement Guide in 1996, we had added six more, all 14 Dimensions are listed in the table below. We also defined the Value = Quality (Operational definitions of the 14)/ Total Cost (Price tag + cost to use). Total Cost leveraged Deming's Point #4, Stop buying on price tag alone. 

1.

Performance

Primary operating characteristics

2.

Features

Secondary operating characteristics, added touches not included in other dimensions

3.

Time

Time waiting, cycle time, product available in market window

4.

Reliability

Extent of failure-free operation over time

5.

Durability

Amount of use before replacement is preferable to repair

6.

Uniformity

Low variation among repeated outcomes of a process

7.

Consistency

Match with documentation, forecasts or standards

8.

Serviceability

Resolution of problems and complaints; Service Recovery

9.

Aesthetics

Relating to the senses such as color, fragrance, fit or finish

10.

Personal Interface

Punctuality, courtesy and professionalism

11.

Flexibility

Willingness to adapt, customize or accommodate change

12.

Harmlessness

Relating to safety, health or the environment

13.

Perceived Quality

Inferences about other dimensions; reputation

14.

Usability

Relating to logical and natural use; ergonomics

Excellent reference

The HBR article you cited is worth reading. This is something I did not know until I read it: "In 1950, only one-third of the U.S. Navy’s electronic devices worked properly. A subsequent study by the Rand Corporation estimated that every vacuum tube the military used had to be backed by nine others in warehouses or on order."

The eight dimensions cited seem to relate primarily to utility (the numerator of the value equation) noting that something that lacks performance, reliability, serviceability, durability, conformance, and so on is of limited utility even if it is given away for free. These are nonetheless important aspects of the needs and expectations of customers.