Value added defined

Many definitions and interpretations are offered up. July 29, 2003

What exactly does "value added" mean?

Forum Responses
(Value Added Wood Processing Forum)
From contributor S:
"Value added" means doing something to a product to gain a greater price at sale.

For example, say you have a black walnut tree. You could sell it as a log for pulp, firewood, landfill, etc. and get maybe $20 (or even pay someone to remove it as a nuisance tree). Now say you call it a black walnut log and get more for the log. Now say you have an auction to sell the log and increase the price even more. Or, you could cut down the tree and saw it into lumber and get a greater value. Or, you could take the lumber you cut from your tree and kiln dry it for bigger dollars yet again. Or, you could take the lumber from the tree you kiln dried and make a Chippendale high-boy reproduction and sell it for maybe $5,000 to $10,000. Say your tree yielded enough quality pieces of lumber to make 5 of them - you have a total of $50,000 (give or take).

So, you can see that by adding a little effort or information you can increase your financial returns greatly. Value-added doesn't necessarily mean having to make a piece of furniture out of a tree - you just may have to have a professional declare that your walnut tree is sawlog or veneer quality. Or you could find a market or product for walnut branches.

Contributor S has done a fine job.

One additional point is that value-added does not consider the cost of "adding value." In other words, value-added manufacturing does not consider profitability - you can add value, but it may not be profitable to do so.

Gene Wengert, forum technical advisor

Wouldn't that be called "cost added"?

From contributor H:
Here's my simple understanding of value added: how can I get more for this without having to do more to it?

Example: Our cut-offs in the barrels are garbage. But put them in nice neat little bundles and they become "hobby assortments." Should I bring up the denim pine?

Value added is more about marketing and vocabulary than anything else. It is much akin to the term "high end" - it does not always mean "high quality."

If it walks like a duck and quacks like a duck, it's a duck at 3.95/lb. But if it's a real big duck, we can call it a goose. And goose goes for 6.99/lb.

We'll see what happens to the phrase "value added" when our friendly tax people enact a value added tax. It's coming. The hole that walnut tree will leave in your pocket might be bigger than the one it leaves in the ground.

From contributor N:
Contributor H, what you are talking about is simply marketing.

Let me take another stab at value added from an agricultural view. Let's say a farmer grows 50 acres of corn but decides that he wants to make more money. He could raise 100 acres of corn. This wouldn't be value added, it would be expansion. He could hold on to it until he could get a better price. That wouldn't be value added, it would be marketing. He could feed it to animals and sell it as beef or pork. Or he could distill it and sell it as alcohol (for fuel of course). This would be value added.

You take a given product and do some secondary processing that makes it worth more. That's value added. How much you spend to add this value and whether or not it is profitable is another story.

From contributor H:
I don't buy the beef and pork scenario. My parents have a farm and raise beef cattle. Are they adding value to their hay? I would be more inclined to agree that the hay/corn is a material cost in the production of a new product (pigs and cows).

The phrase "value added" seems to me to be a catchall depending on your particular point of view or need.

Then again, I guess putting all that hay into bales and selling it might be value added. Then the buyer would be using it for material.

From contributor N:
I think you're catching on. If you start with cows and buy hay, that is a production cost. If you have a field of hay and bale it, that is value added. The idea is the further processing of a given substance that adds value to it.

From contributor S:
You are absolutely correct, in my opinion, to say that some of these value added techniques are simply marketing techniques. I will go further to say that good marketing is a form of value added.

My example: I am a small operator. Really small. When people ask me how much wood they need to have for me to come and saw I say "one log will do" (they pay by the hour for a minimum of two hours to make sure I don't lose too much money). Where is the value added here? The customer who has a tree in their backyard sawn into lumber tells their neighbor or friend or relative how good of a job I did and they hire me to do their large woodlot worth of logs.

Someone once asked me if I could recommend a good tree removal service. I asked why. They wanted a tree in their backyard removed (simple enough, eh?). Well, it turns out that that tree was planted by their grandfather when they bought the house. My marketing strategy? "Wouldn't it be nice to have a table or bench built out of Grandpa's tree?"

Boom! A tree removal for someone else turns into a saw job for me. Landfill becomes heirloom.

There is "value added" (which does have a lot to do with marketing) and there is "value added manufacturing" (which has a different twist).

A good friend and mentor of mine (Ben Foster) wrote an article for Southern Lumberman magazine some years ago and here is what he had to say about value added manufacturing:

"Value added in manufacture is determined by subtracting from the value of the final product when shipped (to its next destination), all the cost of the 'things'... materials, supplies, fuel, power, containers, and contract work... used to make the product. The resulting value added figure represents money available for, and generally attributable to, wages for labor, salaries for management, interest on borrowed capital, profits, taxes and depreciation and depletion of equipment. In short, it is the life blood of a community's, region's or state's economy. Value added represents benefits in the form of employment, payrolls, profits, and general economic prosperity. The greater the value added, the greater these benefits."

I know this is more than you wanted to hear, but I believe the above definition is useful in separating value added "manufacturing" (ex: drying and planing your lumber instead of shipping it green) from the "marketing" side of value added (ex: you give your product a catchy name, raise the price, people flock to your doorstep to buy, and suddenly you have "added value").

Make sense?

Steve Bratkovich, forum technical advisor

From contributor H:
What about the value added tax proposals? Any opinions? Shouldn't it be enough to pay taxes on our profits and inventory? How many times is a product going to be taxed?
Value adding raises the price of that product. That does not always equate to proportionally higher profits on that product for us. But a higher price would be the taxed figure?

From contributor E:
Are you talking income tax or sales tax? Sales tax gets passed to your customer. Income tax is only on the "profit." The rest you write off. The best way to keep from paying taxes is to never make a profit.

Then I have had the Feds tell me it is a hobby business and I end up in Tax Court. Is that then value added in manufacture or is it value added in manufacturing? It then becomes one of loss in both categories and sometimes in the Tax Court. Welcome to America.

From contributor E:
My zero profit = zero tax statement was tongue in cheek. My father used to say he wanted to pay lots of income tax. Not that he wanted a higher rate but that at any given rate the more tax you pay the more money you are making. Recently I was talking to a fellow who had just sold an investment property for a substantial sum of money and was complaining about all the capital gains tax he was going to have to pay. I think he actually expected me to feel sorry for him. I should have such problems. Taxation has been around as long as I can remember and doesn't look like its going away anytime soon so we might just as well get used to it. Thank God we live in America.

From contributor Y:
Europe uses value added taxes (VATS) and it seems to me that it would be a paperwork nightmare, though in principle it is easy. You subtract what you paid for it from what you sell it for and then calculate the tax on the difference and add that to the selling price. The next person in the production of the final good simply does the same thing. In principle, it is just like the sales tax on the final good.

Now, my father always said that he passed all of the sales taxes he paid onto his customers but as an economist, I doubt that. It is hard to even imagine how a screw manufacturer would know how much of the tax should be appropriated to each screw.

This whole issue of tax shifting is an interesting one and it is not clear that consumers pay all of the taxes that producers pay. It's a pretty tricky business.

WRT taxes always being with us - well, not if Bush has his way. Don't mean to start an ideological debate here but your friends capital gains tax will likely disappear before long. In any case, he pays a lower rate on it than I pay on my earned wages.

From contributor P:
This is very interesting to me. Let me get this straight. If I take a piece and copy it for a customer, I'll get one price, and if I do the same thing for another and call it an authentic reproduction, and get more for it, that is value added?

From contributor Y:
Contributor P, I don't know how you came to this conclusion from this thread. But, one thing that is missing in this entire discussion is the demand side of the equation. Ultimately, it is not just the producer who determines value. This was called the labor theory of value that Adam Smith and Karl Marx among others believed in.

The other side is the utilitarian side that says it is the utility derived by final users that yields value. This is just demand side value determination. Alfred Marshall put these together to give us today's supply and demand determination of value.

You can keep adding labor to a toothpick but its value is not rising unless someone wants a colored toothpick with a finely carved 'David' on one end. (don't know why I thought of David but I don't want to think about what that implies too much).

If you've added more cost (value) than customers are willing to pay, then you will only sell it at a loss.

Now, selling more copies is an increase in supply, which reduces price, all else equal. If there is some conspicuous consumption or pecuniary emulation (keeping up with the Jones's) going on, then your reproduction of your original piece may be worth more. Of course, you may also be creating the next craze, in which case you'll be wealthy.

From contributor P:
Just trying to make sense of this. I did 19 pieces for a customer, an original design, all the same (copies). Next job is replicating approximately 100 pieces from old work (reproductions). Is this justification to charge a little more per piece?

From contributor N:
Both examples seem to me to be plain old production.

If you saw an extremely valuable antique chair, for example, and you copy it, that's just plain old production. If you take that reproduction and age it to pass for an original, that's value added. Wouldn't be too nice.

From contributor P:
I think I understand. Making parts is fine, the extra comes when something else is done to them to improve the item, correct?

From contributor N:
That's the way I see it.

From contributor Y:
I think we are still confusing issues here.

You can produce a product or an intermediate product. Then you can do more production to it or you can send it to another up line manufacturer for them to do it. You can do this a hundred times until the product is finished. But, none of that matters if the customer doesn't think what you did was valuable.

Now, aging is just production too. Take fine wine for example. You can grow the grapes, pick the grapes, mash the grapes, ferment the grapes. Now you can either bottle and sell it or store it up to let it age. That is just another production decision. If you think aging it will add value in the mind of some customer sufficient to cover your inventory and monitoring costs, as well as risks of losing the whole batch to some bacteria, then go ahead and age it. If not, sell it now.

Antiques have a vertical supply curve. There is a fixed quantity no matter what price is offered. The price then is determined solely by demand.

Reproducible pieces have an upward sloping supply curve so if demand rises, producers will see that they can get more for their product and will produce more. This depends upon what happens to their per unit costs as they increase production. In any case, supply plays an important role in determining price.

What happens when you add a "bonus" for the time it takes you to make an item out of the material? Client came to me today for a quote for a corporate display. I said $4800. Then she said, it needs to be at the show by August 5th. I said add $2350 to the price. Is that value added or extortion? Or as I phrased it to her, Pain In The Ass Payment.

From contributor H:
It is neither. It is an expediting charge. It is common. Some door companies have a "rush charge." One supplier I use offers a 48 hour turn around time for 100% upcharge. It's not about value. Its about "Me, now, forget everyone else." That costs you and you need to be compensated for it.

From contributor Y:
The 'rush charge' is related, it seems to me, to the elasticity of demand. This is why airlines charge higher fares to those who want a ticket at the last minute. The more desperate the customer is, the greater the price you can charge.

Now, the moral issue arises when a good is essential in some material way. After hurricane Andrew, people were charging exorbitant prices for plywood. While this is how the market knows to reallocate plywood from the NE to FL, there is a point at which is seems, to me, to be extortion.

Before Adam Smith wrote the Wealth of Nations, he wrote The Theory of Moral Sentiments. It is sort of the Old Testament of economics as far as I see it. So whether it is extortion or just taking advantage of what the market presents is a personal judgment, I guess.

From contributor N:
I'm satisfied with calling it a 'pain in the ass payment'.

From contributor Y:
Would you call it a pain in the ass payment for the premium airlines charge business passengers?

I have a friend who makes sure he makes quotes for jobs he doesn't want to do so high that only a fool would take him up on his offer. Don't know why he doesn't just say he can't do the job.

Your friend realizes that there are people out there who haven't a clue (did not check prices) and if one ever takes him up on his quote, he's headed for Hawaii on vacation.

There can be some good reasons for not saying no. Some product manufacturing companies have had problems with customers, dealers, and lawyers when they make obsolete parts for machines that may be 20, 30, and even 40 years old but still in service. In those cases it is easier to just raise the price so if you have to make just one, you will still make money and they may realize that it would be cheaper to buy a new one.

I thought I knew what value added was until I read this thread. It reminds me of the old saying that a man with one watch always knows what time it is, but a man with two watches is never quite sure. For me it is easiest to look at value added from the tax view where you deduct your raw material and other costs from the selling price and the difference is value added. This VAT tax will place a larger tax burden on those who add little value but a big mark up on the product such as brokers, distributors, etc.

From contributor Y:
How is the VAT any different of a burden to different manufacturers? A 10% tax is a 10% tax. It doesn't matter whether it is on $0.10 or $10.00. What could matter is whether each producer is marking up on the taxes paid by the previous producer. If that is the case, then each producer is profiting on the tax, not just on the value they added.

As for the not knowing what time it is, or what value added is, the greatest thinkers of all of human history can not resolve the basic questions about what determines value in the first place. That philosophical debate is one thing, but understanding what we are doing as producers is another entirely. One is philosophical, the other is practical.

From contributor L:
Here is an example of something I have just done that I consider value added.

I cut a lot (relative to my small operation) of western red cedar. Over time I had accumulated quite a large volume of 1x4, 1x6 in 2, 3, 4, 5, and 6 foot lengths.

1x4's 8 feet long are about $400 per thousand wholesale by the truck load, and shorter ones are worth even less.

I had these t&g'd and surfaced 2 sides and have developed a market selling small quantities to the end users, custom home builders. They are using them on the ceilings and walls as paneling and wainscoting.

By adding 7 cents per lineal foot (cost of milling), I am selling the shorts for $900 and the longs up to $1500 per thousand.

This is my idea of value added. If I was to pre-stain or oil them, it would be more value added. If I was to package as wainscoting in custom lengths and select grades and include a top cap, this would be more value added.

Value added to a product must make it more marketable or there is no purpose.

From contributor N:
Yes! Finally someone who understands this very simple concept the way I do. Until you get to the end of your epistle when you inject that damnable word "marketable." That's a completely different subject.

From contributor Y:
Marketable is not a different subject unless it just has value to you. If you are adding value just to add value, then you may just be adding costs.

If you derive value from working on an item just for the sake of the work, then that's fine. Starving artists do this all the time. But, they also wait tables, a place where they are adding marketable value - the only kind that matters if they want to eat.

Value added is an easy concept, as others have said. But, it is meaningless in a market economy if you can't market what you think has value.

From contributor N:
The question is "what is the definition of value added?" I agree with you that value added is not practical unless it is marketable, but still they are not the same.

To build a birdhouse, you might have to saw and nail. Unless you have both, you won't get your birdhouse. Still, sawing isn't nailing and nailing isn't sawing and neither one is a birdhouse.

From contributor L:
I agree the marketing is not exactly part of value added. It goes hand in hand with it, though.

My point was we usually do value added to put more money in the cash stream or to make a product marketable at all.

Sometimes I think we can get so wrapped up in thinking we should make the profit all along the way that we chase pennies with dollars and time that could be used for better purposes.

If I can make a profit and someone else can make a profit, that's great. I don't have to make it all. If I help someone else make a profit, he is apt to work with me again.

From contributor N:
All true as far as I'm concerned.

The original query was "What exactly does value added mean?" To me that means taking what you have and doing some kind of processing that makes it worth more. All the extra stuff added in this thread is good advice and smart business practices, but not all define the term in question.

Value is always in the hands of the purchaser. Anything you do that makes the purchaser feel that they are getting value for their money is value added. It does not matter whether it is a process or packaging or pricing or any other means. Remember the story about the little boy advertising free puppies and could not give them away. Then he made a sign about special dogs and put a good price on them and sold them. He marketed his puppies so that the buyer felt there was value in these puppies.

Businesses go broke putting perceived value in something only to find out their buyers did not find that much value in what they produced. That is what businesses do, market something by making something the buyer finds value in, and do it at a profit. We try to think of what we can do to get our customers to buy. So when you are thinking of adding value to a piece of wood, you must believe that someone out there is willing to pay you for the time, materials and effort to do it. It does not matter what you do if no one pays you for it. You do not know the value added until after the sale.

At the USDA Rural Development web site, there is a definition of "Value-Added" that was published in the Federal Register.

From contributor H:
The first definition refers to altering the physical state of any product to enhance and make it more valuable. Don't we do this every day with our raw materials?

The last definition refers to segregating a product from its current market and through marketing create a new and more valuable product.

Talk about talking out of both sides of your mouth at the same time! Like I said in one of my previous posts, value added is a catchall phrase. Its definition depends on your particular point of view or need.

The idea of value added is kind of like trying to explain what quality is. Some people say quality is just what you like, but not everyone likes or sees the same value in something. It's elusive because you never really know how good something is. Some people pay ludicrous amounts of money for things because they only want what they perceive to be high quality things. An item's value is based on what someone is willing to pay for it. To add value to something is to get someone to perceive it as being worth more. It's all classification and perception. Leftover pieces of wood can be garbage, firewood, or toll painting blanks. Doing as little as possible to get the most amount of money is value added.

The comments below were added after this Forum discussion was archived as a Knowledge Base article (add your comment).

Comment from contributor A:
Simply stated, "value added" is: 1) any process or operation that shapes or transforms the product or service into and/or towards its final form, 2) the customer will pay for it, and 3) it's done right the first time.