There are numerous costs that go into producing and selling any given product. Sometimes these costs work to enhance the product itself, while other times they simply exist as behind-the-scenes costs that don't necessarily improve the product's value, but are essential to its production and sale nonetheless. This is where the concepts of value-added and non-value added costs come into play.
A value-added cost is one that improves the quality of a product or service, or enhances customers' perception of that product or service. Another way to think of a value-added cost is an expense that customers are willing to pay for. A non-value-added cost, by contrast, is one that adds to the total cost of a product or service but does not outwardly enhance its value from a consumer perspective.
Say a company produces mobile phones and spends $2 million to develop technology that allows users to turn on their devices using voice commands. Since this change enhances the function of the product in question, it is considered a value-added cost, as customers are more likely to pay a premium for phones that include this feature. On the other hand, if a mobile phone company spends $500,000 on patents and legal work, that $500,000 is a non-value-added cost because it doesn't increase the perceived value of the products being sold in the eyes of customers.
Both value-added and non-value-added costs can ultimately improve a company's bottom line. Value-added costs offer the benefit of increasing the perceived value of products. If a company spends money to make its products more appealing, it's likely to see an increase in sales, and in turn, revenues. Furthermore, customers may be willing to pay a premium for a product that's considered to be higher in quality than its counterparts on the market, and as demand for a given product grows, the producer of that product has more opportunity to increase its price.
Non-value-added costs don't offer the same obvious benefits as value-added costs, but they're often essential nonetheless. For example, if a company spends money to improve faulty packaging to better protect its products while in transit, it can increase its bottom line by having fewer damaged units to replace. While customers won't necessarily notice the change in packaging, the company itself can save money by better protecting its product.
Reducing non-value-added costs
To maximize profits, companies need to distinguish between costs that are value-added versus those that are non-value-added. Though it's generally impossible to completely eliminate non-value-added costs when producing and selling a product or service, it is in a company's best interest to keep these costs to a minimum. Improving the production process and replacing non-skilled workers with professionals who are less likely to make errors are two ways a company can work to reduce its non-value-added costs.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at email@example.com. Thanks -- and Fool on!
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.