No profits! Unless you create value…

In my role as a professor of business and management to undergraduate and post-graduate management students for over a decade – I have been telling my students that the entire art and science of business can be summarized as – creating value, communicating value, and delivering value to all the stakeholders of the entrepreneur’s business. Somehow, I always found this definition of a business to be the best. Alternatively, we may say that the purpose of any business is to create value (through work), sell or trade it to customers, and capture some of that value as monetary surplus that results in profits for the entrepreneur.

I read an interesting thought somewhere that “value is created through an irreversible process that gives a resource’s ‘order’ greater usefulness to other humans.” Under this definition, almost any activity can be value-producing. Let me give a few examples: offering physical help to anyone in need, summarizing your professional experience of several years to author a book, converting unrefined sugar from a factory to manufacture orange candies, and deploying the cumulative technical knowledge of a team of engineers to create a software, etc. 

We can also define value addition as the selling price of a product (that customers are willing to pay) minus the direct cost of inputs required to create that product. Entrepreneurs try enhancing value addition in their businesses by adopting several strategies like providing additional features or attachments in the products (like special anodized handles in refrigerators, costly fused buttons and/or fixing pearls and precious stones in apparels), offering free and/or faster home deliveries, and providing customer-friendly after-sales services, etc.      

All businesses must create value, but some types of value (and methods of value creation) are more useful than others. Creating value by producing a commoditized product is not a pathway to success. If your industry is in competitive equilibrium, the death of your business would not matter to the world: some other undifferentiated competitor will always be ready to take your place. This is the condition for most businesses — what they sell is not unique, but generally substitutable. 

If you want to create the kind of value that builds a lasting and successful business, you must be unique. All happy companies are different: each one earns a monopoly by solving a unique problem. This set of ideas is really to lead-in in studying competitive advantage, the ‘how’ of developing and delivering on this unique value proposition. What does your business do that others cannot match? We call this approach Product differentiation. Production differentiation can be successfully deployed in a larger market segment as also in a niche market. 

Delivering a commoditized product with a radically improved cost structure is certainly a Low-Cost Competitive Advantage, and is a very worthwhile method of value creation. We call this approach Cost Leadership. Cost Leadership can also be successfully deployed in a larger market segment as also in a niche market. 

Porter’s Value Chain

To understand – how the value is created within organizations, we must learn about the famous strategic management tool called Porter’s Value Chain (PVC). PVC works by breaking an organization’s activities down into strategically relevant pieces so that you can see a fuller picture of the cost drivers and sources of differentiation, and then make changes appropriately.

Primary activities in the PVC are the processes that do the ‘work’ to create the value that customers are paying for. These are summarized below:

  • Inbound logistics — These are all the processes related to receiving, storing, and distributing inputs internally. Your supplier relationships are a key factor in creating value here.
  • Operations — These are the transformation activities that change inputs into outputs that are sold to customers. Here, your operational systems create value.
  • Outbound logistics — These activities deliver your product or service to your customer. These are things like collection, storage, and distribution systems, and they may be internal or external to your organization.
  • Marketing and sales — These are the processes you use to persuade clients to purchase from you instead of your competitors. The benefits you offer, and how well you communicate them, are sources of value here.
  • Service — These are the activities related to maintaining the value of your product or service to your customers once it has been purchased.

Support activities in the PVC comprise procurement, human resource management, technological development, and infrastructure. These activities support the primary activities mentioned above.

Any business will have some version of each of these activities, even if it is just a one-person service company. This set of primary activities are the foundation for creating value as an organization. In the end, we must remember that without creating any value addition, we are not going to get into the profit zone.

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