Breaking down the science of value to help you understand what you actually provide your customers.
Key Insights
What value does your business really provide? How do you provide more?
value = benefits - cost
To increase value, you need to decrease your costs because the benefits are subjective.
Business’s sole purpose is creating value for customers.
What value are you providing your customers?
Your fundamental role as a business is to provide value to your customers. But what is value? What value do you provide your customers?
Understanding the value that business provides starts with understanding:
1) your business’s costs
2) what customers will pay for your product/service.
Business Science: Value
It should be clear already that understanding value is fundamentally important to business science, but what is value exactly? How is it measured? How can it be created?
The formula for value is:
Value = Benefits – Cost
Benefits are subjective and can change given individual circumstances, unique needs, natural or learned abilities, etc.
Cost is not subjective. Within the value formula, cost is an objective measure translated to currency. You might argue that a cost can’t be placed on certain human or intangible elements; this is not true.
The Costs and the Benefits of your Business
Everything has a cost
Cost (in currency terms) is simply how energy is made physical, in order to be tracked and traded.
Everything that lives and moves can be given a cost. Even consuming “free” things (e.g., reading library books) take time and energy and can therefore be quantified from an opportunity cost, substitution analysis, or direct cost of energy perspective. Cost acts as an objective comparison factor across subjective benefits and perspectives.
Where people are paying for things, value is being created.
When a population pays for a good or service consistently enough that a business can design and enable a stable process around producing it, it is guaranteed that value creation is occurring; otherwise, the population will eventually stop paying for it (assuming a free market).
What benefits you may not benefit others
If the objective nature of cost is what defines the value, why are the subjective “benefits” included in the formula for value?
There are always two parties involved in creating value for customers (assume “company” and “customer”), each with subjective experiences of the benefit of a given process in comparison to their cost needed to receive that benefit. This difference between customer benefits (goods or services received) and company benefits (possible profit opportunities) creates a space that allows for value creation to exist.
Example – Let's go shirt shopping
1) Perceived Customer Value
Joe is walking through the store and sees this shirt that he really likes. Joe, the customer, likes the shirt so much that he would be willing to pay up to $100 to buy it. He does not know the shirt’s store price.
2) The Store Wants Profit
The store charges $80 for the shirt with the intent to make a profit and be competitive, knowing that their objective cost per unit at that moment is $60.
Their costs could uncontrollably become higher than $80, but they may still operate for a time because the $80 in revenue is perceived as a profit opportunity until the company starts measuring negative value creation.
For a company, their subjective benefit is always profit opportunity, not the objective revenue number (AKA the objective cost to the customer).
Companies operate within the market on subjectively assessing profit opportunities, and then controlling their objective costs to maximize those opportunities over time.
3) Both the Store and the Customer receive $20 of value
Here, both the customer Joe and the store receive $20 worth of value.
How?
Understanding the balance of cost and benefits as the formula which defines value presents a strategic insight for process professionals: it is unnecessary to qualify whether value creation exists.
The creation of value from the company perspective should be solely based on cost control, not revenue generation. In fact, companies with sustainable processes aggressively decrease their prices by reducing their costs commensurately, in order to maintain high value creation for customers.