VALUE CREATION
Value creation is a term that crops up so often and in so many contexts that it is tempting to dismiss it as just another business buzzword. It is anything but. Value creation is the animating principle of modern management and its chief responsibility. It reflects a view of what perfomance is and how organizations perform.
What Is Value?
In industrial markets calculating the economic value of a good or service (that is, determining how much it’s worth) is often fairly straightforward. The value created for the customer usually resides in time or labor or materials saved, and those savings can be quickly translated into a cash equivalent.
But the service may also create value in another way. In consumer business, which account for two-thirds of the U.S. economy, there is usually a difficult –to-quantify leap to be made between the product or service delivered and the value created. Charles Revson, the cosmetic executive, once quipped that his industry sells “hope in a jar”. For consumers, value often resides in such intagibles: in a product’s look and feel; in emotions such as nostalgia; in status and prestige. When people are asked what single item they’d in the event of fire, they seldome talk aboutthe most expensive thing in the hose. They talk about the family photographs. Even here , where value seems to defy definition, it is possible.
Customers Define Value.
Value then not only takes many forms, but also it comes from many sources – from a produc’s usefulness, its quality, the image associated with it ( by advertising and promotion), its availability, the service that accompanies it. The more intangible the value appears, the more important it is to recognize that value is defined by customers, one person at a time. Many people love fast food, but many hate it. Some people swear by their cell phones, others swear at people who use them in public places. A two week vacation in a primitive nature sanctry is one person’s heaven, and anothers hell.
When management defines its objective as ceating value for customers, it means the organization exist s to serve the needs of people who are outside it. This is what diffrentiate an organization from a tribe, a social club, a family, or another group that focuses only on the well being of its members. One of management’s chief responsibilities is to remember this external orientation and to remind others about it constantly.
Constant reminders are necessary, because it’s natural for people to who live inside an organization to get wrapped up in what they do, to focus on what they make. The may forget to look outside, how the customers valueing their products. One of the most powerful insights of modern management is that there is really only one test of a job well done – a customer who is willing to pay for it.
Customers don’t care how much hard work or ingenuity goes into designing a product. In the 1990s, for example, Silicon Graphics had some of the best engineers in the Valley. The company pored million of dollars into the development of interactive television, which its engineers rightly thought was a ground – breaking technology. But ITV turned out to be a product in search of a customer. Kittu Kolliri, one of the lead engineers , explained company’s fiasco this way: “ We got all wrapped up in the technology. We all thought, ‘Dammit this technology is so cool. It must bring value to someone.’” It didn’t. Bringing vale to some vaguely defined someone isn’t good enough. Only by meeting the needs of customers as customers themselves define those needs, can an organization perform.
Value as Efficiency: The Manufacturing Mindset
Recently we talk about customers and their insight about value. Historically business were defined by producers, what they made. A company was in the steel business, say, or the coffee business or the car business. The way to succeed was to figure out how to make more steel or more coffee or cars using the same or fewer resources.
The challenge in other words, was to increase productivity, and the way to that was to make the production process as efficient as possible. This focus on efficiency made great sense in an industrial economy in which demand far out stripped supply. Management’s mission was making more things, more cheaply. Making the product affordable created a vast new market.
They assumed that value meant making whatever you were making more efficiently. They were not wrong, they were just narrow in how they thought about management’s mission. It didn’t occur to them to question whether they were making the right things to begin with, or whether you could create more value by undertaking broader missions. It was a reasonable assumption to make at the beginning of the twentieth century, when the number of goods produced was relatively small, and the major challenge was simply to produce more of them at lower cost. But now the scenario has been changed. So, the question – what is value? – needed a new answer.
The Marketing Mindset: What Does the Customer Value?
Peter Drucker in his landmark book, The Practice of Management, offered a critical redefinition of value. Efficiency was necessary, but not sufficient. Customers don’t buy products, drucker observed, they buy the satisfaction of particular needs. This means that what the customer values and buys is often different from what the producer thinks he sells.
Defining value as efficiency, led to an intense focus inward, on what company makes and how it makes it. This has become known as the manufacturing mindset. It suggests that you start with what you make, you price it based on what it cost you and then you sell it to the customer. It is a make – and – sell model of how a business works.
Drucker urged a completely new way of thinking. If you want to understand value, don’t focus inward on what you make, the way the engineers developing ITV did it. Look through customer’s eyes, from outside in. The new perspective became known as marketing mindset. It is a sense – and – respond model that starts with that what the customers wants, and with how much she or he is willing to pay for it. This determines both what you make and how much you can spend making it.
Entrepreneurs who succeed always create value for customers. But over time, organizations, especially large ones, tend to make on lives of their own, and can lose touch with the market surprisingly quickly. This is why drucker’s discipline remains such an important antidote to the natural tendency to focus inward, on what you make and you do.
Maximizing Shareholder Value: A Parenthetical Perspective.
Till this point, we didn’t consider another important group for discussion – they are shareholders. Managers are more responsive to the interest of owners, and more aware of the direct link between delivering value to customers and creating value for shareholders. In some industries, satisfactory underperformance had been a kind of gentlemen’s agreement. Those days were gone. Now shareholders would set the bar, and the capital markets would define performance.
Economists like Milton Friedman argue that the shareholder must always come first, that the goal of management, purely and simply, is to maximize shareholder value. Although individual managers may differ in their social philosophies, no contemporary CEO can afford to take the capital markets for granted or ignore their discipline. Thus, it has become more critical than ever for executives to understand the process of value creation and the drivers of superior performance.
How Is Value Created?
Over the past two decades, management has been transformed by the insights about how value is created and the need, therefore, to manage across the organization’s boundaries. For example, a decade ago, purchasing was a low profile function, the goal of which was to get the best terms for a predetermined set of items. Today purchasing has evolved into supply-chain-management, and this is a real shift, not just an instance of title inflation. Supply-chain management reflects a far more systematic way of thinking about how a company creates value for its customers: through what it buys and not just the price it pays, through access to suppliers know – how and innovative capability as well as its goods.
The value creation we’ve been describing has worked its way into every aspect of a company’s business. When organizations look from outside in, they often see a brave new world of innovative offerings in the form of solutions and value – added services aimed at customers’ needs, not simply selling them products. To get a sense of how dramatically this can transform a company, consider how GE has changed under Jack Welch’s leadership. Once one of the world’s premier industrial companies, GE now gets 80 percent of its from services.
GE has not been alone in discovering that often more money can be made from the services related to a product than from the product itself. Consider the service contract that you are offered when you buy a new television or computer, or the financing available from the dealer who sells you a new car. Much of IBM’s success in the 1990s reflected its shift in strategy from hardware to solutions. In the new economy, value lies increasingly in such intangibles.
Value Is a System
This article with the assertion that management’s chief responsibility is to create value. But whether it has delivered on its responsibility isn’t management’s call to make. That is the province of outsiders who are free to decide, day by day and year after year, whether they will continue to support that organisation.
Determining who the relevant outsiders are may be management’s single most critical decision. In the business world, customers aren’t the only constituency modern management has to satisfy. In reality, every successful organisation depends on multiple players, each of whom defines value in a particular way.
Shareholders and others who provide investment capital define value in financial terms that are easy to measure. For employees, the equation is more complex. They value today’s wages and health benefits, but they are also likely to price such things as training or stock options whose value lies in the future. Value or employees may also reside in such noneconomic factors as job satisfaction, status or pride. Suppliers may value long term relationships and the chance to develop cutting-edge technology as much as they care about price alone.
Modern management’s challenge is to ensure that each of these necessary players will choose to participate in the system that creates value for all of them. The term value creation captures this larger, more systematic understanding of performance in a way that earlier definitions of performance did not. Value creation includes the industrial era’s focus on efficiency, as well as the consumer era’s focus on the customer, o quality, and on choice, but it is capacious enough to include all of modern management’s other constituents as well.
