value created model

Value created modelclick for a larger image
Fig. 87 Value created model.

value created model

an analytical framework which builds on the concepts of VALUE ADDED and the CONSUMERS SURPLUS which assists business strategists to identify opportunities for establishing COMPETITIVE ADVANTAGES over rival suppliers and to increase the firm's profits.

‘Value created’ is the difference between the value that resides in a product and the cost of producing it. In Fig. 87 ‘C’ is the cost of producing the product which includes ‘bought-in costs (materials etc) and the ‘additional costs incurred by the firm itself in making-up the product in its final form. ‘P’ is the price charged for the product and ‘B’ represents the value (perceived benefits) of the product to the consumer. ‘Value created’ consists of two elements (a) the firm's profit which is the difference between the price (P) charged for the product and the cost (C) of producing it (i.e. PC); (b) the value of perceived benefit of the product to the consumer (B), part of which is the value of the product embodied in the actual price the customer is required to pay (P) and part of which is the extra value received by the consumer in the form of the consumer surplus (B-P). The consumer surplus (see entry for further discussions) is the difference between the price the consumer actually pays compared to the price the consumer would be prepared to pay, ie. if the product's actual price is £50 and the consumer would have been prepared to pay £75 the ‘consumer surplus’ is £25. The total ‘value created’ thus consists of the firm's profit and the consumer surplus.

The model is useful to strategists in that it enables them to explore various ways of establishing competitive advantage over rival firms and increase profit potential. To illustrate it the firm can reduce its costs (while keeping ‘perceived benefits’ unchanged) then either it can continue to keep its price unchanged and obtain higher unit profit margins, or it could lower its price, undercutting the prices of its competitors thus gaining market share. See COST DRIVERS. Conversely, if it can increase the ‘perceived benefits’ to the consumer (while keeping costs unchanged) it will encourage customers to switch away from competitors, thus gaining market share. Increasing ‘perceived benefits’ can be done through ADVERTISING extolling the attractions of the product and increasing the quality of the product. See BENEFIT DRIVERS.

The firm can also explore ways of ‘capturing’ – more of the consumer surplus through differential pricing (see CONSUMER SURPLUS entry for details) and various MARKET SEGMENTATION strategies. See RESOURCE BASED THEORY OF THE FIRM, VALUE CHAIN ANALYSIS, CRITICAL OR KEY SUCCESS FACTORS.

Collins Dictionary of Business, 3rd ed. © 2002, 2005 C Pass, B Lowes, A Pendleton, L Chadwick, D O’Reilly and M Afferson