VALUE CREATION APPROACH- THAT BUILDS EVERLASTING COMPANIES..

BUSINESSES ARE SUSTAINABLE AS LONG AS THEY CREATE A NET POSITIVE VALUE ..


If the purpose of a business is to create a net positive value for the stakeholders, the Value Creation approach differentiates, true Business Persons from Busy Fools.
A 'Busy fool' is one who toils away hard at work for hours but either fails to generate any value from his work or creates a net negative value.


Every action or a decision taken in an organization could be value accretive or value destructive. When the net value of the actions taken are value accretive in the long run, businesses prosper and continue to grow.

Successful organizations know that the purpose of any business is to create value for their investors, employees, customers, suppliers and the society. Sustainable value can be created only when all the elements of the corporate eco-system get a perceptible share of the value created.

The Total Value created by an organization is generally equal to the sum total of :

a) Value to consumers ( perceived benefit less the price paid),

b) Value to Suppliers ( Cost paid to suppliers less the costs incurred by the suppliers)

and 

c) Value to the firm ( Price realised from customer less Money paid to all suppliers and Vendors less sum total of all expenses incurred in the creation of the products and services.

The term generally used globally to understand the value created by a firm to itself is quantified by EVA,defined as follows:

EVA (economic value added) is the measure of output (taken as operating profit after tax and some other adjustments) less input (taken as the annual rental charge on the total capital employed, both debt and equity). 

As long as the EVA is positive and increasing, the firm is said to be creating value  and if EVA is decreasing or negative, the firm is on the down-trend and continuing in this trend may one day lead to the non existence of the company.

Successful Organizations assess the effect on the EVA of the organization when they undertake any major investments.

It must be however noted that focusing purely on the projected EVA in the short term may be detrimental to the long term value creation process of the organization.

For example when the firm prices the products too high, their sales volumes could be adversely affected as the price may be more than the perceived benefit of the product by the consumer or the price the competitor is charging.

This will result in significant variance from the sales projections leading to piling up of inventory and blocking up of working capital. Hence the EVA projections can go haywire and the company could end up destroying the value in the process.

For example in 2004, Nokia launched value for money branded mobile phones by crashing the price-lines by over 40%. This has led to a huge surge in volumes by 3-4 times in a span of 12 months leading to tremendous value accretion. Thus while precise estimation of the effect of the company's financially linked decision are not possible always, a calculated risk with a time-frame in mind is often taken the companies to assess the net value added

Similarly, BPL slashed the price of its double cassette audio model SW138 by 50% in 1995 to clear excess inventories. The resultant surge in the sales of the model and its impact on the market share of BPL in the market, resulted in a drastic improvement of overall sales and financial performance of BPL-Audios w.r.t competition like Philips thus adding a positive value. Economies of scale often have a suppressing effect on the costs and the resultant competitive pricing will be perceived positively by the customers when the selling price is lower than the benefit they perceive.

It can be understood that the factors like demand supply scenario for the product/service in the market place, strength of the competition, efforts required to communicate the proposition to the customers have a direct bearing on the value created by a company.

In a sellers market for example, the petrol market in India, where the demand is forever exceeding the supply, the organizations stand to create a huge value for their stakeholders due to their control on pricing without affecting the demand.

However when the supply far exceeds the demand, the companies with strong brands and significant competitive edge are able to enjoy positive value addition while the me-too companies struggle to survive. Innovation and strong marketing thus add a significant value and aid in the value creation process.

Organizations focused on value creation often explore ways to enhance the size of the market addressed by the products and services as the resultant increase in sales will lead to a better demand-supply scenario thus increasing the price realized from the customers leading to higher value.

Value focused companies do not believe in squeezing the suppliers too much or compromise on the quality of the raw-materials used as this may have a negative effect on the quality of produce as well as the perceived benefit to consumers, resulting in lower pricing and value destruction.

Net additional value creation is an important parameter that not only influences critical corporate decisions like Mergers and Acquisitions. Any corporate acquisition or takeover that results in a negative net value added due to parameters like high cost of transaction, inability to economise on common areas of expense, increased expenses due to problems associated with a more complex operation etc. will lead to destruction of organizations. Kingfisher Airlines' acquisition of Deccan Airways has resulted in a value destruction of over 75% due to negative value added.

Successful organizations have a long term and strategic perspective to value accretion in each of their activities and thus in the long run create huge values for the stakeholders and society as well.