Value creation: A commonly used term, but what does it mean?

11/12/2018

Much has been written about the notion of value creation since the phrase became 'hot' in business circles several years ago. Today, one does not have to listen for long to hear questions such as "Does XYZ add value?' or "What's our value proposition?"The term is dropped into sentences hither and thither, flowing from the tongue freely, as if it were an old friend. This implies that 'value creation' is front-of-mind; something that is not only topical but also to be striven for.

But what is 'value creation', and how is value created? Here's one view:

Value creation is the primary aim of any business entity. Creating value for customers helps sell products and services, while creating value for shareholders, in the form of increases in stock price, insures the future availability of investment capital to fund operations. From a financial perspective, value is said to be created when a business earns revenue (or a return on capital) that exceeds expenses (or the cost of capital). But some analysts insist on a broader definition of "value creation" that can be considered separate from traditional financial measures. "Traditional methods of assessing organizational performance are no longer adequate in today's economy," according to ValueBasedManagement.net. "Stock price is less and less determined by earnings or asset base. Value creation in today's companies is increasingly represented in the intangible drivers like innovation, people, ideas, and brand."

This description, from Reference for Business, reveals that 'value' can mean different things to different people. As with many concepts within the social sciences and liberal arts (of which management and governance are expressions), context is crucial. Clarity of language is needed if leaders are to be effective and businesses are to prosper. Listeners and readers must be able to comprehend messages readily. The following questions provide a useful starting point for such an enquiry:

Who is the recipient of the intended value?

What is valuable to them, and why?
Can this value be created cost-effectively?
How will 'success' be measured?

Rather than make assumptions or assertions (think how often have you heard people claim a 'unique value proposition'), put these questions to the beneficiaries (because, rightly understood, the 'value' of anything is determined by the recipient not the creator).

Start your enquiry at the 'top' of a company. Boards should sit with shareholders and ask (or propose, if the shareholder is unclear) what 'value' looks like to them. This is the 'core purpose' question. Responses might include increased share price; a long-term market position or business model; increased market share; a social priority; or some combination of these, or even something completely different. Senior managers and staff should meet with customers (or prospective customers) and ask the same question. Ask staff themselves as well: the motivations of employees are likely to be different from those of shareholders and customers. 'Great solutions' that 'add value' to are highly unlikely to hold any sway at all if the intended beneficiary does not recognise, or is not interested in, the 'value' that is supposedly being offered. As with strategy, boards need to take the high ground, by ensuring that value created for one recipient does not erode value elsewhere. Boards need to work with management and together become crystal clear about value in a holistic sense: what it is, who the recipient is, and how it is created.

Once the value matrix (what, to whom, how and why) is understood and agreed, the answers need to be communicated in a clear and concise manner, so that effort and expectations can be aligned accordingly.

Finally, a note to boards: You have an ongoing responsibility to ensure that purpose, strategy and managerial and operational activity are not only aligned, but also the desired value (outcome, strategic goal) is actually being achieved and that it is recognised by the intended recipients. The importance of ask probing questions cannot be overstated.

An earlier version of this article first appeared in 2015.

2 Comments

Peter Tunjic

13/12/2018 14:52:44

Hi Peter,

Good work on keeping this on the agenda. In my view, what is value is the critical question of our time.

In my view, our theories of value become our theory of corporate purpose, governance and law. It is the domain assumption that explains why theories of corporate governance are so polarising.

For example, Smith, Marx and Ricardo would all have disagreed with your statement:

(because, rightly understood, the 'value' of anything is determined by the recipient not the creator).

The classic economists thought value was objective and not subjective as you put forward.

Personally, I think the most useful description of value is the work that something can do. From the perspective of a company director, value is a measure of the capacity of a thing to bring about change. People, ideas and brands can have more value than money because they have the capacity to affect greater change than value in its monetary form.

Thanks for posting

Peter

Peter Crow

14/12/2018 07:44:55

Thanks Peter, appreciate you taking time to post your thoughts.

The exploration of 'value' is one waypoint on a rather personal journey of enquiry as I continue to explore the role of the board of directors and, more generally, that of companies in society. While I am by no means an expert, the view held by some classical economists (that 'value' is/was objective) does not sit comfortably with me. To proclaim or project that something has [a particular] value in an objective sense seems, to me, to be the antithesis of free will and all that is important to the smooth functioning of a civil society.

If I may explain, in an attempt to clarify my position:

First, it is the value that one ascribes to something possessed (an object, idea or a relationship, for example) that makes it valuable or not. That someone else may assign a different value from me suggests that the value is relative or, at least, subjective. If you will allow an example. My fountain pen is valuable to me; value in this case takes the form of sentimental value because of what it represents—a relationship. But to anyone else, this particular pen it probably 'just a writing instrument' and i may even be 'a relic from the past to be discarded'.

Second, price and value are not the same. In fact, they may not even be related.

Third, if value is held to be subjective, the possibility of a less selfish world awaits in which suppliers of products and services think more in terms of what their customer gets (value) than what they assert.

Regardless, my hope is that, in asking the question, others [especially company and institutional leaders] might be motivated to consider the possibility that service to others might offer a better and more sustainable pathway to prosperity than self-service.

Value creation: A commonly used term, but what does it mean?

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