02 Sep 2015 17:41 IST

Are organisations capturing the full value of what they create?

Many times, firms create a high level of value but fail to appropriate or capture even a decent portion of the value created

Any product or service goes through several stages of value addition before it reaches the final consumer. While mapping the entire end-to-end value stream is straight forward and relatively easy in a manufacturing context, for instance, Tracing the journey of steel from its iron ore stage to the steel frame you use at home is fairly easy. However, this is difficult to ascertain in a service contextdue to the significant proportion of intangibles involved in the production process. This exercise, of mapping, indicates the value created by each player in the stream and, hence, their relative importance.

In the example of the steel frame, there may be several players involved in converting/adding value in the journey from iron ore till it becomes the door frame in your new residence. At each stage, aside from adding value, each process increases the cost. While a conventional accounting and monitoring system tracks the revenue earned and the cost incurred, and hence the surplus/deficit made, it doesn’t trace what was the extent of the value created versus the value appropriated in the form of revenues. Many times, firms create a high level of value but fail to appropriate or capture even a decent portion of the value created.

Waltzing away with the business

Let me illustrate with an example this gap between value created and value appropriated with an example. Walt Disney is a name we are all well familiar with. When Walt Disney started the first theme park in the 50s their perspective was restricted to having a large number of people visiting the theme park and they hoped to generate revenue through at the gate collections (entry tickets) and through a franchisee fee they levied on the food and other stalls that operate within the park. The theme park, though, was seen as highly risky venture due to the heavy investment requirement (there were other reasons too), became very popular as it captured the fancy of children and families. It became a super hit and Disney made huge profits from the theme park(s). It soon became a common phenomena that families would fly down from across the US just to visit the theme parks.

At some point of time Disney realised that people spend several times more money in making the trip to the theme park and the gate collection was only a fraction of the total cost incurred. A family of four travelling from, say, California to the Florida theme park would spend something like $2,500 including local travel, flight charges, food, hotel stay and so on. Disney was collecting a measly $250 at best out of this, as its gate collection and franchisee fee.

The very purpose of the family visiting Florida was to visit the Disney theme park. In that sense Disney created business worth $2,500 (per family) but could appropriate (capture) only 10 per cent ($250) for itself. The rest, 90 per cent, was appropriated by hotels, airlines, taxi companies and restaurants.

Once Disney realised this, the outcome was obvious. They came up with a strategy to grab (appropriate) maximum from the value otherwise created by them. They got into hotels, travel, cruising, decided to own stalls in the parks, shops for toys/books, that with immense potential to cross sell. The performance of Disney just zoomed.

Slack and Hold

This inability to appropriate maximum from value created happens due to very many reasons. Some of the obvious ones are ‘Slack and Hold’ up, according to Pankaj Ghemawat, a famous professor from Harvard. ‘Slack’ is the inefficiency that sets into organisations over time. Like human beings tend to put on weight and are less agile as they grow old, the same happens to companies. Hold ups occur when co-creators of value, be it our employees, suppliers, vendors, channel partners and other partners bargain away the value created.

It is observed that even profitable companies are often unable to appropriate maximum of the value they help create and hence operate with far lower profits than their true contribution warrants. Often if this trend is not arrested, it can lead to deterioration of the actual profits made.

So, it not sufficient that we our performance in the form of actual profits made but also measure and worry about what is made versus what the potential is.

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