So far in this series about the Cavi Method for process improvement, we’ve mentioned the idea of “value” a few times:

It should be clear already that understanding value is fundamentally important to process science, but what is value exactly? How is it measured? How can it be created? In this post, we will explore the definition of value in greater depth.

The formula for value is:

 

Value = Benefits – Cost

 

Benefits are subjective and can change given individual circumstances, unique needs, natural or learned abilities, etc.

Cost is not subjective. Within the value formula, cost is an objective measure translated to currency. You might argue that a cost can’t be placed on certain human or intangible elements; this is not true.

Cost (in currency terms) is simply how energy is made physical, in order to be tracked and traded. Everything that lives and moves can be decomposed into its energy elements and given a cost. Even consuming “free” things (e.g., reading library books) take time and energy and can therefore be quantified from an opportunity cost, substitution analysis, or direct cost of energy perspective.

When a formula contains subjective elements like “benefit,” value itself will be a subjective measure. Though this may seem like a problem for scientific analysis, this is where cost comes in. Cost acts as an objective comparison factor across subjective benefits and perspectives. This creates an inviolate law: where people are paying for things, value is being created. When a population pays for a good or service consistently enough that a business can design and enable a stable process around producing it, it is guaranteed that value creation is occurring; otherwise, the population will eventually stop paying for it (assuming a free market).

Why are the subjective “benefits” included in the formula then, if the objective nature of cost is what defines the value? It is because there are always two parties in value creation (assume “company” and “customer”), each with subjective experiences of the benefit of a given process in comparison to their cost needed to receive that benefit. This difference between customer benefits (goods or services received) and company benefits (possible profit opportunities) creates a space that allows for value creation to exist.

For example, if a customer wants a shirt and feels subjectively it is worth $100, they would be willing to incur an objective cost up to $100 to obtain it. For a company, their subjective benefit is always profit opportunity, not the objective revenue number (AKA the objective cost to the customer) that they receive in the transaction. The actual revenue means nothing to a company, because it could represent a loss (negative profit) if their operating costs exceed the revenue per unit. Companies operate within the market on subjectively assessing profit opportunities, and then controlling their objective costs to maximize those opportunities over time. In the shirt example, a company charges $80 for the shirt with the intent to make a profit and be competitive, knowing that their objective cost per unit at that moment is $60. Their costs could uncontrollably become higher than $80, but they may still operate for a time because the $80 in revenue is perceived as a profit opportunity until the company starts measuring negative value creation. In this example, both the customer and the company make $20 worth of value, because in both cases their benefits exceeded their costs.

Here is a generalized visualization of the shirt example, illustrating these variables:

 

Understanding the balance of cost and benefits as the formula which defines value presents a strategic insight for process professionals: it is unnecessary to qualify whether value creation exists. The job of a process professional starts with recognizing that the mechanism of value creation need only be discovered and improved.

Further, if the intent is process improvement, then creating new value (such as adding a new product line) would be doing the wrong job. Process improvement is about clearly articulating the value currently being produced by a process, and then figuring out how to increase value creation by reducing the energy required to generate that value.

The creation of value from the company perspective should be solely based on cost control, not revenue generation. In fact, companies with sustainable processes aggressively decrease their prices by reducing their costs commensurately, in order to maintain high value creation for customers. The takeaway here, which is foundational to the Cavi Method, is that process only exists because there is some value which customers are seeking; otherwise, there would be no demand, no energy inputs, and no process.

The Cavi Method can be articulated as the process to find, understand, analyze, and manage value creation. In the next post, we will continue this conversation on value by defining the concept of the “value chain”. This will help highlight the structure of value creation in the context of a real life business process with multiple steps and sequences, as opposed to the example of the simple exchange used in this post.

Spread the love
  • 4
    Shares