Optimal Value Chain: Effective Value Creation and Value Capture Strategies

How do firms create, deliver and capture values? What is the nature and function of effective customer relationship management? What are the critical phases of the Value Chain? What are some policy implications of the Du Pont model in formulating effective pricing strategies? These policy questions relate to the optimal value chain model of a business enterprise-the appropriate mix of profitability and productivity that maximizes the return on investment and shareholders’ wealth while minimizing the cost of operations-value creation and capture, simultaneously.

Clearly, effective creation of value, delivery of value, and capture of value is critical to a sound business strategy designed to maximize the wealth producing capacity of the enterprise. In these series on effective value creation and value capture, we will focus on the pertinent strategic margin and volume questions and provide some operational guidance. The overriding purpose of this review is to highlight some basic price theory, strategic margin relationships, and industry best practices in effective value creation, value delivery and value capture. For specific financial management strategies please consult a competent professional.

A preliminary analysis of the relevant academic literature suggests that the optimal value chain process and appropriate value creation, value delivery, and value capture for each firm differs markedly based on overall industry dynamic, market structure-degree of competition, height of entry/exit barriers, market contestability, stage of industry life cycle, and its market competitive position. Indeed, as with most market performance indicators firm-specific value chain strategic posture is insightful only in reference to the industry expected value (average) and generally accepted industry benchmarks and best practices.

In practice, firms capture value through competition and persuasion. At least two strategic value propositions and pricing options based on Du Pont ROI model are available to most firms: Premium pricing (focusing on profitability) which seeks to maximize the profit margin from each sale; and High turn-over rate (focusing on productivity) which seeks to maximize number of sales and effective use of available assets instead of profit margin. There is significant empirical evidence suggesting that when the marginal revenue is negative, the firm cannot be profit maximizing. This is because loss in revenues due to price effect tends to outweigh gain in revenue due to output effect. Additionally, there is growing empirical evidence suggesting firms that opt for scale and volume tends to outperform those that opt for segment and premium, ceteris paribus.

In designing effective pricing strategies at least two critical variables must be considered: Pricing objectives and price elasticity of demand. These important variables converge to inform optimal specific product price and value propositions, in general. Customer relationship management (CRM) consists of customer data analytics, practices, strategies and technologies that firms use to analyze and manage customer interactions and data throughout the customer lifecycle, with the goal of enhancing business relationships with customers, assisting in customer retention and driving sales growth efficiently and effectively.

Additionally, firms must create and sustain effective relationship with customers. Effective customer relationship is a function of at least three critical variables: Empathy, trust and commitment. In designing effective value capture strategy, firms must maintain effective customer relationship. Carefully managing such relationship averts and or mediates the loss of sales attendant to price hikes by firms with limited market power. There is mounting empirical evidence which suggests that explaining price hikes to customers before implementing them tends to reduce the adverse impact on sales and the derivative loss of revenue.

According to relevant academic literature, firms create value through the Value Chain process: A set of activities that are performed to design, produce, market, deliver and support firm’s products. At least two critical activities are required: Primary activities which consist of inbound logistics, operations, outbound logistics, marketing and sales, and service in the core value chain directly creating value; and Support activities which consist of procurement, technology development, human resource management, firm infrastructure supporting the value creation in the core value chain. Therefore, based on this formulation and concept, a Value Chain disaggregates a firm into its strategically relevant activities in order to understand general costs patterns, the behavior of specific costs, existing and potential sources of differentiation.

Based on current industry best practices, there are at least three critical phases of the Value Chain: Phase One-Product design, research and development; Phase Two- Production; and Phase Three- Marketing, sales and service. The Value Chain is the process by which firms add economic value to the product concept. As the product idea is conceptualized and proceeds through the Value Chain process, value is created for customers. However, the product concept can fail and the value creation and capture terminated at any stage of the process. The optimal value is efficiently captured for the end-user through careful execution of effective service strategy and programs.

Some Operational Guidance:

In sum, effective value creation and value capture depend on various factors such as value proposition, pricing objectives, the price elasticity of demand, competitive position of a firm in the global marketplace and the stage of the product life cycle. Some key pricing strategies may include penetration, parity and premium.

Penetration pricing strategy is most effective when demand is elastic and involves charging below competitors’ prices to create scale economies as a key method for building a mass market or to deter potential market entry due to low price and profit margin. Parity pricing strategy is most effective when demand is unitary and the product is a commodity; and involves charging identical prices with competitors. Premium pricing strategy is most effective when demand is inelastic and involves charging above competitors’ prices to recover R&D costs quickly or to position the product as superior in the minds of the customers.

Effective value proposition derives from promising customers (expected or standard value) what a firm can deliver and delivering more than the firm promised (premium or superior value). As I have already explained, two strategic value propositions and pricing options based on Du Pont ROI model are available to most firms: Premium pricing (emphasizing high mark-ups, high profit margins and profitability); and High turn-over rate (emphasizing high productivity and effective use of available assets). There is significant empirical evidence suggesting firms that opt for scale and volume tends to outperform those that opt for segment and premium, ceteris paribus.

In the end, knowledge is a strategic weapon and source of effective value creation, value delivery and value capture. When firms apply knowledge to tasks they already know how to do, they call it, productivity. When they apply knowledge to tasks that are new and different they call it, innovation. Only knowledge allows firms to achieve these two strategic goals.