Cost, Price, Value Relationships
Three key numbers: cost, price and value
Cost, price and value are very important numbers about any economic activity. Though modern society is founded on economic activity, there is a surprising lack of information about cost and value though there are massive datasets about prices. ... that is what a buyer pays for a product or services, and what prices stocks and other financial interests are trading at, what prices commodities are trading at, etc.
The explanation why there is little information about costs may well be that those that make decisions would be embarrassed at the internal value chain within their organizations prior to the transaction where the customer buys the product or service.
Corporate accountancy is only about money cost and money price. TVM uses cost, price and value. The value derivatives of cost, price and value are key numbers that describe economic activity. The relationship between these numbers determines the performance of almost any economic activity. All of these measures are important ... any one missing and the understanding of the dynamic of societal progress is compromised.
Cost and price
Cost and price make it possible to calculate margins and profits ... and this is what is done in normal corporate accountancy and financial reporting. As we shall see later, in modern financial reporting both cost and price are capable of being distorted so that the most favorable margins and profits are being reported ... something that professional accountancy was structured to avoid.
Cost and value
Cost and value make it possible to calculate value adding ... something that is very important for society. For this to be of greatest use, the calculation of cost must include not only the money cost but also the value consumed associated with the activity.
What is this? In the case of the oil industry, the costs of crude oil production include payments made for royalties, licenses, etc, as well as the costs of exploration, drilling and extracting the oil from the oilfield, and shipping the product to refineries and to market ... but the costs do not take into account in any financial metric the depletion of the resource, and what it would take to replace this resource. This is a huge problem, because the resource being depleted has taken many millions of years to accumulate, and the cost of this
There are other examples ... see ????
Price and value
In some cases price and value are the same. In this situation the value chain through delivery to the final consumer is extracting from the consumer a price that is equivalent to the value. The consumer does not get anything of the added value. In fact the typical business model is one that aims to extract as much revenue from the market as possible.
The use of resources does not automatically mean that there is either going to be efficient or effective use of resources.
Disbursement is no way to measure performance
The World Bank did a disservice to itself and to the whole process of development by using the amount of loan disbursed as a proxy measure for how much development progress was being made. It was a stupid idea and went on for years.
In the current global malaria control programs, the amount being disbursed is a more prevalent measure than the amount of malaria disease reduction. The idea of effectiveness measurement is missing!
What is the cost?
Performance is both efficiency and effectiveness. The profit and loss account summarizes the activities of the organization in money terms showing the revenues and the expenditures. The profit and loss account that is presented to outsiders tends to show the least amount of information allowed by law, while the internal profit and loss accounts will show all the information needed to facilitate good management.
Cost efficiency … how much actual was relative to standard
Cost efficiency is how much the actual cost was relative to what the cost should have been … often expressed as a standard cost. There are many ways to evaluate cost performance including also comparison with activities undertaken in other places or with activities undertaken by other organizations.
Well designed data systems makes it possible to compare how much something actually cost with what it should have cost.
Cost efficiency is a measure of how well something is done. Cost efficiency answers the question about whether or not resources used are more or less than would normally be expected? Comparative cost efficiency answers the question about cost relative to other similar works at another time or in another place.
Cost effectiveness … How much value for the cost?
Well designed data also makes it possible to measure the relationship between the cost and the impact … that is the change in value arising for the community. Cost effectiveness is a measure of how well doing something results in getting the desired impact. Did the use of resources solve the problem that is being addressed or not. Did the use of resources have a favorable impact on the community and quality of life … and was the impact what should have been achieved.
Cost effectiveness is the more complex idea of relating cost to the value of the accomplishment. The idea is simple in theory, but becomes more difficult as the problems being addressed are more complex. TVM uses techniques to get an overall idea of cost effectiveness, and then goes into more detail to assess the way different initiatives contribute to progress. This may require multi-variate analysis of the datasets where there are multiple interventions being used.
TVM accounts for value with as much rigor as possible even though value is perceived differently depending on many subjective elements. TVM uses a system of standard values which makes it possible to compare cost with value on a uniform basis.
Standard costs and standard values facilitate analysis and avoid data overload. Separately TVM allows for the analysis of standard values and the use of this set of metrics to understand differences between societies and to help with the determination of priorities.
External resources complicate analysis. The performance of the community is a function of the amount of external resources needed to maintain a good quality of life. A low performing community is unable to maintain its quality of life without getting external resources. A high performing community needs no external resources to maintain and improve its quality of life.
There are organizations that use large numbers of unpaid volunteers. The labor resource is money free to the organization, but the “opportunity cost” for the volunteers is not zero, and the optimum opportunity for the organization should be bigger than the value of just “stuffing envelopes”!
Quantifying Value
Standard value is key to efficient analysis
The core hypothesis that justifies the development and deployment of TVM is that money profit is not enough, there also has to be value. But value will never the there if value cannot be quantified in a widely accepted way.
If you cannot measure it … you cannot manage it
The TVM solution to this problem is to make use of “standard values” rather like “standard costs” are used in cost accounting … but even this has to be done with care. Value is not a simple metric … but it is a very important one.
Value is subjective … and this is part of of its importance as a key metric of progress and performance. A simplified value construct will not work to guide society to its best performance … or even to know what best performance might be.
Ignoring value … which is essentially what has been done in money accounting and economics certainly simplifies analysis, but over time the result of this is increasingly poor allocation of resources. Value is subjective, and as such its quantification has to have an element of pragmatism in order to be practical.
One part of the solution is to have standard values for everything that is of value … in other words, for everything.
The idea of a standard value in TVM is similar to the concept of standard cost in cost and management accounting. Everything has its standard value computed, just as everything has its standard cost computed. Periodic comparison of actual cost to standard cost makes it possible to have standard costs that reflect the actual cost very closely. Routine management analysis may be done using the standard costs … and the answers are good enough for most day-to-day decisions. Similarly with standard values … they may be used in day-to-day analysis and the answers are good enough, and easy to get.
Price as a proxy for value
Price is often used as a proxy for value … because sometimes the price is close to the value. But this approach to value has many problems of which (1) price is determined in the main by the seller, and (2) the analysis going into determining price usually ignores almost all the elements of the value construct except what value a buyer might place on the item. In other words, you cannot set the price higher than the customer thinks the item has value if you want to sell the item!
This idea that price is best when the price of the item and the value of the item to the buyer is the same is an interesting dynamic … with the result that all value adding then becomes attributed to the business part of the value chain, and none for the consumer. In the end, a damaging economic idea.
Value is everywhere
Examples in every sector
A standard value needs quantification, but not as money value … not as a monetization of the value quantity … but using a separate unit of measure.
Value changes depending on whose perspective is being used … and these changes are complex and difficult to explain. They are not only based on simple economics, but there are cultural and social issues as well.
Every person has their own profile of values … many people may have similar profiles … and within a community there may be only one general profile … or a relatively small number.
There needs to be a large repository of value profiles so that what people think one value is relative to another value. Many of the value ideas will be different … many will be the same. When all the profiles get linked together relatively, it becomes possible to see the aggregate average value profile.
Housing has value … a house has value … part of the value is its role in sheltering the family … part of the value is being a home for the family, the social center of the family … part of its value is the image it gives of the family … part of its role is a contribution to the neighborhood as a whole.
An education has value … part of the value is the socialization learning that children and young people get at school and college … part of the value is what they learn … part of the value is learning how to learn … part of the value is the opportunity expansion that results from being well educated.
Infrastructure has value … part of it is to enable socio-economic activities to take place more easily … a bridge saves people time in getting from one place to another, or getting there at all … a road makes it possible for people and goods to move from place to place efficiently. The value arises because people save time and things can be more productive. In some cases infrastructure makes the community safer. In some case infrastructure makes it possible for a community to expand … or to build some new economic activity in the place.
Health has value … part of the value of health is that good health enables people to live their lives in a far better way than when they are sick. All the things that are possible when a person is health become compromised when there is debilitating sickness.
Low crime has value … quality of life is at its best with no crime, but becomes impaired when there is crime. Low crime has a big social value, that is lost when crime increases. Getting low crime is expensive … police, courts, prisons and remedial programs are high cost parts of the community fabric, but important.
Electricity has value … quality of life is improved with access to electricity … when used electricity is clean … though there are questions about how clean electricity is when it is being generated.
Jobs have value … to the employee, those that are remunerated have a value in the family that is big relative to the same person when they are unemployed and unremunerated. Jobs are interesting in that they are also of value to the employer … every job helps in the process of carrying out the mission of the organization … and build value for the organization.
Things that impact value are everywhere
Things that impact value are everywhere as well … so the framework of metrics needs to be able to handle the multiple characteristic of the value item and how issues impact the matter.
Good health has high value
Good health has a high value … but this is reduced by the onset of illness. Being sick lowers quality of life. Being cured improves quality of life. Being in good health is the desirable norm in the quality of life matrix.
Health in GDP is nonsensical
With modern GDP metrics, the cost of treatment is captured, but nothing else. The erroneous supposition is that the more treatment there is, the stronger socio-economic performance. TVM disagrees profoundly and has a very different approach.
Good health is always desirable … but maybe good health has a different value at different points in ones life. This should be reflected in the way the value matrix comes together. Maybe health value is going to be different for different people who do different jobs. The details are tricky … and they should be respected … and also there should be some simplification so that the system stays workable.
Low crime has high value
Low crime is very desirable and enhances quality of life in a community. In turn low crime has a favorable impact on the desirability of the neighborhood and house prices. Low crime reflects the people who live in the neighborhood and those that come into the neighborhood. Low crime also reflects the capability of the police and law enforcement.
In the quality of life measure, low crime should be the norm, and be a value component. All the various forms of criminality … anti social behavior … are negatives that detract from quality of life.
The cost of police and law enforcement may be needed to have a low crime outcome … but the costs are a negative in the quality of life. That money has to come from somewhere.
Efficient public transit systems have high value
Efficient public transit systems have high value and should be the norm in a well measured society. If the value of having excellent efficient public transit systems is incorporated in quality of life as the default, then the various costs can be set off against this. If there is a good transit system there is a history of investment in the transit infrastructure and the equipment, and an ongoing cost of operating staff, operating costs and maintenance. There is also a cost of congestion that varies according to the state of the transport infrastructure and the performance of the transit system. With a good transit system the desirability of neighborhoods can improve … but not always.
Urban and regional mass transit systems
It is difficult to imagine a modern city without a high performance urban mass transit system as well as regional mass transit systems. Most of these systems are run by government entities that use cash based money accounting, a system that fails completely to keep the value of past investment front and center of performance analysis.
The value of transit systems is a component in quality of life … not having one is a deficit .. and the cost of building one and the cost of running one is also a deficit … the cost of congestion is a deficit. The cost of building and running transit systems is substantial … and the matter of whether this is best paid through a public funding process … bonds, taxes, etc … or by user fees is an important question.
Not funding mass transit adequately, and having the system deteriorate is usually a value destroying outcome. At the same time, allowing high costs and low efficiency in the operation of the system to become the norm is also a value destroying outcome
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