Source of Profit/Value Adding
Impact in different parts of the value chain
The value chain starts with a resource and ends with an impact on quality of life. Value chains exist in a complex and chaotic economic ecosystem with a variety of resources, a variety of actors and a variety of interactions that produce a variety of outcomes. It is virtually impossible for a value chain analysis to be academically rigorous, but it is incredibly useful in understanding the main drivers of socio-economic performance.
The prevailing money accounting metrics has the corporate organization as the primary reporting entity with no metrics at all that relate to the impact the entity's activity has on the community and society at large. This is a major limitation of the present system of metrics
For the corporate stakeholders the only metric that matters is aggregate profit of the organization … but for society what matters is the impact of the business activity throughout the value chain and in all the communities where the business has activities.
Value chain analysis shows that in some cases a business has a favorable impact in one community while have an unfavorable impact in another community. This might be a function of employment, or what a company is doing to the environment.
Who wins and who loses in the value chain?
Value chain analysis is a core analytical technique that may be used to help understand why some people and organizations accumulate wealth and others do not. Value chain analysis is used to show cost and profit distribution across multiple areas and organizations as in the petroleum industry, or across time as in the case of education and the student's subsequent career.
TVM makes use of the idea of value chain analysis. What appears successful in one part of the value chain may be negative in other parts of a value chain.
Corporate profit reporting is based on a small part of the value chain ... a small part that excludes all of the consumption of social value. This reporting takes no credit for the social good that a good economic activity creates. Looked at from the TVM perspective, typical corporate reporting is very incomplete and does a major disservice to society as a whole.
Value chain analysis is not difficult except that the data needed to do it are rarely available. This may be because responsible parties do not want their performance to be visible or the data do not exist. Most of the effort goes into having data to work with.
These are some value chain example
Supply chain value analysis.
It gets very interesting to see which part of the value chain is profiting and who are not.
Longitudinal (over time) value chain analysis.
This may be intergenerational or it may be over a person's life-time, or the life of a product.
Inter-organization or inter-group value chain analysis.
What organization profits ... and which ones do not!
Inter-place value chain analysis.
Is it the rural village or the big city that makes the profit ... is it one country or another?
Value chain analysis may be the single most powerful element in TVM ... but also the aspect of TVM that concerns those that are making profit from an elite position in the prevailing value chains.
Value chain analysis is a technique that relates cost, price and and profit ... and value consumption and value creation in a complete transaction matrix. The value chain analysis explains the aggregate of value consumption or destruction and the aggregate of value creation and value adding and reconciles the aggregate with the winners and losers at different stages of the value chain. The value chain analysis may be applied either over time, over geographic space, or between organizational entities. Value chain analysis shows how critical local community based economic activities are to the community and how damaging many profitable global value chains are to society.
The TVM value chain incorporates both the money costs and value and the social value consumption and social value creation. That is the value chain has both profit and value adding in its construct.
Value chain analysis is used to identify the winners and losers in various parts of the economic structure, and makes it possible to understand the systemic flaws in the way the economy operates. Value chain analysis is used to show cost and profit distribution across multiple areas and organizations as in the petroleum industry, or across time as in the case of education and the student's subsequent career.
A healthy value chain has two key characteristics (1) end to end value adding; and, (2) value adding at each step of the value chain. A healthy value chain serves to “pull” economic activity because it is in everyone's best interest for it to continue and grow. When either of these characteristics are missing, economic activity declines because there are interests that are not satisfied.
Follow the money!
The phrase “follow the money” suggests that the basic concepts of “value chain analysis” are being used. Decisions are often made with multiple “agendas” … frequently a public agenda that is all about how much good a project will do the the community, and a private agenda which is about how much money individuals connected with the transaction are going to make. High costs and low performance in publicly funded projected can most often be traced to a private agenda that was more important than the public agenda! The value chains show how costs accumulate and what profits are extracted from the value chain. Value chain analysis is used to identify the winners and losers in various parts of the trade flow, and makes it possible to understand the way the economy operates, especially the international trade economy. Value chain from raw material to consumer is important. It shows why some companies are very profitable and others are not. The value chain show how costs accumulate and profits are extracted from the value chain
Value chain for goods and services
From raw material to final consumer in petroleum
The value chain from raw material to consumer helps to show why some companies are very profitable and others are not..
The petroleum value chain helps to explain the various connects and disconnects between the origin of oil in a poor part of the world to gas being used in rich places. How is it that excellent crude oil in the Niger Delta makes some Nigerians super rich, with the country remaining terribly poor. How is it that there is seemingly little rational link between high gas prices at the pump and the costs of producing this gas? How do markets work ... and who do they work for?
An example … the petroleum value chain
From raw material to final consumer in coffee
Coffee is an interesting value chain. Farmgate prices for coffee have been relatively static for decades … yet the retail price for a cup of coffee has increased by almost two orders of magnitude. The farm may not be making much profit, but somewhere in the value chain there are big profits and good true value data would show this. Who is making the profit? Where is the value adding going?
Very few transactions are simple an have impact only on the direct participants ... most have other ramifications which are important in the money accounting of the business world, but have even more importance in the context of the combined flows of value and money around the community.
An example … the coffee value chain!
Modern corporate accountancy is complex. Most of the rules apply to the way an organizations reports to the financial stakeholders and, to a much lesser degree, to the public. These reports are the result of complex consolidation that takes into consideration the way the internal and external value chains impact costs, revenues and profits.
Managing these value chains makes it possible for a corporate organization to minimize its exposure to taxes, duties and other regulations that impact its financial performance ... and understanding and having data about value chains makes it possible for the public to hold organizations accountable for their performance in the community and towards society as a whole.
Within the service sectors … banking and finance
Value chain analysis in the banking and finance sector is interesting. Very little of what any bank or financial institution does has any direct role in value creation … they function merely to move value around the economy, and in doing this they extract profit. This profit is not related to value creation, but merely moving value from one place to another. The profit is part of a zero sum economic activity, and because of this the value chain analysis is to locate the counterpart losses.
In the recent financial sector implosion the profits of the banks were obtained on top of losses by millions of ordinary people who were totally misinformed about the reality of what they were doing in financing house purchases.
Within the service sector … retail
The retail trade sector satisfies needs up to a point, but it also merely serves to satisfy wants that are purely “entertainment”. In the “more and more” culture, “shopping” is a way of entertaining oneself … of indulging oneself and enjoying it.
If one has wealth … there is nothing inherently wrong with buying things with it. The money goes into circulation in the economy, and the economy appears to do well. When people feel wealthy and spend on luxury goods, the luxury goods sector does well and it hires more employees. Whether the luxury industry and this value chain is as good a source of quality of life improvement as some other value chain is another question.
Sports and entertainment sectors
The sports and entertainment sectors contribute to quality of life … and in many ways these sectors in the modern economy are very efficient. A small number of people are able to play in the big teams and in the big entertainment spectacles, and an enormous number of people get pleasure from it.
There is a reason that sports stars and entertainment stars are paid large amounts of money for what they do … these sectors have a money model that supports this.
The value model for spectator sports and entertainment is also favorable … but probably not as favorable as small scale community level sports and entertainment. There is value in spectating … it entertains … but the value is modest compared to being a participant. Playing the game, competing in a sport is very satisfying … as is being an entertainer. It is not about the money, it is about the well-being associated with doing these things.
Examples … value chain analysis over time
The value chain technique may also be applied over time. In this case an activity that has costs today creates profit and value tomorrow. The concept is fairly well established in money accounting and analysis … and similar concepts also work for value. In fact the value arising in the future because of good activity now is very, very important.
The education of a child is a big expense ... but it is an investment that will pay back many times over the life of the person. Value chain analysis shows something of how a cost in early years creates opportunity for benefit in later years ... and could be the basis for economic analysis to justify investment not only by parents, but also by society in education and building human capital for the future.
Examples … value chain between sectors
The building of the US Interstate Highway System is an example of how activity in one sector creates value in another sector. The construction cost the US Government more than $100 billion ... an immense investment in the 1950s and 1960s … but the increase in property values around the country were way more than this immediately ... and the productivity improvement of the national economy were even bigger and kept on for decades. The value chain analysis of much infrastructure shows similar amazing results and shows how good infrastructure investments can be for society.
Treating disease is a big expense ... and again with an economic dynamic that changes over time. A strategy that invests so that there is no need to treat disease because the disease is controlled or eradicated is probably better than one that merely waits and treats the disease and incurs the associated costs. Value chain helps to determine whether prevention rather than cure is the optimum strategy.
This is an example from the design and construction of a seafood processing plant in Africa in the 1970s. Freezing and cold stores require a lot of energy … and it needs to be reliable. The local electrical energy infrastructure was missing so the electrical energy had to be produced within the organization using generators owned and operated by the company. In a more developed economic environment the energy infrastructure would have already been in place!
Examples … value chain analysis between places
Within community transactions add value
Transactions that appear as costs in one entity in a community are revenues in another entity in a community. The net cost to the community then becomes zero. In corporate consolidation accounting, this is a consolidating elimination! This has very important implications for planning and the optimization in the use of resources.
The most important example of this is wage remuneration. Wage remuneration is a cost to the employer, but is a critical revenue to a family. The value construct in this situation may even be more significant. The cost to the employer may be quite unimportant in the greater scheme of things, while the income to a poor household may be a matter of life and death … or certainly with a very significant role in the economics of the family.
But this wage remuneration may go further in delivering value to the community. The family that might have had to depend on some form of welfare, either from an NGO, the government or others in the community is now able to buy what they need. Food, shelter, clothing, water and sanitation services, health, education may now be purchased and are not delivered based totally on a welfare type of funding.
External to the community transactions lose value
Transactions that involve entities that are external to the community may be to the advantage of the community or not. It depends. The analysis is rarely done … but where it has been done, it becomes clear that an external transaction has the potential to be either advantageous or disadvantageous. In general the “export” of goods or services and the receipt of a money payment is good, while the “receipt” of a money loan will only be good if the money can create money profit sufficient to repay the loan together with interest. This does not always happen … usually the loan repayment is for sure, while the profit generation is a maybe.
Foreign direct investment (FDI) is an example of a transaction with an entity or entities external to the community. For the investor the profit potential has been the subject of analysis and approved by the entity's decision makers. For the community, there will be jobs which are usually considered to be a valuable benefit … but what is being given up. In the extractive industries there is a reduction in the amount of the item in the community eco-system … the natural resources of the community are being depleted. They may not be generating cash profit by standing being left alone … but they have value which does not diminish as long as the resource remains unexploited. The value of diminishing the resources is rarely if ever articulated in the course of justifying an external investment in a community.
Profitable Value Destruction
Very common and very bad
Value adding is good, and so is profit. But being profitable does not mean that the economic activities are value adding. Profits may be earned while the activity is value neutral, or the profit may be arising while the activity is destroying value. Value destruction is often associated with environmental costs that impact society, but do not have to be incorporated in the financial accounts of the corporate enterprise. In recent times, more and more environmental regulations have made environmental degradation a cost to the enterprise and a drag on profit ... but the cost to society is still not part of the corporate accountancy and reporting system. TVM, on the other hand, takes the cost to society and makes the cost explicit and associates this cost directly with the enterprise that is causing the value destruction.
Value destruction compounds to form a vicious cycle of increasingly difficult outcomes. Value destruction may start slowly, but if not corrected the compounding eventually takes hold, and it is very difficult to control.
In the complex reality of the economy, both value creation and value destruction are going on at the same time ... one offsets the other ... but there is always the potential for one of the other to get the upper hand. When it is value destruction that becomes dominant, the socio-economic outcome is catastrophic ... and this is what is happening in most poor settings.