Describe the methods used to calculate value added. How does value added contribute towards understanding the connections between the business and its product markets? Use relevant examples to illustrate points. Within the framework of value added in general, Pigou and Bernard Cox suggested the calculation of Value Added that is used for classical nationals accounts. In 1920, Pigou gave his interpretation of value added, consisting of being able to precisely determine the earnings of a company; whereas the sales turnover isn’t precise since the expenses aren’t take into account.
In this fact, he presents value added as the subtraction of the output related to the inputs. Thus, outputs that aren’t generated by our self aren’t taken in account. In 1979, B. Cox in his book “value added” agrees with Pigou’s definition and goes even further in his explanations. He interprets value added in two different points of view: the subtractive and the addictive. On one hand, the subtractive value added, is calculated by subtracting purchases of materials and services from sales revenue. This value added represents its creation.
On the other hand, addictive value added is calculated by adding labour cost (including social charges), depreciation, and operating profit. This enables us to estimate the way in which the created profit should be distributed. A business is a system in which goods and services are exchanged; market product is a market where products are sold (usually to organisations). Therefore, business and product market are connected since the business allows products to be sold in markets. Finally, there is a correlation between vertical integration and value added.
In fact, the more a company has resorts to vertical integration, more its Value added ratio would be high. But most of companies do not create, on their own, their products completely. We come to wonder, if value added is a key element for business and its product market, and therefore in which way they are connected? First, we will study the problem of the cost of products in companies, in order to understand the strategy of differentiation of products in a business to finally analyse the role of value added as benchmarking, versus performance.
To start off, a company will carry its interest on cost of its products. Some companies manufacture the major parts of them products; so as to raise the rate of vertically integration is in this way raised. The main gains due to vertical integration are that, transactions costs become lower, supply and demands are synchronized along the chain of products, and there is less uncertainty and higher investment and an ability to monopolize market throughout the chain by market foreclosure.
Moreover the principal benefits for the company’s is that it will have better opportunities for investment growth and a higher ratio of value added. The calculation of value added can therefore determinate how vertically integrated is a company and thus enable a cost strategy for a business and its product market to be established. To be clear, based on economics in a business context, “It is necessary to understand the balance between internal and external costs and so identify strategic initiatives to reduce costs”.
This theory is quite understandable in an industry framework, but why value added is so important for a country? Offshoring is for example, a source of conflict in some countries like in France. It can be explain in the same companies strategy ideas. The more a country offshore his industry, more its ratio of value added will be low. And we know that the sums of all value added gives the GDP, which determinates the wealth of a country. The calculation of value added allows us therefore, to compare at all levels, even for countries, businesses and product markets.
However, other organisations support outsourcing. Outsourcing consists to compare an organisation with another in order to find out which one will produce a product at the lower price. For example, a car manufacturer can’t produce itself the manufacturing defect, tissue for the seats, the motors … Instead, they by the parts, such as the seating, bolts and motors, from smaller companies which can then be assembled to produce the final product i. e. the car. But based on what we said before, it would mean that for these, companies, their value added ratio would be very low.
So how could be explained how worldwide companies like NIKE, which produce nothing entirely by themselves, have such high ratio of value added? This brings us to study the strategy of differentiation of products in businesses. Calculating value added, could also contribute to determine a strategy of differentiation of products in businesses. Lets take the previous example NIKE. Nike has a low vertical integration but a high value added (thanks to its logo). Since this value added is marketing, value added is in this case an intangible entity. Differentiation is one of the competitive advantages.
In general, most of industry produces a huge number of products that are similar but not identical. Amongst all varieties, a few are produced, and consumers usually buy a fraction of all the varieties of products available. This observation shows that companies are likely to produce a large variety of same goods. This variety is source of power of market and also of profit. Without differentiation, homogeneity of the product will limit companies to the quantity (Cournot) and price (Bertrand) only. If a company has important differentiation of products, its value added will increase.
That means that, while calculating value added, it is possible to understand if a company makes differentiation and in this way if a company is performing well in its businesses. Finally, an organisation obtains information, such as class management practice, through benchmarking. It is a technique allowing comparisons of companies of a same industry/sector to be made. The value added framework is one of the benchmarking techniques. Using such an analysis can identify different strategy and thus improve the market product of a business.
For example, the French water EVIAN and CHRISTALINE come from the same source but one is the most expensive in the country (Evian) and the other the cheapest (christaline). Evian’s value added is huge, that the reason why they sell much more than christaline. Its value added is intrinsic of the company. If two companies have different value added they will have different achievement because one of them will be capable to create more with the same foundation/root/base. To conclude, we can say that Value added is an important notion in order to understand the connections between the business and its product markets.
Indeed there is a connection between the business and its product markets since to bring a product on a market, business is needed. The calculation of value added enable to identify a business strategy like for example the vertical integration which consists for a company in manufacturing the most part of its product in order to have a high value added ratio. Value added allows also knowing if a company use differentiation. Moreover, currently most companies don’t use vertical integration. In fact, companies that do this will maybe increase their value added but loose lot of money.
Indeed if an industry manufacture everything on its own, then it supposes that it has all the necessary machines needed to produce every single part of that product as well as a many competent workers! At last, value added can be used to make comparison between two companies in order to know which one is more performing, as well as being able to elaborate good business strategy. Nowadays, we talk more and more about fair value: a kind of value estimated by an individual. For example, to be cote on stock exchange, you have to be entered/listed in fair value.
A website like Facebook is estimated at fifteen billion of dollar; but what is its value added in reality? In this way, we wonder what does value added really mean and is now … such that with the current economic crisis we are not able anymore to judge the real value of assets. Sources: Internet websites: http://en. wikipedia. org/wiki http://brises. org/ http://www. berr. gov. uk/ Books: « Economics in a business context »? By Colin Haslam, Alan Neale, Sukhdev Johal « Microeconomie »? by Marc Montousse,A Bertrand,Kim Huynh,Collectif,,Damien Besancenot « Management strategique »? by Ulrike Mayrhofe