Every business intends to add value, which means the selling price of the product less the cost of inputs. The added value represents an increase in value due to the production or assembling processes being carried out on bought-in materials and components. Firstly, it enables the business to recover the further associated costs (labor, overheads, and indirect expenses) in making the products available for sale. Secondly, it ascertains the firm’s profitability.
If we take an example of the construction business, the added value can be determined by subtracting the cost of input materials (bricks, cement, etc.) from the selling price of the newly constructed building. However, the added value (sales price – cost of materials) of the building must be adequate to meet other expenses in constructing the house, such as labor, transportation, and supervisory expenses, etc. Moreover, it must also give a reasonable margin over and above all costs (material + others) as a profit or return on investment.
The Significance of Added Value
For the long-term sustainability of any business, it is important to understand the model of its added value. No business can sustain itself without a reasonably enough value addition to the product materials. Meeting just the cost of inputs out of the sales revenue of any business can not guarantee its long-term sustainability. In the long run, the survival of a business depends on the recovery of all costs such as production costs plus allied costs/expenses being incurred in finishing and marketability of the product. Survival also depends on the ascertainment of a reasonable yield out of sales revenue. Because the objective of wealth maximization of any business can not be achieved without profitability.
Apparently, it looks pretty simple to add value. However, creating added value is difficult for many businesses, especially for start-ups. That is why some businesses can’t sustain themselves and are destined to fail even in the shorter run.
Ways to increase the added value
There are two ways to increase added value. One is to increase the selling price and another is to reduce costs. But both of these methods have consequences. Raising prices beyond certain limits deprives businesses of revenue streams because consumers are unwilling to pay more than what they can afford or believe to be a fair price. Customers build the perception of just or unjust pricing against the utility they are getting out of usage of that product or service. On the other hand, reducing the cost of inputs and other allied costs can seriously jeopardize customer satisfaction due to compromises on quality and customer service. This can also lead to losing the customer base and consequently fall in the sales revenue.
In some ways, raising the prices of finished goods or services can enhance the added value. One of such options is branding. Businesses around the world endeavor to build brand names by enhancing the product’s reputation based on quality, functionality, or utility. For the brands, consumers are usually willing to pay more. Other options for enhancing added value include adding extra features to the product to fulfill any other needs of the consumers. For example, offering more robust customer support or after-sales services, etc.
For start-ups, knowing the concept of added value is very important for making room in the competitive market. However, the concept is equally important for established businesses because they must be able to sustain or grow their revenue generation with additional offerings to customers. Considering that customers always have choices, winning or maintaining customer loyalty is the most obvious job for all businesses if they want to keep generating revenue and adding more and more value.
Book: Value-Added Selling, Fourth Edition: How to Sell More Profitably, Confidently, and Professionally by Competing on Value―Not Price