Businesses add value by taking raw materials and turning them into goods and services which they can later sell to consumers.
Whatever good or service a business produces, it will try to add value at every stage of the production process – when extracting raw materials, when turning raw materials into finished goods and when finally selling finished goods to customers at a price greater than the cost of the raw materials used in their production.
Added value is one of the most important objectives of every business. Let’s take a look how value is added in the production of a cake and a house.
EXAMPLE 1:
Resources: flour, eggs, sugar, butter
Production processes add value: mixing all of the ingredients in the mixer, using the oven to bake the cake
Finished product: the cake
EXAMPLE 2:
Resources: wood, clay, nails, bricks, cement, water
Production processes add value: using tools like hammers and ladders to build a house
Finished product: the house
What is added value?
All businesses aim to create value by selling goods and services for a much higher price than the cost of raw materials. Added value is the difference between the cost of purchasing bought-in materials and the price of the finished goods are sold for.
Added value = Price – Cost of raw materials
If a customer is prepared to pay a price that is greater than the cost of materials used in making a good or providing service, then the business has been successful in adding value.
How to add value?
Let’s take a look in details at a number of different ways a business can increase its added value.
1. Adding value by branding
Have you ever wondered why Coca-Cola, Sony and other well-known companies spend huge amounts of money on advertising and other promotional activities? They do this to build and then maintain their brand. The products produced by each of these companies all have close substitutes. You can easily buy other brands of drinks and electronic goods such as Pepsi or Samsung. However, these companies are able to charge a much higher price than their competitors, even though the costs of production are pretty much the same.
Branding can increase added value because people want or feel that they should buy the item from the particular company. Chocolate bars manufacturer will promote their brand extensively to create an easily recognized name, brand identity and attractive packaging, and sell through established confectionery shops and not cheap vending machines. Higher prices charged justified by successful branding will create value.
2. Adding value by excellent service quality
In some industries providing a high quality personalized service can be the difference between charging a high price. The price of a fancy tailored suit will be higher than the price of a mass-produced suit from Walmart. The cost of the materials such as cotton and buttons used to produce those suits will be very similar, but the personalized service (e.g. measuring, fitting, conversations about fashion, etc.) increases the added value, hence tailored suit will be sold for higher price.
3. Adding value by unique product features
Products that have more features and functions than similar products will allow the producer to charge a higher price. Although these additional features will also increase costs, modern consumers are prepared to pay a much higher price for a product with more unique features or extra functions, for example such a TV set with high definition. Usually, the mobile phone market or a computer market are very good examples of how features and functions are used to increase added value.
4. Adding value by design
Jewelers around the world use well designed shop window display, attractive shop fittings, well-dressed and knowledgeable shop assistants and beautiful boxes offered to customers to put new jewelry in. Tiffany & Co. does not just sell regular jewelry. It sells ‘exceptional jewelry’ with ‘timeless design’ and ‘exceptional stones’ like ‘luminous pearls from freshwater’ from breathtaking Tahiti. These features will allow an increase in jewelry prices much above the additional costs of raw materials involved when producing golden, platinum or diamond rings and necklaces.
5. Adding value by convenience
Many of us consumers lead very busy lives. We are often prepared to pay a higher price for goods and services which can be purchased and delivered immediately to our house, for example ready meals or online grocery shopping.
How can businesses increase added value (create value)?
Increasing added value means creating value. So, creating value is increasing the difference between the cost of purchasing bought-in materials and the price the finished goods are sold for.
Value created by the business is not the same as profit. Profit is the difference between sales revenue and total costs while added value is the difference between price and the cost of raw materials.
Without creating value, a business will not be able to survive. From the value created by the business, other costs have to be paid such as such as managers’ salaries, workers’ wages, transportation, rent or utilities. These costs need to be deducted from the added value to calculate final profit.
In practice, it is quite difficult to increase added value without increasing costs, e.g. new products with more functions can be sold for higher price, but developing those functions will require new spending on research and development, e.g. paying software developers wages to implement those new functions into new products, etc.
However, if a business can increase added value (create value) without increasing its costs, then profit will increase.
And, creating more value will ultimately generate more profit.