Notes on Value, Value Chain, and Value Wedge — MGMT 3900 Module 4

Learning Objectives

  • Explain the key concepts about business principles such as value, value creation and value capture.
  • Define key elements about value, such as willingness to pay, opportunity cost and the value wedge.
  • Discuss the relationship between willingness to pay and opportunity cost, and understand how value is determined.
  • Discuss the relationship between profitability of a business and its value, and the value wedge.
  • Apply the concept of value in a specific business or industry.

The Concept of Value

  • Value is created through the interactions between buyers (customers) and sellers (suppliers) along a value chain.
  • Key terms and ideas:
    • Willingness to Pay (WtP): the most a customer would pay for a good or service relative to the next best alternative.
    • Opportunity Cost (OC): the least a supplier would accept to provide a good or service relative to the next best alternative.
    • Value wedge: the difference between WtP and OC, representing the potential surplus available across the transaction.
  • Value in a firm context can be interpreted as the value created for customers and/or suppliers through the firm’s activities in the value chain.

The Value Chain

  • The Value Chain includes:
    • Products/Outputs
    • Customers
    • Focal (the firm at the center)
    • Money Flow
    • Business Resources/Inputs
    • Suppliers
  • A simple depiction: suppliers provide inputs; the focal firm turns inputs into outputs; money flows from customers; value is realized through the exchange.

The Extended Value Chain

  • A business model describing the full range of activities needed to create a product or service (Investopedia definition).
  • Examples: automotive sector value chain includes car manufacturers (OEMs), suppliers (lower tier and Tier 1), logistics companies, distributors/wholesalers, dealers, and maintenance/insurance service providers.
  • Grocery supply chain example shows upstream and downstream segments:
    • Upstream: suppliers, manufacturers, logistics
    • Downstream: distributors, wholesalers, retailers, consumers
  • Main actors and stages include: manufacturing, suppliers, logistics, dealers, and after-market services.
  • The concept can be summarized as: upstream activities feed into the production process, downstream activities deliver the product to the consumer.
  • The diagram shows a continuous flow from inputs to outputs to customers, with money flowing back through the chain.

Suppliers and Buyers/Customers

  • Value is created by the interaction of suppliers and customers along the value chain.
  • Both suppliers and customers are integral parts of the value chain, and their engagement determines the added value delivered by the focal firm.
  • The focal firm coordinates activities and creates value through its relationships with suppliers and customers.

Added Value

  • Added value = total value with you − total value without you
    • Formula: ext{Added value} = ext{Total value with you} - ext{Total value without you}
  • Drivers of added value include:
    • Variety
    • Quality
    • Aggregation
    • Intermediation
    • Coordination
    • Access to information
    • Favorable distribution
    • Reliability
    • Service and expertise
    • Other factors (Etc.)
  • Market changes (demographics, technology, information, search and transportation costs) can radically alter a player’s added value.
  • A player can add value for buyers and/or suppliers through unique capabilities, resources, or networks.

Value Capture vs. Value Creation

  • Value creation is the total value generated in the market (e.g., the total willingness to pay across participants).
  • Value capture concerns how that value is distributed among firms (e.g., firms A, B, C) and other actors.
  • When market shares shift over time (t=1 vs t=1+n), different firms may capture different portions of the total value created.
  • The distribution of shares depends on bargaining power, contracts, brand, differentiation, and other competitive dynamics.
  • The illustrative diagram contrasts three firms (A, B, C) and how their shares may evolve from time t=1 to t=1+n as markets grow or change.

How is "Value" Measured?

  • Value for a firm arises from two sources:
    • Customers value the products they are buying (
      willingness to pay)
    • Suppliers value the resources they are selling (opportunity cost and alternative uses)
  • Overall value in a transaction is the sum of the values as perceived by both sides, with the focal firm acting as the connector.
  • In shorthand:
    • Customer value is anchored in WtP and the perceived benefits of the product.
    • Supplier value is anchored in OC and the costs or alternative opportunities of providing the resource.
  • The focal firm’s role is to align these valuations to create a viable market transaction.

Principle of Business: WtP, OC, and Value Wedge

  • Willingness to Pay (WtP): the most a customer would pay for a good or service in relation to the next-best alternative.
  • Opportunity Cost (OC): the least a supplier would accept for a good or service in relation to the next-best alternative.
  • Value wedge: the difference between WtP and OC, i.e.,
    • ext{Value wedge} = ext{WtP} - ext{OC}
  • The wedge represents the total potential surplus available from the exchange.

Value Creation and Value Capture (Diagrammatic View)

  • Elements in the diagram include:
    • WtP (customer willingness to pay)
    • Price (paid by the customer)
    • Total value created (the value the transaction generates)
    • Cost (incurred by the focal firm/suppliers)
    • Supplier OC (the supplier’s minimum acceptable return)
    • Customer's share (surplus captured by the customer)
    • Firm's share (surplus captured by the focal firm)
  • Important concept: Shares of value (prices and costs) are indeterminate and depend on bargaining power and market structure.
  • Supplier’s share is also determined by bargaining and market dynamics.

Example 1: Customer Choice Between Firm 1 and Firm 2

  • Setup: You are a customer looking to purchase from Firm 1 or Firm 2.
  • WtP: Firm 1 = $50; Firm 2 = $70.
  • Prices: Firm 1 price = $40; Firm 2 price = $50.
  • Calculations:
    • Customer surplus from Firm 1: 50 - 40 = 10
    • Customer surplus from Firm 2: 70 - 50 = 20
  • Conclusion: You would prefer Firm 2 due to higher consumer surplus (value capture by the customer is greater with Firm 2).

Example 2: Supplier Perspective with Two Buyers

  • Setup: You are a supplier; Firm 1 offers to pay you $10 per unit; Firm 2 offers to pay you $16 per unit.
  • Question: Why might your OC differ for Firm 1 and Firm 2?
  • Explanation:
    • OC is the minimum acceptable return given alternative uses of the resource; it can vary with the buyer due to differences in reliability, demand certainty, long-term contracts, risk, and alternative buyers or uses.
    • A higher offer from Firm 2 does not automatically mean the same OC as for Firm 1; factors such as payment terms, volume commitments, and relationship value can shift the perceived OC.

Quick Facts: Coffee Industry Context

  • Quick facts highlighting pricing and market structure:
    • Premium coffee shops historically expand in number (examples show dramatic growth in the late 1990s).
    • Price points from a team discussion example:
    • Starbucks Café latte price ≈ $
    • McCafé price ≈ $4.00
    • Local premium coffee price ≈ $5.00
  • Interpreting the market:
    • There is a spectrum from mass-market coffee offerings (McCafé) to locally premium coffee shops.
    • Price and perceived quality create differentiated value propositions within the same industry.

McCafé vs Local Premium Coffee Industry Context

  • McCafé: a value-competitive, mass-market coffee line from McDonald’s.
  • Local premium coffee shops: higher perceived quality, specialty offerings, and potentially higher prices.
  • The industry is presented with a tiered structure of offerings and price points, illustrating how value creation and capture operate across different business models.

Specialty Coffee Industry Overview

  • Key players and segments discussed: McCafé, Local Premium Coffee, Starbucks, etc.
  • The value chain implications differ by segment:
    • McCafé emphasizes scale, efficiency, and price-based value for a broad audience.
    • Local premium shops emphasize product differentiation, experiential value, and higher willingness to pay.
  • The overarching lesson: different value propositions can coexist in the same market, each capturing value through different wedges and business models.

Connections, Implications, and Relevance

  • The value framework connects to strategic decisions about:
    • How to structure the value chain (upstream vs. downstream activities)
    • How to create added value that customers and suppliers recognize
    • How to negotiate price and terms to optimize the firm’s share of value
    • How market changes (demographics, technology, information flow) alter added value and bargaining power
  • Ethical and practical implications include fair pricing, transparency in value creation, and maintaining healthy supplier and customer relationships.

References and Cases to Explore

  • Value chain diagrams and concepts from the lecture slides (core principles) and Investopedia definition for the extended value chain.
  • Real-world case examples used in class:
    • Automotive sector value chain (OEMs, suppliers, distributors, dealers, logistics, maintenance services)
    • Grocery supply chains (receiving, shelving, distribution, after-market services)
    • McCafé vs local premium coffee shops as a lens for value wedge and market segmentation
  • YouTube case references related to McCafé and local premium coffee shops (for context, not required to memorize URLs here).

Mathematical References (LaTeX)

  • Added value definition:
    • ext{Added value} = ext{Total value with you} - ext{Total value without you}
  • Value wedge definition:
    • ext{Value wedge} = ext{WtP} - ext{OC}
  • Customer surplus example (Conceptual):
    • If WtP = 70 and price = 50, surplus = 70 - 50 = 20
  • General balance components in value creation: WtP, OC, price, and costs define how the total value created is split among customers, suppliers, and the focal firm, with shares determined by bargaining power and contractual arrangements.