Adding value is important for businesses because, with it, they can make a profit. Then, when it is better than their competitors and maintains it over time, they can make more profit.
Businesses satisfy the needs and wants of consumers through the goods and services they produce. They make a profit by adding value to the input. They process the input and make it a higher value output. That way, they can sell their product at a higher price than the dollars they spent paying for the input. Long story short, they have to create value to make a profit.
Then, businesses succeed in creating value if customers are willing to pay the price higher than what they charge input suppliers. However, there is another aspect they must consider in creating value, namely competition.
In maximizing those profits, businesses must also create a better value than – and therefore outperforming – competitors. It requires them to offer superior value creation to customers. Thus, consumers prefer to buy their products over competitors’ products.
And, if a company manages to outperform competitors and generate a higher rate of profit – measured by return on invested capital (ROIC) – than competitors, the company gains a competitive advantage. Then, if able to maintain it over time, the company generates a sustainable competitive advantage.
Reasons adding value is important for business
Adding value, or as we call it, creating value, offers several benefits to companies. The six benefits are:
- Making more profit
- Standing out from competitors’ products
- Long term cost-efficiency
- Positive association
- Growing market share
- Maximizing customer equity
Making more profit
The value a company adds should be directly proportional to its profits. Therefore, the more a company adds value, the more willing consumers are to pay more. For that reason, adding value allows it to charge a higher price.
Conversely, without added value, customers will not buy the company’s products. Instead, they will choose other value-added products.
If they can charge high prices, companies can earn high-profit margins, making more profit. It would be more significant if they managed to sell more.
Now, take, for example, a company buys bauxite and processes it into aluminum plates. The price of aluminum plates is worth much more than the price of bauxite. Then, it will be even more valuable when processed into car or airplane frames.
Another example is cotton. Processing it into yarn also generates higher added value. It can be a multimillion-dollar business if processed into clothing.
Standing out from competitors’ products
In creating value, companies can add unique features to products. Such features make their products stand out from competitors’ products. As Michael Porter put it in his generic strategy, such a strategy is what we call “differentiation,” as Michael Porter put it in his generic strategy.
By offering uniqueness, they can charge a premium price. But, on the other hand, it also attracts consumers, and they are willing to buy it.
Another way to make a product stand out is to offer a slightly lower price than the average competitor. For example, the company’s products may be standard and have relatively similar features to competitors’. The company then sells it to the mass market.
But, because it is more affordable than competing products, it makes consumers more likely to choose the company’s products. As a result, they can save money by buying the product and spending less money.
Even if the price is slightly lower, the company can still generate high profits if its production costs are lower than the average competitor. In other words, if it can maintain a lower cost structure than competitors, the company can make more profit than competitors. We call this strategy “cost leadership.”
Under cost leadership, the company also generates added value. However, the company’s focus is on unit costs, not selling prices.
Cost leadership tends to have lower margins than differentiation strategies. For this reason, to make more profit, the company must be able to sell more products.
Long term cost-efficiency
Say the company produces a successful product in the market. Customers see their products as offering superior value. They are more likely and willing to buy and recommend their products to their friends or family for such reasons.
If, over the long term, the company consistently offers superior value, it can lead to strong long-term relationships with its customers. It makes its customers loyal to the company’s products.
Then, such loyalty will save costs for the company’s advertising and promotional activities, for example, when it launches a new product in the future. Without spending many dollars on advertising, the company can attract existing customers to buy its new product because they trust the company.
Moreover, loyal customers are more likely to promote and recommend their new products to others. So, with the same promotion costs, the company gets a bigger benefit.
Then, in general, the cost of retaining a customer is less than the cost of attracting a new customer. Encouraging new customers to buy often requires intense promotion.
Customers are willing to pay for products not only for functional but also for emotional and expressive benefits. They are more likely to spend more money on a product if they feel the product, for example, fits their style or values, generates positive self-associations.
Let’s say a company offers a luxury item. The higher the price, the more satisfied customers, will be and the happier they will buy it. It happened because the higher price increased their image and social status. When we learn about economics, that’s Veblen’s stuff.
Nest, positive associations influence consumers in selecting products. For example, consumers with values and principles of sustainability are not arbitrary in choosing products. They will only buy products that meet their criteria. This aspect – sustainability – is growing in importance as more consumers adopt it.
Growing market share
Generating added value is important in growing market share. By generating better-added value than competitors, firstly, it enables the company to retain existing customers to remain loyal. So, at least, the company can maintain the existing market share.
Second, it is also a pull factor. The company can win over competing customers because it offers better value. And, the company can also easily attract new customers, for example, thanks to promotions and recommendations from existing loyal customers.
Finally, with a larger customer base, the company can sell more products. As a result, it ultimately increases its market share.
Maximizing customer equity
Companies can maximize customer equity by building strong long-term relationships. What is customer equity? It represents the total lifetime value of all the company’s customers.
Strong relationships encourage existing customers to continue to buy the company’s products. If successful in doing so, the money will continue to flow into the company in the long run.
Then, the company can also increase the money flowing in by increasing the customer base. It requires superior value creation over competitors. Thus, competitors’ customers switch to the company.
What to read next
- Value Creation: Definition, Shareholder Value, Customer Value
- 6 Benefits of Creating Value for Customers
- How does your company create value along the value chain?
- Added Value: Definition, Why It Matters, Formula
- Why is adding value important for a business?
- Value Added Formula and How To Calculate It
- Value Added: Meaning, Formula, Importance, Way to Create