Follow us...

The Future of Business in the New Economy - Part 3: Value Analysis

By Julian Sammy, IIBA Head of New Media

In Parts 1 and 2, we established the strange and powerful relationship humans have with scarcity, value, abundance and worthlessness. We defined different kinds of value— features, characteristics and experiences—and how they are exchanged in familial and contractual contexts. We finished by looking at four ways that some value can be safely converted into money.

In this part, we discuss ways that organizations can use this knowledge to make better decisions about investing limited resources. We start with an illustrative example, exploring a single, simple transaction—a very simplistic Value Network Analysis.1 This example will lead to a discussion of the relative nature of value, and the very narrow measure we call money. Finally, we will discuss ways you can use this information to guide your business. This was intended to be a three part series, with this being the final part. During the writing of part two and the research for part three, it became clear that this is actually a four part series.2

Ultimately—in part 4—we look at ways to integrate these principles into organizational funding and resource allocation decisions. This will extend the traditional business case
beyond money and scarcity, to include value and abundance. This Abundant Business Case refocuses the organization on generating and delivering value to customers and getting customers to deliver value to the organization. Money plays a key role, but is not the bottom line.

Giving and Receiving Value


This example takes the form of a thought experiment with four scenarios related to a simple transaction. In each scenario you will be asked a question. Please take a moment to record your answer in each case; at each stage, your answer is very likely to change, and in ways that may surprise you.

Remember, these are not riddles or trick questions; answer them based on the information at hand, and presuming that you can’t do anything ‘fancy’ like cutting up the muffins.

Scenario 1: Customer Testimonial

You are a baker. You ask three of your best customers to record a short testimonial about your store and products, in exchange for a dozen muffins. They agree. A few minutes later, you have some nice material for your website, and they have a box of 12 muffins to split between them.

Question

How should the customers divide up the muffins to be as fair as possible? Remember, you have to answer based on the information available—you don’t know what kinds of muffins they are, how big they are, etc.

Discussion

Almost everyone agrees that each customer should take four muffins. This is related to fair ways to divide a cake, such as “You cut, I choose.”

Scenario 2: Types of Muffins

Identical to Scenario 1, except the 12 muffins are:
  • 1 carrot muffin
  • 3 chocolate muffins
  • 8 vanilla muffins
Question

Given this new information, how should the customers divide up the muffins to be as fair as possible? Your answer may take the form of a process, rather than a number of muffins for each person. Remember, you can’t cut a muffin!

Discussion

This scenario is a bit trickier. The muffins are not divisible, so you can’t have a ‘fair’ solution of four each as above. If your answer was “I don’t know what they like” stop reading, go back up the page, and make a decision. This is a forced choice—somebody is going to get stuck with the carrot muffin.

Most people try to make the division as even as possible:
  • Customer A: 1 chocolate muffin, 3 vanilla muffins
  • Customer B: 1 chocolate muffin, 3 vanilla muffins
  • Customer C: 1 chocolate muffin, 2 vanilla muffins, 1 carrot muffin
Some people define a decision process for the customers instead of assigning the muffins. For example, “each person takes one chocolate and two vanilla, and the last three muffins are chosen at random.” This is a bit of a cheat, because it requires a bit of information you have not been given: you explicitly do not know what the customers preferences are, and this process requires that the customers reveal their preferences.

Scenario 3: Types of Customers

Identical to Scenario 2, except the customers have some preferences:
  • Afia is Ghanaian and wants to put on weight for her wedding. (If she is too thin, it will look like her husband-to-be can not feed her enough, which would be very embarrassing. 
  • Ben is American and enjoys cupcakes, but is on a diet. (He is about to go on a cruise, and wants to look as good as he can in a bathing suit.)
  • Cory is English and loves chocolate. (They really, really do.)
Question

Given this new information, how should the customers divide up the muffins to be as fair as possible?

Discussion

Most people find this scenario easier to answer than scenario 2:
  • Afia: All the vanilla muffins—calories are the most important thing.
  • Ben: The carrot muffin—a healthy reward.
  • Cory: All the chocolate muffins—to feed the sweet tooth.
Now that you know what people want or need, it’s much easier to decide what is fair. This tells us that ‘fair’ has two major components: characteristics of the stakeholder, and characteristics of the product. This logic applies to most business analysis work as well: you can’t figure out whether a solution option is worthwhile until you understand the needs of the stakeholders in that option.

Before reading the next scenario, make note of the changes that have happened in your answers with each additional piece of information.

Scenario 4: "The love of money is the root of all evil"

Identical to scenario 3, except the sale price of each muffin is $1.00.

Questions

Is the distribution of muffins still fair?

What is a fair distribution of muffins amongst Afia, Ben and Cory?

What happened to change the answer?

Discussion

The introduction of money into the discussion has a profound and radical effect on what ‘fair’ means. In scenario 3, you likely agreed that everybody had a fair deal. For most people, the mere mention that the muffins had a price completely shifts the answer. Some people suggest that Ben is getting a raw deal, and Afia is making out like a bandit. Some say Afia, Ben and Cory should barter or negotiate for a share of the muffins.

A moment ago the 8-3-1 split seemed fair.

What happened?

Absolute Dollars

When we discussed money in Part 2: Free – the Disruptive Price, we said that money is useful, but not particularly valuable in itself. We have just discovered that it can throw our sense of ‘fairness’ off balance with surprising ease. It has three main characteristics that contribute to this unbalanced reaction:
  • It is a battery for some types of value (instead of electrons). When stored—or “banked”—money doesn’t do much. Stored money is useful because it is immediately available to purchase skills, experiences, knowledge, effort, products and so on.
  • It is fungible3.
  • It is a measure of some types of value, in a narrow way. If you can put a price on something, money can be a universal metre-stick.
Taken together, these features make money a very disruptive measure. The first two mean money is persistent and everywhere. By recalling the price of the muffins, you automatically compare their ‘value’ against anything else you have done or might do with money. It doesn’t matter that you can’t actually convert the muffins to money.

The third feature of money may be the most damaging. To see why, imagine having a single unit of measure—for example, length in metres—to compare a missile, your child and a river. This comparison is obviously ridiculous: no sane person would attempt to use a tape measure to compare these things and make decisions about how to interact with them. Unfortunately, money is just such a narrow measure, but we use it for this kind of decision making all the time. Return On Investment (ROI) is the most significant portion of many business cases—a purely monetary measure. Even risk-adjusted ROI decisions are of limited use in making good decisions. 

One of the principles of making good decisions is to reduce the situation to the minimum set of relevant factors—and to stop there; “Make things as simple as possible, but not simpler.”4 In many cases, organizations go too far, ignoring necessary information. In this context, a project may fail before it begins through oversimplification; “For every problem there is a solution that is simple, obvious and wrong.”5

Relative Value

One motivation for oversimplification is the unavoidable fact that measuring value is enormously complicated. For example, consider the calculating the value in the third scenario, above. Each customer considered a different feature of the muffins to be important: Afia wanted calories, Ben wanted health and Cory wanted chocolate. Any measure of value needs to account for the valuation of these features from the perspective of each stakeholder. The math moves into very complex statistics and calculus very quickly.

Using Value in Your Organization

Many organizations have come to the conclusion that money is necessary but not sufficient for good decisions, but may struggle to find a better way, because useful quantification of value is very hard to do. As noted in the introduction, value analysis should ultimately be incorporated into almost all decisions an organization makes, with particular focus on the business case. The Value Measuring Methodology (VMM) created by the US Government6 is one approach7 to this large-scale effort. In this section, we will look at relatively simple ways to incorporate value into making organizational decisions, starting with a high level value analysis.

Simple Value Analysis

For this analysis, we will explore a simple purchase: a customer buys bread from a local bakery. The core of the transaction is simple:

A. Baker delivers bread to the Customer.

B. Customer delivers money to the Baker.

Value analysis begins by exploring each side of the transaction independently. In most cases, you want to work your way up the production process until you reach a step that converts money into some form of value. In this example, there are three high level steps for each side of the transaction. (Bold text indicates a stakeholder. Products—things carrying value—are underlined. ALL CAPS are used to indicate money.)

A. Baker delivers bread to the Customer
10. Baker converts MONEY into raw materials.
20. Baker uses raw materials to make bread in the bakery.
30. Baker delivers bread to Customer in the store.
B. Customer delivers money to the Baker
10. Customer enters store.
20. Customer selects bread.
30. Customer delivers MONEY to Baker.

Select High Value Interactions

Now consider the types of value generated by each stakeholder and product (see tables, next page). In most parts of the world all these features are generated faster and cheaper by large food companies. This means the baker can’t compete on features; no surprise, based on our understanding of value. 

This leads to a key question: what characteristics and experiences are most valuable to the baker and to the customer? Ideally, the baker wants to sell something that consumes little value from his perspective and delivers high value from the customer’s perspective. Going through the list, it appears that authenticity and friendly interactions are the most likely candidates for profitable value exchanges.

  Stakeholder   Features   Characteristics   Experiences
  Baker
  • Purchasing (raw materials)
  • Baking    
  • Authenticity (real deal; high quality; craftsmanship)    
  • Friendly customer interactions    
  Customer
  • Purchasing (bread)    
  • Patronage (supports local business)
  • Community (customers of baker)    
  Product   Features   Characteristics   Experiences
  Raw Materials
  • Can be combined into bread    
  • Authenticity (high quality)    
  Bread
  • Make meals
  • Calories
  • Vitamins
  • Minerals    
  • Authenticity (high quality, high status)    
  • Smell and taste of fresh bread
  • Exotic / specialty flavours    
  Bakery
  • Can be used to combine raw materials into bread    
  • Status of ‘baker’ conferred to owner    
  • Friendly customer interactions    
  Store
  • Sell bread
  • Display bread    
  • Authenticity (high quality)
  • Community (local business)    
  • Smell and taste of fresh bread
  • Friendly customer interaction    

If these are the highest value interactions, the current processes should be adjusted or focused to improve the delivery of value in both directions. To focus the organization on delivering this value, add a step to each process:
             
A.25. Baker interacts socially with Customer.
             
B.25. Customer interacts socially with Baker.

Finally, work with the stakeholders to establish appropriate types of social interactions to build the strongest sense of community and authenticity.

This analysis may also expose an opportunity to take advantage of one of the business models incorporating free.

Conclusion

This basic approach to value analysis can be used to examine the interactions of any organization and it’s stakeholders. It is enough to expose problems and opportunities with current operations, and can provide useful guidance at many levels in an organization, and at many levels of detail.

To use this effectively, remember that we are developing a set of critical thinking skills and a framework for analysis, not a tool that will spit out answers. Like most important business analysis work, this requires the attention and effort of a skilled, knowledgeable practitioner. It is relatively subjective—though it can be persuasive—and the results need interpretation. Decision makers will need help to use the information, and to understand the nature of value, whether they read parts 1 and 2 or not.

In part 4, we will build a formal structure for incorporating value analysis into business cases—the traditional kind, based on scarcity and ROI, and the new kind, based on abundance.


1 This paper is both a simplification and an extension of the US government Value Measuring Methodology (Oct 2002 [http://www.cio.gov/documents/ValueMeasuring_Methodology_HowToGuide_Oct_2002.pdf]) and value network analysis (Verna Allee, Journal of Intellectual Capital, Volume 9, No. 1, 2008, pp. 5-24 [http://www.vernaallee.com/value_networks/Value_Conversion_JIC_online_version.pdf]). 

2 While I admire Douglas Adams, “a trilogy in four parts”—or five or six!—was never my intention. As an author, it is somewhat disconcerting to discover that the subject at hand is orders of magnitude more complex than expected, when first pen pressed paper    

3 fun·gi·ble [fuhn-juh-buhl] adjective Law (esp. of goods) being of such nature or kind as to be freely exchangeable or replaceable, in whole or in part, for another of like nature or kind. [http://dictionary.reference.com/browse/fungible]

4 Usually attributed to Albert Einstein. [http://en.wikiquote.org/wiki/Albert_Einstein#1930s]

Misattributed to Mark Twain. [www.snopes.com/quotes/twain.asp]
.

6 See http://en.wikipedia.org/wiki/Value_Measuring_Methodology for a useful starting point and directions to more resources.

7 Many of these approaches talk about tangible and intangible value—which is a good start—but they generally miss the critical differences between delivering familial value through gifts, and delivering contractual value through transactions. In these models, features and money are tangible; characteristics and experiences are intangible.