The formula for value is: “Value = Benefits – Cost”. Understanding the concept of value is central to the process science discipline. Process scientists learn how to define and measure value. The first principle of process science states that “Energy flows through processes to create value”.
The concept of value is key to the entire discipline of process science. After all, the term appears in the first process principle: “Energy flows through processes to create value”. A process scientist or consultant must be able to define and measure value in order to successfully optimize a process. There are many definitions of the word “value”; and sometimes it can seem like an overused corporate buzzword. So before we proceed any further in the realm of process science, we need to get clear about how we are using the term.
What exactly do we mean by “value” in the context of process science?
What is value?
The simple definition of value is this: value is the difference between benefits and cost. This definition gives us the “value formula”:
value = benefits - cost
The formula looks simple, but it is important to understand what each of these elements actually means.
In a business context we would typically define cost as resources spent on business goods or services. This could include money, labor or any other way we might expend energy. Cost is a measurement which is objective and quantifiable.
Benefits, though, are harder to quantify. The measurement of benefits is subjective, and depends on the context of the recipient. For example, the benefit which an adult experiences from receiving a $1 bill is different to the benefit which a child would experience. So we can’t say that something is providing $1 worth of benefit and just leave it there.
This is why we sometimes need to perform a “cost-benefit analysis” when we are trying to decide the value of an activity or purchase. If benefits could be quantified like cost, we would simply look at the two numbers and see whether it was a net positive or net negative outcome — but it’s not that simple.
Value is a subjective measure
Because the value formula contains a subjective element (benefits), value itself is a subjective measure. But we can still analyze value objectively because the formula also contains the objective element of cost. Cost acts as an objective comparison factor. I can use cost to compare different options, determining which will generate the greatest value (for me), and spend my money (/time/resources) accordingly.
This leads us to a rule of thumb: where people are paying for things, value is being created. If value is no longer being created, people will no longer be willing to pay for it.
Value creation goes both ways
There are always two parties involved in value creation (in a business context, the “company” and “customer”). This is where the subjective element becomes so important. Each side of a value exchange experiences the benefits of a given process in relation to what it costs them to get these benefits. The gap between the cost for a company to produce something and the benefit the customer receives (even when buying it at a higher price) is the space within which value creation can occur.
For example, if a customer wants a shirt and feels subjectively that this shirt is worth $100, they would be willing to incur an objective cost up to $100 to get it. This would be the customer’s benefit metric. So a company could charge up to $100 for the shirt and a customer who perceives the benefit of having the shirt as being worth $100 will pay for it.
For the company, however, the benefit is the revenue they receive, and the opportunity to generate profit (the amount above the cost to produce the shirt) from that revenue. If the shirt only costs the company $60 to make, the company could decide to charge only $80 for the shirt with the intent to make a profit and be competitive. In this case, both the customer and the company would receive $20 worth of value, because in both cases their benefits exceeded their costs.
Company value equation:
benefits ($80 purchase price) - cost ($60 cost to produce) = value ($20 profit)
Customer value equation:
benefits ($100 perceived value) - cost ($80 purchase price) = value ($20 savings)
Understanding the value formula–and how both subjective and objective elements contribute to the equation–allows process scientists and consultants to quantify and improve the processes they analyze. Process in the business world only exists because there is some value which customers are seeking; otherwise, there would be no demand, no energy inputs, and no process. This is why defining and understanding value is essential to the study of process science.
The most important thing for process professionals to remember is that it is unnecessary to qualify whether value creation exists. The job of a process professional is simply to identify what the value is and how to increase the value creation by reducing the energy (cost) required to generate that value.