What is value creation?
Value creation can be thought of as the increase in value from transforming raw inputs to the final output. Processed foods are (even just sliced vegetables), for example, are more ‘valauble’ than they were before the processing stage. Value is added as the materials are transformed from one state to another.
You can think of value creation as the extra benefit that is derived from the transformation of raw inputs to final products. As you transform the products, the customer’s willingness to pay for the goods increase. The greater the customer’s willingness to pay, the greater the value that has been created.
What is value capture?
While value creation refers to the total additional benefit created in transforming the input to output, value capture refers to your ability as a business to ‘capture’ that value yourself, as your retained profit. There may for example be immense value created in the products or services that you provide, but if the majority of that value is captured by your customers (potentially because they are able to bargain down the price), or your suppliers (potentially a part that you are dependent on a particularly supplier making, which they can thus a high price for), then the value that you create is ultimately captured by others.
What impacts the proportion of value that you can capture?
Porter’s Five Forces is a useful framework for considering the extent to which value that is created can be captured by your firm (or industry), or whether it is captured by others. Each of the forces connections directly into the proportion of value that can be captured:
- Buyer power: The extent to which buyers are able to drive down the price of the goods (and in turn capture value that is created themselves).
- Supplier power: The extent to which suppliers are able to push up the price of the inputs (in turn capturing value themselves).
- Rivalry within the industry: The extent to which value is competed away by price competition within an industry (in turn resulting in the customer capturing greater value through better prices).
- The threat of substitutes: Whether the value is competed away by substitute products (which in turn, drive down the price of goods in your industry, in turn allowing customers to capture a greater proportion of the value).
- The threat of new entrants: Whether new entrants are able to enter the industry or not (which would drive down the price charged through greater competition in the industry).
The importance of considering both value creation and value capture
When starting a business it is important to consider both the total value that you are likely to create through your operations and also your likely ability to capture this value. If there is little to no value that is actually created (for example, adding yourself as an intermediary to a sale, without brining significant benefit to either side), then the total pie that you have the potential of capturing is not very large. If on the other hand, you are able to generate a lot of value but unable to capture it, then your business is also not well-positioned for financial success. Ultimately, both value creation and value capture are important components for organizational success.