Previously we argued that a market driven business model, which has a benevolent intent, makes business sense and will generate the same, if not vastly more rewards than a profit driven model.

To recap, the true entrepreneurial spirit, al la Gates, Kellogg, Disney, Ford and our own Ackermann thrives on the value their activities have added to people’s lives – not on ROI, RONA ROTA, EVA, MVA, NOPAT or some other exotic financial acronym. Shareholder returns, therefore, depend ultimately more on the company’s capacity to make a difference in its market, than on financial wizardry.

The business concept of adding value to people’s lives gives business its ultimate legitimacy. It arguably need not embellish its public profile with facades of social investment, donations to good causes, etc. Profits generated as a result of adding value are a legitimate reward for the role capital has played in adding value to the community through the product or service the company has brought. So are salaries and wages. Given free markets that through competitive forces temper the expectations of both capital and labour, there is normally a natural force that contains profiteering or exorbitant wage demands. In addition, society uses a legal structure to ensure that these forces are allowed to work and are not abused.

If a benevolent intent, as reflected in most mission statements today, makes business sense, then all activities have to be aligned to support this focus. The profit focus and its accounting tool, the income statement, are questionable in this role. They do not reflect contribution, but rather reward. And then a very narrow reward – that of the shareholder.

The value-added statement, on the other hand does account for contribution, and also the reward for a much broader partnership, that of labour, capital and state. Not only is the concept of adding value the oldest business concept known to mankind, but also it is the most powerful. We previously touched on its three dimensions: process, measurement and intention. These give a full, and comprehensive template for business excellence.

Process, (or transformation) means changing one state into another. In a business sense it implies taking what exists and converting it into something more useful for a specific group of people in a community. These are customers or future customers. For example, a builder will use existing materials purchased from others, and change them into a house.

A retailer primarily takes goods and changes their position into a more accessible state. The process, or transformation understanding of value added gives one the most powerful tool possible to test virtually all activities in the business. Structure, systems, plant, equipment, capital, and indeed all jobs are just some of business features than can and should be subjected to the simple test: are they adding value?

This understanding of value-added is uncompromising. It covers everything from a senior executive’s job to the purchase of plant to the presence of a chair in an office. But of course, the acid test is whether they are adding value or creating capability of adding value to the customer – not the business, an individual in the business, or even a group such as employees or shareholders. If some activity or item cannot be linked, either directly or indirectly, to adding value to one’s market, it has no right to exist. The less clear this link, the less validity in having that activity or item in the business.

The second pillar of value-added is its measurement. We have already dealt with its simplicity and the philosophical importance of being the only measurement in accounting that measures the contribution to society by the company as a whole. It is synonymous with wealth creation and as component of GDP is the only valid focus that binds all the stakeholders towards a common goal. Following the logic that value-added is taking what exists and changing it into something more useful, then its measurement should be the difference between the value of the former and the value of the latter.

Both are easily measured in market driven economies. The value of what exists is measured by what one has to buy from others – in other words, the costs of goods and services bought from suppliers. This is called outside costs. The value of the changed state is what the customers pay. This would be sales, turnover, income or revenue (depending on which accounting term is preferred.) Therefore, sales less outside costs gives value-added or wealth created.

This is easily measurable for any company as a whole. It should also be easily measurable for a subsidiary, business unit or even a plant. In most cases where the figures do not exist in say a plant, they can be readily constructed provided one applies sensible and market related transfer pricing. It becomes a bit more difficult to measure value-added at a team or individual level. Here one reverts to sub-scores of the value-added statement to link the activity to wealth creation a level or two higher, or to the company’s value-added as a whole.

The full value-added statement goes a step further to show how the wealth has been distributed. Value-added is shared with the three main groupings in GDP – labour, capital, and state. They are all contributors to wealth creation, and therefore should legitimately share in its distribution.

However, another way of viewing wealth distribution in a truly market driven, customer focused company model, is that wealth distribution is not about “reward” as such, but about creating capability for further wealth creation. The philosophical argument is that reward is a means of recognizing and encouraging contribution. It is not an end in itself. This gives a very different slant on the way we can view wealth distribution and how it can and should be directed in company strategy. It also gives one a fruitful direction on designing sub-scores linked to wealth distribution.

The process and measurement perspectives of value-added present a very effective and unique template for operational excellence. Nothing that we have seen of the franchised operational excellence tools comes near to the value-added template. The latter offers:

A method of sensibly and understandably linking the smallest operational activity to the overall performance of the company.

A total coherence in all measurements translating into strategic objectives and the company’s mission and vision.

A practical way holding people accountable to measurements that make sense.

Enrichment of operational meetings.

An easily understood convention for employee reporting and information sharing.

Forming the base for a flexible pay system such as gain- or fortune sharing.

And many others.

Virtually each of the above points can be the topic of a separate article. For now, however, let’s examine a very simplified, illustrated value-added statement and how it is compiled.

In the simplest terms, the value added statement reflects how a company creates wealth (Sales less outside supplies).
And then how it shares wealth between the stakeholders of labour, capital and the state.

Capital is represented in two headings: Savings, which is made up of retained income and depreciation; and dividends that go to the owners in the form of cash.

Tax reflects company tax only, and does not include P.A.Y.E. that is included in the employee share.

The above proportions of wealth distribution reflect how wealth is shared generally in companies in South Africa as a whole. There’s a host of implications to this distribution, which gives us our subject matter for the next article.