Why do people buy and what is value
People buy for six reasons
- Design. They want the benefits, tangible and intangible, that the product or service offers.
- Quality in the sense of performance to requirements
- Reliability. How long will the product or service give the benefits.
- Delivery. This covers all aspects of the purchase situation, the means of payment and delivery when required.
- After sales service. This could be advice or training or service.
The first five together give what is called customer perceived quality. This in relation to price gives:
Most organisations consist of a hierarchical organisational structure with vertical reporting paths with a horizontal flow of work. Michael Porter called this the “Value Chain” (Porter, “Competitive Advantage: Creating and Sustaining Superior Performance”, The Free Press, 1985). Porter split up the firms cash flow into the proportions in which it was used by the various functions of the firm. These functions were in turn divided into primary (in-bound logistics, production etc.) and support activities ( HR management, procurement etc.).
Porter did not intend the value chain to be used for analysing added-value. While the only activities directly concerned in the creation of the product or service are the primary activities, he regarded both primary and support activities to be “value” activities. That is to say activities where competitive advantage could be gained.
Porter also discusses the vertical linkages that can exist between the suppliers, the company and the channels of distribution. In the past these vertical linkages had often been analysed in terms of vertical integration where one company acquires its suppliers and channels. The classic case of this was Ford motor car company in the US.
As part of his strategy to reduce cost Henry Ford had not only used the production line assembly process but had also acquired forestry companies to produce the timber for the car bodies, rubber plantations to produce rubber for tyres and so on. The risks of this strategy became clear when Sloan at General Motors introduced customers to the concept that they could have colours other than black, provided that they paid a little more, and when metal bodies were introduced, Ford had to close his plants for a whole year to make the necessary changes.
Today the analysis is often carried out in terms of Just in Time and supplier chain initiatives.
To be useful in this type of environment a strategic management accounting system must give information on industry profitability and competition as well as benchmarking the processes and economics of the value activities amongst competitors.
Costs and Pricing
Because of its key relation to customer perceived value, the price of a product relative to its main competitor is a key strategic variable. For many industries (excluding commodities) their pricing policy is determined by their unit cost and its impact on cash flow and profits.
Firms have a number of concepts at their disposal for controlling cost. One of these is the use of an experience curve. In many industries as experience doubles (usually measured by a doubling of output) then costs should drop by 20% – 30%. However their is a real risk that costs will not drop unless the accounting system is set up to bring this behaviour about. Another tool is cost analyses of competitors by management accountants using published financial data and known characteristics of the technology and materials that the competitor is using.
Another concept is the cost of quality. For many firms the costs of not getting it right – rework, wasted time, warranties and so on can add to over 20% of revenue. Statistical quality techniques and methods such as ‘Six Sigma’ can reduce it to less than 5% and in some cases as low as 1%..
Product/Market Strategic Focus of the Company
Apart from competitive advantage and entry barriers the company strategy will also include its decisions on which products to sell in which markets- the so-called product/market decision. This decision is often illustrated by the Ansoff matrix, called after Igor Ansoff who originated it in the 1960s. The matrix plots markets against products giving in each cell the type of strategic decision.