How do companies create value?
Economic theory predicts what every manager knows – it’s hard to make a profit let alone sustain margins over time. Success attracts competitors who imitate your strategy and woo your customers. Important clients demand price reductions while suppliers push for price increases. Substitute products or services threaten to render your offerings irrelevant. Then, of course, there are shifts in the legal or regulatory context that can fundamentally alter the rules of the game. Given these difficulties, how can firms grow revenues, earn profits, and survive? Economic theory describes three distinct ways that firms create value: establishing and defending a positional advantage, building and leveraging superior resources, and seizing fleeting opportunities.
Creating value through superior position
The first approach emphasises establishing and defending a desirable position. The underlying logic is to identify an attractive market, establish a secure position, and erect defences to prevent competitors, customers, and suppliers from appropriating your profits. To use military imagery, this resembles finding a high hill, building a secure fortress with barbed wire and machine gun turrets, and defending it against attacks from all sides. An attractive position, according to this viewpoint, has two components. First, a company should identify a profitable industry. Numerous studies have demonstrated that industry is an important predictor of a company’s profitability. Firms in the pharmaceutical industry, for example, generally earn higher returns than companies in the steel sector. This is not always the case, of course.
Creating value through superior resources
The second approach emphasises winning by developing and leveraging valuable resources. Resources, according to this view, include hard assets such as specialised factories or prime real estate as well as intangible assets, such as brand, technology, and even knowledge possessed by employees or embedded in organisational processes. Firms can succeed, according to this perspective, to the extent they develop and own resources that help them to create value – through a recognised brand name that warrants a price premium, for example, or proprietary technology that competitors cannot copy. Of course not every Of course not every resource creates value. A retail chain may own stores in undesirable locations or a technology firm hold patents on outmoded technology.
Creating value by seizing fleeting entrepreneurial opportunities Firms can also create value by identifying and seizing opportunities more quickly than their rivals. An opportunity is defined as a novel combination of resources that fills an unmet market need and creates value in excess of the cost to acquire the use of necessary resources. It is important to note that the resources are often not owned, but rather leased or rented. When easyJet began operations, for example, the company relied on two leasedplanes and outsourced many of the support functions done in-house by most flag carriers. Value flows not from owning a valuable resource or staking out a defensible position, but rather from effectively managing the uncertainty inherent in trying something new.
Want to know more how we apply this London Business School’s* value creation strategy to Indonesia Complex Adaptive Environment? Contact us: email@example.com
* Donald N. Sull & Martin Escobari
(firstname.lastname@example.org) is an associate professor of management practice at the London
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