Value chains

Very few ... if any ... economic activities take place independent of everything else. Only very small and simple transactions have impact only on the direct participants ... most have other ramifications which are important. The corporate system of financial analysis extracts the factors that result in the most money profit for the enterprise, but leaves out the analysis of impact on others in the value chain, and the impact on people, place and planet throughout the value chain. This is an important weakness on money profit accounting and a core part of TVM Value Accounting.

Modern corporate accountancy is complex with many rules, mostly relating to the way an organization reports to its financial stakeholders and, to a much lesser degree, to the public. These reports are the result of complex consolidation that takes into consideration what is allowed in reporting the internal and external value chains that impact costs, revenues and profits. There are no requirements for any of the impacts on people, place and planet to be reported in a rigorous way.

There is a growing set of initiatives that are trying to improve the framework for the reporting by organization in respect of sustainability, corporate responsibility, carbon footprint, and the like. Compared to money profit accounting for the corporate organizations, these initiatives are weak with little or no regulatory or legal reporting mandates to encourage and support them.

Managing value chains makes it possible for a corporate organization to minimize its exposure to taxes, duties and other regulations that impact its financial performance. None of this is easily accessible to the public at large. Were the public to have an understanding about value chains it would make it possible for the public to hold organizations accountable for their performance in every place where they operate and throughout the value chains they use to support their operations.

Value chain analysis

Value chain analysis shows who are the winners and losers in the chain of economic activities that link together in the saupply chain to produce the goods and services people need.

The result of value chain analysis can be very powerful ... but because of this it is not always easy to get the data that are needed for objective independent analysis.

TVM Value Accountancy sets the stage for having much more data on the record that are useful ... and though the data will not be good enough to satisfy legal criteria for criminal guilt ... the data will be good enough to make it quite clear what is going on.

Value chain analysis for profit maximization

It can be argued that the most powerful tool that MBA training has given to their students is the spreadsheet mathematics to take the inherent costs, prices and values of the value chain and optimize the value chain to maximize profit for organization. These experts know how to move value from various pieces of the value chain and move it into the optimizing organization.

This is a very powerful concept and has facilitated a very rapid and efficient concentration of wealth into large organizations and entities with a minimum of investment.

Value chain for maximum social benefit

The accounting used for corporate profit maximization does not include social costs nor social benefits.

These are both important and are brought into account with TVM Value Accountancy. The costing is not obvious ... but it is pretty clear that some cost needs to be attributed to the consumption or destruction of social value.

Replacement cost of fossil fuel resources

In the energy industry the fossil fuels that are being extracted originated millions of years ago ... the replacement cost of these resources is unimaginable ... so it gets ignored! This is easy and convenient ... but not a good approach.

Cost and price determine profit.

Price for the seller becomes cost for the buyer. This next buyer sells for a new price, and profit is again the difference between cost and price.

Where are the profits? Where are the losses?

How do valuable raw materials create profit with little benefit to the community of origin?

Value chain analysis shows who are the winners ... those that have small cost and high price. But costs are usually based on simple GAAP concepts and not on TVM Value Accountancy analysis.

When cost is based on the consumption of TVM Value Accountancy value rather than the consumption of GAAP cost and value adding and value destruction instead of profit, there are different results.

Value chain and the market economy

Value chains flow through markets ... but the market is more a fiction than a reality, which is part of why they are so valuable in value chain manipulation and also so dangerous. It is not easy to tell when a market transaction is driven by supply and demand for physical goods, or whether the market is being driven by speculation about future market values, or whether the driver is legitimate hedging against future price movements.

Profiting from the value chain

One of the ways in which profits are maximized is by using the value chain to get profits domiciled where they most benefit the company.

Outsourcing from a high cost location to a low cost location results (rather obviously) in lower costs and therefore higher profit.

Example

In a practical situation, however, lower costs may be offset by some inefficiencies and other issues. In the 1970s, I pulled back production that had been outsourced to South Korea from the USA. Production cost savings were offset by the costs associated with unmanageable supply chain logistics and rapidly changing consumer tastes.

Value chain can be used to move profits from one legal entity to another ... this may have tax or other financial advantages.

Tea auction – Malawi (as of 1989)

If you are a tea grower in Malawi, your product is sold for export through the Tea Auction. The idea is that this auction price is a market determined price that will maximize the amount paid to the tea industry in Malawi. Up to a point, this is right ... but there is a substantial part of the Malawi production that originates from estates owned by international tea companies. These companies have to sell at the auction ... but they also want to have tea for their international business. As tea distributors they want low prices ... and if low prices mean that the estates get less profit it does not matter much ... in fact it helps because they get less problem with local taxes and with the repatriation of profits.

Value chain can be used to make profit performance look good but not mean much

$200 Sneakers (as of 2002)

It costs about $2 to make a pair of sneakers in China and a number of other low wage countries. Manufacturers make a good profit by selling a lot of them at (say) $4. But the profit made by manufacturing is tiny compared to the profit made by the marketing organization and the wholesale and retail system in North America or Europe. Retailers have a very comfortable markup ... and so do the wholesalers and the marketers. They have expenses to keep their “brand” popular ... like sponsoring high profile stars ... but everything in this part of the value chain is about perception and not about the essential substance.

The added value substance happens at the manufacturing stage ... only value perception gets added subsequently. Over time perception loses its value and at the limit there is not much left. Value chain

The value chain is very well understood in the corporate sector, and there has has been very effective profit improvement for the corporate sector by taking advantage of all sorts of cost improvement opportunities in manufacturing to improve the profit bottom line.

But the deep knowledge of the corporate value chain is not matched by anything like the same amount of understanding of the value chain as it impacts social value and the impact of corporate activities on society. The relocation of manufacturing from the United States to China has been very profitable ... but what are the costs to society that do not figure in the corporate accountancy. Nobody has been doing TVM Value Accountancy and nobody knows.

We do know corporate profits increased as more and more manufacturing was outsourced to low cost areas. We do know something of the job creation in these low cost areas and we do know something of the job losses in the place4s where manufacturing plants were closed ... but what we know is far less than what we need to know. We do not really know very much at all about the impact on the communities --- this is not part of a system of metrics, and only part of what we need to know is on the record.

Al Gore on July 17th, 2008 ... 'We're borrowing money from China to buy oil from the Persian Gulf to burn it in ways that destroy the planet,' he said. 'Every bit of that has to change.'

Regulation in banking

Over the past 30 years the USA has taken apart most of the regulatory framework around banking and the capital markets, with very good results reported by the institutions in the sector over this period of time. The good results do not, however, take into account the costs of the periodic failures of big institutions in the sector (Continental Illinois) and whole segments of the sector (Savings and Loan). But worse they do not take into account the wealth that is merely removed from one segment of society to become profit in the banking and finance sector. The sub-prime mortgage crisis is just the latest in a series of moves over the years by the banking and capital market industry to concentrate wealth in their sector at the expense of society as a whole.

Replacement cost of fossil fuel resources

In the energy industry the fossil fuels that are being extracted originated millions of years ago ... the replacement cost of these resources is unimaginable ... so it gets ignored! This is easy and convenient ... but not a good approach.

Value chain analysis

Value chain analysis shows who are the winners and losers. The result of value chain analysis can be very powerful ... but because of this it is not always easy to get the data that are needed.

TRM Value Accountancy sets the stage for having much more data on the record that are useful ... and though the data will not be good enough to satisfy legal criteria for criminal guilt ... the data will be good enough to make it quite clear what is going on.

Value chain analysis for profit maximization

It can be argued that the most powerful tool that MBA training has given to their students is the spreadsheet mathematics to take the inherent costs, prices and values of the value chain and optimize the value chain to maximize profit for organization. These experts know how to move value from various pieces of the value chain and move it into the optimizing organization.

This is a very powerful concept and has facilitated a very rapid and efficient concentration of wealth into large organizations and entities with a minimum of investment.

Value chain for maximum social benefit

The accounting used for corporate profit maximization does not include social costs nor social benefits. These are both important and are brought into account with TRM Value Accountancy. The costing is not obvious ... but it is pretty clear that some quantified measure needs to be attributed to the consumption or destruction of social value.

The value chain is very well understood in the corporate sector, and there has has been very effective profit improvement for the corporate sector by taking advantage of all sorts of cost improvement opportunities in manufacturing to improve the profit bottom line.

But the deep knowledge of the corporate value chain is not matched by anything like the same amount of understanding of the value chain as it impacts social value and the impact of corporate activities on society.

In the value chain, price for the seller becomes cost for the buyer. This next buyer sells for a new price, and profit is again the difference between cost and price.

Where are the big profits? Where are the losses?

How do valuable raw materials create profit with little benefit to the community of origin?

Value chain analysis shows who are the winners ... those that have small cost and high price. But costs are usually based on simple GAAP concepts and not on TRM Value Accountancy analysis.

When cost is based on the consumption of value rather than simply on the consumption of calculated cost based on GAAP and value adding and value destruction instead of profit, there are different results.

Value chain and the market economy

Value chains flow through markets ... but the market is more a fiction than a reality, which is part of why they are so valuable in value chain manipulation and also so dangerous. It is not easy to tell when a market transaction is driven by supply and demand for physical goods, or whether the market is being driven by speculation about future market values, or whether the driver is legitimate hedging against future price movements.

Monopoly control

Everyone has heard of the story of John D. Rockefeller and Standard Oil. It is amazing how much money can be made when an organization gets monopoly control of the value chain. And amazing also, that so little has been learned from that experience.

One of the lessons is that monopoly is powerful ... and laws do not work very well unless they are very careful crafted. Most statutory laws are notable not for what they control, but what they allow ... whether this is because of sloppy lawmaking or because the lawmakers know exactly what they are doing is a matter of opinion.

1970s – new oil and old oil

The oil shock of 1973 was a wake up call ... and not surprisingly Washington went to work to legislate a solution. Part of the solution was going to be the profit incentive and removal of price controls over domestic production of oil and gas.

Oil from oil wells that were already producing was to keep the old price. Oil from new wells could be sold at the (then much higher) prevailing market price.

Not surprisingly production of old oil declined and production of new oil increased ... never mind the timeline for creation of new wells was months and years, but the change took place in days. Did the legislators know this was going to happen and give great profit to (their friends) the oil industry? Clearly this was good popular legislation because the old price controls were kept in place, and high price incentive was only allowed for incremental new production that was needed ... or was this just a sham?

1970s – Foreign Corrupt Practices Act

In the aftermath of the 1970s oil shocks, a new era of international profit opportunities emerged. For the first time in history there were many governments that had previously unimaginable wealth ... the oil exporting countries ... and the world's entrepreneurs wanted to tap into this market.

Bribery, kickbacks, etc. emerged as the marketing modality of the era ... but it was found offensive by much of the public when the media started to tell stories. Stories about Lockheed were everywhere ... but not much about Boeing. The American press has all sorts of stories ... but not so much in the European press.

Washington had to do something ... and this something was the Foreign Corrupt Practices Act. I am not a lawyer but I get the impression that this law, like so many others is big on PR, but rather irrelevant in terms of addressing the underlying core problem ... and it is relatively easy to step around.

Getting control of a value chain is enormously valuable ... this is true with the oil value chain ... it is true with any market where there are a limited number of competing entities.

The External Enterprise Case