Most business improvement programs and methods are focused on a firm’s supply side. They are aimed at helping a firm to supply the same or more output at a lower cost. Initiatives like Lean, Six Sigma and so forth are valuable for helping a firm to obtain greater efficiency and productivity – producing the same, or more, output with less, or the same, resources.
However, efficiency – the amount of output produced per unit of input – is one way to look at productivity. Another, more meaningful way is to look at the value of the output produced. Using the same resources to produce a more valuable output which commands a higher price in the marketplace has several advantages over mere cost reduction.
When a firm produces more valuable output which commands a higher price, that implies differentiation from rivals. Customers will pay that higher price because the good or service offers more value for the money and is not readily obtainable elsewhere. Secondly, higher value also implies innovation. To cut costs, one does not have to be particularly innovative, but creating additional value requires it.
Creating higher value output is a demand side issue. To offer higher value, a firm must understand customers’ needs and design and create superior value which satisfies that need. To accomplish this, a firm needs to understand consumer and utility theory, neither of which are supply side solutions.
I find it interesting that Lean adherents profess to be oriented around value, but yet jump immediately into improving the efficiency of value chains, and don’t necessarily improve the value being offered. Lean adherents will claim that reducing waste and inefficiency is commensurate with improving value, yet this assumptions has two flaws. First, if it doesn’t command a higher price, it is not higher value. Even higher quality is not higher value unless the customer perceives it to be so and is willing to pay the higher price to offset the higher costs that providing such quality entails. Secondly, superior value has to be designed from a deep understanding of the demand side of the business. Fixing the supply side doesn’t address that.