Page 290 - DMGT545_INTERNATIONAL_BUSINESS

Unit 15: Global Strategic Management and Business Ethics

In general the more value customers place on firms products, the higher price the firm can notes
charge for those products. However the price a firm charges for goods and services is typically
less than the value placed by the customer on those goods and services. This is because the
customer captures some of the value in the form of what economists call ‘consumer’s surpluses.
The customer is able to do so because the firm is competing with other firms for the customer’s
business so the firm must charge a lower price than it could if it was a monopoly supplier. Also,
it is normally impossible to segment the market to such a degree that the firm can charge each
customer a price that reflects individual’s assessment of the value of a product which economist’s
refer as ‘customer’s reservation price’.
This concept is illustrated in Figure 15.1.

figure 15.1: illustrates these concepts
V – P

P - C V = Consumer Value
P = Market Price
C = Cost of Production
V - C V – P = Consumer Surplus
P – C = Profit Margin
V – C = Value Added

The value of product to a consumer is (V), the price that the firm can charge for that product
given competitive pressures and its ability to segment the market is (P) and the cost of producing
the product are (C).
The firms profit per unit sold (II) is P – C while the consumer’s surplus is V – P. The firms make
a profit so long as P>C and its profit will be greater the lower C is related to P.
The difference between V and P is determined by the intensity of competitive pressure in the
market place. The lower the intensity of pressure the higher the price that can be charged relative
to V.
The value created by a firm is measured by the difference between V and C (V-C); the company
creates value by converting inputs that cost (C) into a product on which consumer’s place a value
of V. A company can create more value for its customers either by lowering production cost (C)
or making the product more attractive through superior design, functionality, quality and the
like so that consumer’s place a greater value on it and consequently are willing to pay a high
price. This discussion suggests that a firm has high profits when it creates more value for its
customers and does so at lower costs.

Strategy can be referred to as that which focuses on lowering production costs as a low cost
strategy. Similarly, strategy that focuses on increasing the attractiveness of the product can be
called as a differential strategy. Michael Porter has argued that low cost and differential are
two basic strategies for creating value and attaining a competitive advantage in an industry.
According to Porter superior profitability is earned by those firms that can create superior value
and the way to create superior value is to drive down the cost structure of the business and/or
differentiate the product in some way so that consumers value it more and are prepared to pay a
premium price. Superior value creation as compared to rivals does not necessarily require a firm
to have a lowest cost structure in an industry or to create the most valuable product in the eyes
of the consumers.

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