Adding Value

What is adding value?

Water from a tap is nearly free. The same water, in a bottle, from a kiosk on a hot beach, is £2. Nothing was done to the water. The kiosk added value. Adding value means making something worth more to the customer than the things it was made from cost. The whole of this topic is about the size of that gap, the specific methods used to widen it, and the one distinction examiners use to separate a grade 6 answer from a grade 9: value added is not the same thing as profit.

Five ways to add value

Exam answers that say only "it adds value" earn very little. Naming which method is where the marks are:

Which method is at work?

Convenience or USP?

A coffee shop on a ring road adds a drive-through window. Sales rise and it charges 15p more than its high-street branch. Is the drive-through a USP or convenience, and does the answer depend on anything?

• Convenience, unless no rival nearby has one. It clearly saves the customer time, and it is only a USP if competitors cannot match it, so the answer turns on what the rivals offer rather than on the feature itself
• A USP, because it is a feature the high-street branch does not have
• Convenience, always, because a drive-through can never be unique
• Quality, because customers are paying more, and a higher price signals a better product

Value added is not profit

Two calculations that look similar, use different costs, and answer different questions. Mixing them up is the single commonest error on this topic:

Value added per cup

A coffee shop sells a coffee for £3.20. The beans, milk and cup cost £1.00. Staff, rent and power work out at £1.60 for every cup sold. What is the VALUE ADDED per cup, in pounds?

Profit per cup

Same coffee shop, same figures: it sells at £3.20, the beans, milk and cup cost £1.00, and staff, rent and power come to £1.60 per cup. What is the PROFIT per cup, in pounds?

Adding value is not free

Every method on that list costs something. A rebrand costs design fees and new packaging. Better ingredients cost more per unit. A drive-through costs a building. Faster delivery costs drivers and vans. So the real question is never "does this add value?" It is "does the extra the customer will pay beat the extra it costs me?" That comparison is what an evaluation question is asking for, and an answer that only lists benefits has answered a different question. Two ways it goes wrong in practice. The extra price may be smaller than expected, because customers did not notice or did not care. And the advantage may be temporary: design and convenience are the easiest methods for a rival to copy, while a brand built over twenty years is the hardest.

Is it worth doing?

A bakery is quoted £4,000 for a redesigned range of packaging. It believes the new look will let it charge 20p more on each loaf, and it sells 15,000 loaves a year. Should it go ahead?

• Probably yes, but not on year one alone. The extra price brings in £3,000 a year, so the £4,000 is not recovered in the first twelve months; the design is a one-off cost that keeps earning, so it pays for itself early in year two and is profit after that
• No. £3,000 of extra revenue is less than the £4,000 it costs, so the business would lose money
• Yes. Adding value always increases profit, so any investment in it is worthwhile
• There is not enough information, because we are not told the cost of the ingredients

Which of these increase value added?

Value added is selling price minus the cost of inputs. Select the THREE changes that would increase it.

• Redesigning the packaging so the product looks premium, letting the firm charge 30p more
• Negotiating a lower price for exactly the same raw material, with no change to the selling price
• Offering same-day delivery, which customers will pay a £3 premium for
• Cutting the selling price by 10% to undercut a rival
• Switching to a more expensive raw material without changing the selling price
• Selling the same product in a double-size pack at exactly double the price

Two shops, one street

Both buy the same beans and milk, at £1.00 of inputs per cup. Cafe A sells at £2.20 from a hatch. Value added £1.20. Its other costs are low: one member of staff, a small rent, no seating to heat. Profit per cup about 40p. Cafe B sells at £3.80. It has armchairs, its own name on the cup, table service and a roaster in the window. Value added £2.80, more than twice A's. And B's rent is three times A's, it employs four people rather than one, and it spent £9,000 on the fit-out. Its profit per cup is about 35p, slightly less than A's, and it needs to sell far more cups before it has covered the fit-out at all.

Advise a juice bar

A single-site juice bar, three years old, wants to raise what customers pay. It has about £2,000 to spend.

• The owner suggests a national advertising campaign to build the brand. What is the problem with that?
• A rival two doors down has just started selling cold-pressed juice, which was this bar's main selling point. What has happened?
• The owner considers a £1,800 refit to make the bar look more premium, expecting to charge 40p more on roughly 12,000 drinks a year. What is the strongest thing to say about it?

How to judge a value-adding idea

Put the steps for deciding whether a value-adding change is worth making into order.

• Work out what customers would actually pay extra for, rather than what the owner finds interesting
• Estimate how much more they would pay, and on how many sales
• Estimate what the change costs, separating one-off costs from ongoing ones
• Compare the two over a stated period, and say how long the one-off cost takes to repay
• Judge how long the advantage will last before a rival copies it

Adding-value frame

Value added is the selling price minus the cost of the _____, which is a narrower figure than profit because it leaves out wages, rent and everything else. A business can therefore add a lot of value and still make a _____. Value added rises either by charging more or by paying _____ for the same materials. And a feature only counts as a USP for as long as no _____ offers it too.