During the first session of my global supply chain course at UCLA, I often explain the concept of value creation as follows. A firm uses a supplier to produce one unit of a product for a potential customer. The supplier's lowest willingness-to-accept price is A, whereas the customer's maximum willingness-to-pay price is B. To get the deal done, the firm pays the supplier c (c > A) and sells the product at price p (p < B). As shown in Figure 1, this transaction provides value to all three parties: the supplier gains value (c – A), the customer obtains value (B – p), and the firm earns value (p – c).
To create "real" value instead of paying the supplier less or charging the customer more "unwillingly", a firm needs to develop innovative ways so that the supplier is willing to accept a lower offer A' (A' < A) and the customer is willing to pay a higher price B' (B' > B). By doing so, the firm can offer a lower cost c' (c' < c) and charge a higher price p' (p' > p). So, as long as the following conditions hold [i.e., (B' – p') > (B – p); (c' – A') > (c – A), and (p' – c') > (p – c)], everyone wins by getting more value! This is what value creation is about.
There are many ways to create real value, and
Nestlé has done so by launching the "creating shared value" CSV
campaign in 2009, see www.nestle.com/CSV. Since 2009, Nestle has made many contributions to
rural development that have created real value for poor farmers, while at the
same time creating value for its shareholders and Nestlé.
For example in developing countries such as China, India, Indonesia, and Pakistan, the farming business is fragmented and most farmers run their operations on small lots of land (1.5 hectares on average). This small scale, coupled with the wide geographic dispersion of farms, means that farmers have to sell through layers of middlemen, who in turn sell on to wholesalers. This long and inefficient supply chain creates a lose-lose situation: the farmers get a low price for their produce, while the brand owner (in this case, Nestlé) pays a high price for produce that is not always as fresh as it would like (because of the delay in handling and transportation).
Take milk, of which Nestlé bought over 12 million metric tons from more than 600,000 famers in over 30 countries in 2010. To reduce transaction costs, Nestlé CSV calls for direct purchasing from certain farmers. In China, for example, the company worked with over 40,000 dairy farmers by adapting the "Swiss Milk District System". This involves:
- Disintermediation: Cut out the middlemen by developing transportation and infrastructure to collect milk directly from farmers.
- Quality: Establish milk collection centers with quality controls and cooling tanks to reduce spoilage and improve quality.
- Aggregation: Group famers into "districts" to reduce logistics costs for farmers who deliver their milk to these collection centres.
- Productivity: Provide free veterinary services and animal husbandry to improve the quality and productivity of milk production.
- Financial Assistance: Offer prompt payment to farmers for each milk delivery and provide microfinance loans.
During 2010, over 24,000 farmers in Heilongjiang province in the northeastern part of China delivered their fresh milk to 78 collection centres. By cutting out the middlemen and wholesalers, transaction costs are reduced and Nestlé can share the savings with farmers. Nestlé obtains fresher milk at a lower price than before, the farmers get a higher price than before, and the customers are willing to pay a higher price than before because they get to enjoy better quality of milk. A similar approach is being used with coffee and cocoa farmers.
For more details, see the case developed by Lee, Over, and Tang at SCM World.
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