Decisions and value creation, Apuntes de Administración de Empresas

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Chapter 4

Decisions and value

creation

Decisions and value

^ creation

Firms create value by selling products

 (^) Denote Z = product portfolio (z= 1,…,Z)  (^) q=( q 1 ,…,^ q z,..,^ q Z) the number of units sold of each product

 Value created by the company = V

CL

• CP  (^) V CL is clients’ valuation of each product z consumed by client x.  (^) CP is the social cost to produce one unit of product z for client x.

The total value created is the sum of the

value generated for each product sold

 Why clients buy products?

 How can we increase the value of a product?

VT vt x v x cp x VCL CP Z z q x z Z z q x z Z z q x z z z z  (^)        1  1  1  1  1  1 ( ) ( ) ( )

1. Consumer Decisions

 People have different needs (n = 1, ..., N)

 When an individual satisfies a need (n) he

gets a utility U

n

(Satisfaction, happiness)

 If an individual satisfies N needs, then, the

total utility is:

 The satisfaction of a need requires a certain

level of spending G

n

 The resources are scarce, i.e. individuals

have budget constraints: R, where

  N n U U 1 G R N n n    1

1. Consumer Decisions

Problem of the consumer / individual:

 Choose the satisfaction of the set of needs

that maximizes their utility level.

 Subject to budget constraint (you can pay for

it)

Solution:

 Order needs (from highest to lowest) based on

the utility generated by euro spent (U

n

/ G

n

 Then, cover needs until the budget is

exhausted

1. Consumer Decisions

 Example:

Needs Utility Expense Complement for luxurious clothes 100 200 Complement for luxurious house 100 300 Clothes, food, and basic shelter 2000 500 Complement for healthy food 100 100 Transportation 1200 400

1. Consumer Decisions

 Example: compute U/G ratio

Needs Utility Expense U/G Priority Complement for luxurious clothes 100 200 0.5 4 Complement for luxurious house 100 300 0.33 5 Clothes, food, and basic shelter 2000 500 4 1 Complement for healthy food 100 100 1 3 Transportation 1200 400 3 2

Chart 2. Value created

Value V n Expenditure G n n = 1 n = 2 n = 3 n = 4 n = 5 R-Budget available 1 Expenditure

1. Consumer Decisions Example: the available budget can cover 4 needs Standardization: Assume that the valuation of need 4 is equal to its expenditure that is, value creation to satisfy this need is zero. Need 4 determines the monetary equivalent of a unit of utility The valuation of the remaining needs is done with respect to 4: If normalized , we get Value created for each need:  

4 n 1 n

R G

4 4 V  G U (^) 4  G 4 Vn  U n ( / ) 1 4 4 U G  /( / ) 4 4 V U U G n n  Vn  G n

1. Consumer Decisions

 Example: If budget R=1000  3 needs

 Utility= 2000+1200+100=

 Value creation=1500+800+0=

Needs Utility Expense U/G Value Consumer Surplus (value-expense) Clothes, food, and basic shelter

Transportation 1200 400 3 1200 800 Comp. for healthy food 100 100 1 100 0 Comp. for luxurious clothes 100 200 0.5 100 - Comp. for luxurious house 100 300 0.33 100 -

1. Consumer Decisions Implication: Valuation of needs:  (^) Increases with the budget available R  (^) Decreases with spending G n on other needs

1. Consumer Decisions  (^) Exercise 1, 2 and 3

2. Types of products and

 valuation If each product has a set of characteristics that satisfy

one need, then, the value of the product equals the value to satisfy that need: v z = V n

 The decision of which products to consume coincides

with the decision of which needs to satisfy

Needs 1 2 …n….. N Value V 1

V

2

… V

n

…. V

N Characteristics 1,…,5 6,….,8 … c ... C-1, C Product 1 2 …z… Z Valuation of Product v 1 v 2 … vz… vZ

2. Types of products and

valuation

 In general, given a budget and prices, the valuation of needs are independent of each other, but the valuation of a product is not independent of the valuation of other products. For example: Complements: need to consume more than one product to satisfy one need Substitutes: some products cover same need (degree of substitutability)

2. Types of products and valuation 1. COMPLEMENTS  (^) Expense to satisfy need n = price of each product: G n =p 1 +p 2 Need N Value (^) V n Characteristics 1,….,5 6,…, C Product 1 2 Valuation of Product: v 1+

= V

n

2. Types of products and valuation 2. SUBSTITUTES  (^) Products that satisfy the same needs.  (^) Various degrees of substitutability  (^) Homogeneous products: Two products (Z 1 , Z 2 ) are homogeneous if they cover exactly the same needs (have same observable characteristics).

 Example: oranges (no brand name)

 'a priori' consumers value them equally: V

n

=V(Z

1

)=V(Z

2

 We do not consume the two products at once

 Once one product is consumed, the value of the other

will be 0.