Welcome to "Creating Value"!
Hello there! Welcome to one of the most fundamental chapters in your E2 journey. In this section, we are going to explore how organizations actually "make" value. In the past, people thought business was only about making a profit. Today, CIMA and the professional world look at value much more broadly.
By the end of these notes, you’ll understand that a business is like a living system that takes in resources, does something smart with them, and produces results that matter to people. Don't worry if some of the terms sound a bit "corporate" at first—we’ll break them down using everyday examples!
1. What is a Business Model?
Before we talk about creating value, we need to understand the "engine" that creates it: the Business Model.
At its simplest, a business model is the logic of an organization. It describes how the company intends to create, deliver, and capture value for its stakeholders over the short, medium, and long term.
Think of it like this: If you were opening a lemonade stand, your business model isn't just the lemonade. It’s the decision to buy cheap lemons (input), use your secret family recipe (activity), sell it at a busy park (delivery), and charge a price that covers your costs while making kids happy (capturing value).
The Core Components
CIMA follows the International Integrated Reporting Council (IIRC) framework. According to this, a business model consists of:
• Inputs: The resources the business uses.
• Business Activities: What the business does with those resources (innovation, production, marketing).
• Outputs: The products or services produced.
• Outcomes: The internal and external consequences (positive or negative) for the capitals as a result of the business activities.
Quick Review: A business model is the "how-to" guide for a company to turn resources into something valuable.
2. The Six Capitals: The "Ingredients" of Value
To create value, you need resources. In E2, we don't just call these "stuff"—we call them The Six Capitals. This is a very common exam topic, so let's get to know them!
Memory Aid: Try the mnemonic "F-M-I-H-S-N" (Financial Man In His Super Network).
1. Financial Capital: The pool of funds available to the organization (cash, bank loans, equity).
2. Manufactured Capital: Physical objects like buildings, equipment, roads, and bridges. Example: A delivery van for a courier company.
3. Intellectual Capital: The "intangible" stuff. Patents, software, copyrights, and "organizational knowledge." Example: The secret formula for Coca-Cola.
4. Human Capital: People’s skills, experience, and their motivation to innovate. Example: A team of highly trained surgeons in a hospital.
5. Social and Relationship Capital: The relationships and trust between the business and its stakeholders (customers, communities, suppliers). Example: A brand’s reputation for being ethical.
6. Natural Capital: All renewable and non-renewable environmental resources. Example: Water, minerals, timber, and clean air.
Did you know? Even if a company is very rich (Financial Capital), it can fail if it destroys its "Social and Relationship Capital" by treating customers poorly!
3. The Process of Value Creation
Value creation is a continuous cycle. It isn't just a straight line from start to finish. Let's look at the flow:
Step 1: Inputs
The business draws on the Six Capitals. For example, a tech company uses Financial Capital (investor money) to hire Human Capital (software developers).
Step 2: Business Activities
This is the "magic" in the middle. The company uses its Intellectual Capital (coding knowledge) and Manufactured Capital (computers) to create a new app.
Step 3: Outputs
This is the literal result. The Output is the completed app available on the App Store.
Step 4: Outcomes
This is where students often get confused. The Outcome is the impact.
• Positive Outcome: Customers save time using the app (Value created for Social Capital).
• Negative Outcome: The servers used for the app consume massive amounts of electricity (Value eroded from Natural Capital).
Key Takeaway: Output is what you made; Outcome is what happened because you made it.
4. Value Creation, Preservation, and Erosion
Value is not static. A business can do three things with value:
1. Value Creation: When the outcomes are positive and increase the capitals. Example: Training staff increases Human Capital.
2. Value Preservation: Keeping the value you already have. Example: Maintaining a factory so it doesn't break down preserves Manufactured Capital.
3. Value Erosion: When value is lost or destroyed. This often happens when a business focuses too much on one capital (like Profit) and ignores others. Example: Overworking staff might lead to high profits (Financial Capital) but burns out the employees (Erosion of Human Capital).
Common Mistake to Avoid: Don't assume "Value" only means "Money." In CIMA E2, value is about the total increase or decrease in all six capitals.
5. Stakeholders and Shared Value
Who is the value for? In the modern business model, it's not just for the shareholders (the owners). We focus on Stakeholders.
Stakeholders include:
• Customers (want quality and fair prices)
• Employees (want fair pay and safety)
• Suppliers (want reliable payments)
• The Community (want environmental protection)
The concept of "Shared Value" suggests that for a business to be successful in the long run, it must create value for society while also creating value for its shareholders. If you only make the shareholders happy but pollute the local river, the community will eventually force you to shut down!
Analogy Time: Imagine you are baking a cake for a party.
• Value Creation: Everyone gets a delicious slice and feels happy.
• Value Preservation: You put the leftovers in the fridge so they stay fresh for tomorrow.
• Value Erosion: You leave the oven on too long, burn the cake, and set off the smoke alarm (making the neighbors angry!).
6. Connectivity of Information
Finally, the "Managing Performance" aspect of E2 requires Connectivity. This means that a business must understand how its different parts relate to each other.
For example, if the HR department cuts the training budget (saving Financial Capital), the Management Accountant should be able to see that this might lead to more errors in production (eroding Intellectual and Human Capital) and ultimately hurting the brand (eroding Social Capital).
Everything is connected!
Quick Review Box:
• Value is broader than profit.
• The Business Model is the system that turns Inputs into Outcomes.
• Use the Six Capitals to identify all resources.
• Watch out for Value Erosion—it's a major risk to long-term success!
Don't worry if this feels like a lot to take in. The main thing to remember is that Managing Performance in E2 is about looking at the big picture—how all the "Capitals" work together to keep the business healthy and the stakeholders happy!