How Do Businesses Create Value for Stakeholders?

Why do customers purchase goods or services? Why do venture capitalists invest in certain startups? Why do employees choose to work at one company over another? The answer to these questions boils down to an essential business objective: Value creation. Customers make purchases based on perceived value. Investors hope for long-term profit from their investments. Employees exchange their services for financial or personal value by working at a company.

Business leaders who want to increase their company’s profits must understand how to create value for their stakeholders. Here's an overview of the different types of stakeholders and how businesses create value for them.

Key Stakeholders in Business

Stakeholders are individuals or organizations with a vested interest in a company's success. It's important to avoid confusing them with shareholders, who own stock in a company. Stakeholders represent a much broader audience.

There are two categories of stakeholders: Internal and external.

Internal stakeholders operate within an organization or have a direct relationship with a company. They're directly impacted by a business's activities while their own actions affect its operations.

Key internal stakeholders include:

• Employees: The collection of individuals employed by a company in exchange for compensation.
• Business owners: The individuals responsible for a business’s financial and operational components.
• Investors: The individuals or groups who invest capital in a company in exchange for long-term financial gain.

External stakeholders operate outside the company but are still impacted by the organization’s actions.

Key external stakeholders include:

• Customers: The consumers of a business's goods or services.
• Suppliers: The companies selling raw materials needed to produce a business’s goods or services.

Both internal and external stakeholders are necessary for success, so companies shouldn't focus on one while neglecting the other. Instead, focus on maximizing value for each to ensure long-term profitability.

What Is Value in Business?

Finance, at its core, involves value-based decision-making. Business leaders decide which investments to make, how to finance their endeavors, and maximize their return by focusing on creating value.

The term “value” is often used subjectively to reflect an individual’s priorities. Maximizing it, however, is a central objective of business, so leaders need to understand how to define and create value for their firms.

There are two categories of value in business:

• Financial value is monetary value typically reported on a company's financial statements. This type of value is particularly important to investors seeking financial gain in return for their capital and for-profit businesses trying to generate revenue. Companies that create financial value can invest it back into their business to promote sustainable growth for their investors long-term.
• Perceived value is a form of value that’s subjective and includes factors like a customer’s willingness to pay (WTP) for a good or service and an employee's satisfaction with their work environment. It's difficult to assign numbers to perceived value, as it varies from person to person, but it can directly impact a company’s financial value.

Successful business leaders strive to create both financial and perceived value for stakeholders to ensure a well-rounded value portfolio.

Creating Value for Stakeholders

Creating value in business is exceeding stakeholders' minimum expectations. The amount expectations are exceeded—financial or perceived—is the amount of value created.

In the online course Leading with Finance, Harvard Business School Professor Mihir Desai explains that there are three sources of financial value creation:

1. Beating the cost of capital: Businesses must overcome the discount rate, which is the interest rate used to discount future cash flow back to its present value. It's often the minimum acceptable rate of return, also known as the hurdle rate, investors expect, so the greater it's exceeded, the more value is created.
2. Continuing to beat the cost of capital: Exceeding expectations for only one year won’t produce long-term value. To be financially successful, business initiatives must continue to overcome the discount rate.
3. Growing: The more financial success your company achieves, the more value you create. Growth allows you to reinvest profits back into your business, multiplying your value creation.

Creating perceived value is more difficult, but possible. For example, effective branding can motivate consumers to choose one company over another. To increase a customer's perceived value of goods or services, business leaders must ensure they deliver on their promises and create a sustainable business strategy.

Equally important to defining value is determining whether it's been created. The market-to-book ratio and value stick are visualizations of value creation for a business’s key stakeholders.

Creating Value with the Market-to-Book Ratio

Investors are concerned with risk management—minimizing risk and maximizing returns. For your company to attract viable investors, it must create financial value. This requires an evaluation of discount rates, return on equity, and costs of capital, which is represented by a market-to-book ratio.

This ratio considers the relationship between two factors:

• Book value: The historic accounting value of a company's assets and equity.
• Market value: The value of a company's assets and equity today.

Dividing the market value of a company's equity by its book value results in its market-to-book ratio. If an investment produces a result equal to 1.0, no value was created. If the result is lower than 1.0, value was destroyed. A market-to-book value that exceeds 1.0, indicates created value.

Creating Value with The Value Stick

Financial investors aren't the only important stakeholders. It's also vital to create value for customers, employees, suppliers, and the firm itself. The value stick is a representation of value-based strategy and is comprised of four components:

1. Willingness to pay (WTP): The highest amount customers are willing to pay for a product or service.
2. Price: The amount customers must pay for a product or service.
3. Cost: The cost of producing a good or service.
4. Willingness to sell (WTS): The minimum suppliers are willing to accept for the raw materials needed to produce goods or services.

The gap between these categories is the value created for each stakeholder.

• Customer delight is the gap between a customer’s WTP and a good or service’s price. The larger the gap, the happier the customers will be with the price. Business leaders who want to improve this metric can either increase a good or service's perceived value (increasing the customer's WTP) or increase its financial value (reducing its cost).
• A firm’s margin is the profit generated for the business. It reflects the gap between price and cost. This value is purely financial but is directly impacted by perceived value. For example, if a customer's WTP increases, the firm can raise its prices. Or, if an employee is willing to work for a lower salary, the company can reduce its overall costs.
• Employee satisfaction and supplier surplus are represented by the gap between the cost of producing goods and services and the employees’ and suppliers’ WTS. In the employees’ case, their WTS is the minimum compensation they’re willing to receive. For the suppliers, it’s the lowest they’re willing to accept for raw materials.

Business leaders tasked with creating value must focus on improving customer delight, employee satisfaction, and supplier surplus without sacrificing the firm's margins.

Creating Value For Your Organization

Value creation seems easy when viewed on paper, but the reality is that it’s a difficult process. Beating your cost of capital, sustaining your success, and growing your business are incredibly challenging tasks and can only be accomplished with a comprehensive understanding of financial principles.

The first step to creating value for your business is acquiring the skills to inform your decision-making. Financial skills are a must for business leaders, as you can’t create value without profit. Taking an online course, such as HBS Online's course Leading with Finance, can equip you with the tools to effectively create and measure value.

Eager to learn the financial skills needed to create value? Explore our online course Leading with Finance to develop the confidence you need to take your business endeavors to the next level.