The Value Equation

“Price is what you pay. Value is what you get.”
–Warren Buffett

 

Last week I did an interview on Pars3c.com as part of the ongoing High5 series.  In one question I touched upon business models and offered the idea of “the value equation” as being a possible means to evaluate different business models.

What is the value equation, and it is really possible to compare and contrast equivalent approaches using this relationship?

In my current line of work of developing and implementing strategies for acquiring the goods and services needed by mission operations in Houston, the value equation plays a central role.  In soliciting for goods and services, we weigh the proposed benefit in terms of technical, management, and business approaches, along with demonstrated reliability based upon past performance, and contrast that against the cost for the proposed approaches.  The Federal Acquisition Regulations (FAR) defines “best value” as “a combination of competitive pricing and improved performance” (i.e., benefit).

With the above we have some clues.  In a very simplistic way, the relationship between benefit and cost and the resulting value can be expressed in terms of the following equation:

value = benefit – cost

Let’s look at some results for value in terms of benefit and cost.

One way to increase value is to provide the same benefit at a reduced cost; that is, if the benefit is the same, reducing cost provides more value.  Focusing for a minute on the commercial-versus-Government debate on access to low Earth orbit, one can surmise a logical explanation behind the philosophy for handing over routine cargo and crew transportation services to the commercial sector.  It is rooted in the belief that standard commercial business practices and the free market will lead to lower costs in the longer run for the same services (i.e., benefits) provided by systems in existence today.  This is the relationship that many have in mind as to why it is desirable to reduce cost; as long as one can reduce cost yet continue to provide the same goods or services, it is perceived of greater value.  I certainly do.  Wal-Mart is the master of this approach with its volume buying and pressure on it suppliers to reduce costs.

That’s the easy part.  Let’s get a bit more complicated and look at another way to use the equation.

Another way to increase value is to find new benefits at an additional cost that makes it worth the benefit-cost trade.  One way to find new benefits would be to create additional business lines or identify additional customers beyond NASA that can use cargo and crew transportation services to low Earth orbit.  Space tourism is the hot item right now, yet I believe other avenues will be needed to make the business case sustainable in the long run. Could space-based solar power be one of those business lines?  Or harvesting and recycling dead satellites for valuable materials?  I’m sure the leaders in the commercial sector are mulling over these, and a host of others, as potential business lines; I suspect they need additional business lines like these to help close the business case for entry into commercial transportation services.  The examples I cite are areas in which NASA is not really active as far as I know, so these represent new benefits around which additional value can be created, as long as the costs are worth the trade.

Oh yes, I’ve been avoiding intentionally the one question you had as soon as I wrote the value equation (especially if you’re my high school physics teacher, Mrs. Matney).  Time to deal with it.  How can one “subtract” cost from benefit to arrive at value?  Aren’t they measured in different units?

That takes us to the extremely hard part.

One of the key differences between mission-driven Government organizations and the commercial sector is this very element; the fact that for many mission-driven Government organizations such as NASA, benefit is not expressible readily in terms of the unit used for cost: money.  Profit has no meaning.  Attempts to monetize benefit in terms of some kind of return on investment use complicated and obfuscated secondary effects such as spinoffs or economic multipliers.  (The latter says that for every dollar invested in NASA, NASA returns X in economic benefit.  I’ve seen no definitive number for X, with values ranging anywhere from 2 to 9 depending on the source.)  Reasonable people can disagree on how benefit is monetized, and thus we can end up with differing results for value.

(Oh, I probably angered a bunch of CBA analysts with that last paragraph.  So be it.)

In the commercial sector, as much as one may want to see altruistic reasons for getting into a business, often the key measure of benefit comes down to money: what is the profit, and what is the return on investment?  I know, I know – a company built to last does not use the profit motive as its purpose for being in business, yet the bottom line does have a significant role in whether a business stays in business, or not.  Even Disney with its “Make People Happy” purpose has to turn a profit; if it doesn’t, no more Disney shows on TV and no more amusement parks, and I know of at least two young girls who would be up in arms over that.

I don’t have a ready-made solution to this challenge.  Yet perhaps that in itself is a clue: the solution for what is best in the long run for the future of human spaceflight is not to be found through a detailed best value comparison of commercial-versus-Government approaches to low Earth orbit.  Might it be found elsewhere, in terms of the larger picture perhaps?

This goes back to another idea I raised later in the same interview, and touched upon in a recent blog post by Wayne Hale: the need for strong leadership.

That is a topic for another time.