Value-in-exchange

When most of us think of value, we usually refer to monetary worth. This is the value-in-exchange model.

value-in-exchange: A view of value creation that sees value as a property of goods/service. Manufacturers embed value through taking an input and creating an output. Value is realised at the point of sale by exchanging for cash. When that exchange is with an end customer, they then proceed to use-up or destroy that embedded value.

In this model, value is a property we give goods and services. And we measure that property through price. Expensive things are valuable; cheap things can offer good value for the money. Crucially, we’re willing to exchange things of value to obtain other things of value (typically cash for goods and services).

McKinsey goes as far to say:

A product’s value to customers is, simply, the greatest amount of money they would pay for it.

Golub, H., and Henry, J. (1981) “Market strategy and the price-value model” via “Delivering value to customers”, McKinsey (2000)

Value-in-exchange really does seem to reflect our every day experiences and is reflected in our every day language – buying food, paying for transport, subscribing for music and films, and so on. It forms part of what Vargo & Lush call goods-dominant logic (to distinguish from their service-dominant logic with its value-in-use model).

How it works

Here’s how we visualise value-in-exchange working:

Successive manufacturers along the supply chain embed additional value by transforming inputs into outputs. For example, we consider a car more valuable than its individual components, such as the engine, wheels, and body parts. In turn, we see the engine as being more valuable than the metal block from which it is engineered, and so on. We even deem the metal block as more valuable than the raw earth material mined for it.

Once embedded with value, manufacturers seek to exchange their products, with end customers for something of equivalent value. Typically this is cash (something we also see as having value).

Now that the end customer owns the embedded value, they start using it up, or more violently destroying it; or both. We all recognise how the value of a car plumments the moment it is driven away from the dealer. Subsequently, the car’s owner gradually uses up the remaining value, through wear and tear, as they drive the car around.

Whilst we can argue that services are somewhat different, we force them into the same value-in-exchange model. Service providers embed value when designing a service. The output of the service is what they exchange with consumers for cash. The consumer consumes that value. Even here our language is about embedding, exchanging, and using value.

Implications

Prahald and Ramasawan nicely sum up the implications and manifestations of value-in-exchange thinking in their 2004 book “The future of competition – Co-creating unique value with customers”.

When we believe value is created by the firm, we believe the outputs of the firm – goods and services – are the basis of value. The implications being that the point of exchange is the focus of value creation. Leading the firm to create and deliver a variety of offerings.

This manifests in firms focussing on value chains and internal processes – not external needs or what happens before or after the point of exchange. With innovation focussing on technology, products and processes.

From this short introduction we can see value is:

• created by one party through transforming an input into an output
• used up/destroyed by another when using an output from a manufacturer
• exchanged at a point of time

The benefits

Our value-in-exchange model is the foundation of neoclassical economics. Adam Smith captures it well in his 1776 classic “Wealth of Nations”. He argues that a nation’s wealth relates to maximising the amounts of gold and silver received for the goods and services it supplies.

There’s no doubt it has been a wildly successful model – look at the growth we’ve had since Adam Smith’s time. Using Gross Domestic Product for England as a proxy for economic growth, growth increased from £14.6 billion to £1.67 trillion by 2016 (adjusted for 2013 prices! (source)).

Its success comes down to the strong focus on the point of exchange. This drives the manufacturers’ behaviours mentioned above – to maximise the size of each exchange or maximise the number of exchanges. Such focus has driven improvements in goods year after year..

The constraints

However, despite value-in-exchange’s success to-date, growth is stagnating as we can see over the last few decades.

Ultimately, it is the same point of exchange that has driven the previous wild growth that is now constraining growth. The strong focus on a point of exchange means we risk:

• missing opportunities before, after, and across the point of exchange
• becoming shortsighted on solution space and business models
• lowering innovation ambitions to just incremental innovation
• finding value predominantly judged by manufacturer as unattached to customer/consumers’ judgements

Let’s look at our these constraints in more detail.

missing opportunities before the point of exchange

Our focus on exchange encourages us to favour consistent products that demand minimal customer involvement. We can, therefore, mass-produce, lowering costs and providing the same repeatable value.

This has two considerable implications. Firstly, we’re much less interested in customising our products. This means we miss opportunities to create additional value before the exchange.

Whilst not all products sufficiently benefit from customisation, we often ignore opportunities for those that would. Or we restrict opportunities to customise. For example, when buying a car, manufacturers limit your options to a restricted range of paint colours and option packs. This is a case of reducing costs and maximising the number of exchanges.

Secondly, this preference for standardised products that do not need customer involvement means we prefer goods over services. Where we have to consider services we attempt to standardise them to behave like goods.

In fact, we’ve long regarded goods as advantageous to growth due to various properties they have. We can separate manufacturing and use, distinguishing the embedding of value from its destruction. Tangibility allows the creation of inventories, further supporting and reinforcing the value-in-exchange perspective.

Services, on the other hand, we traditionally see as having intangibility, heterogeneity, inseparability and perishability. Zeithmal, Parasuraman and Berr call these the IHIP properties in “Problems and Strategies in Service Marketing”). They have evolved into the 5Is of services; where we see services as:

• inconsistent
• intangible, where we cannot create an inventory
• delivery and consumption are inseparable and require customer involvement

These are the opposite properties to goods. And that encourages us to see a goods vs services world. A world where goods take precedence, and services are considered poor relatives. This is what Vargo & Lush have term goods-dominant logic.

But does this hold up in our modern world? Not totally. Today’s goods are increasingly intangible. Digital goods like streaming music, videos, and eBooks eliminate the need for inventories, as creating and distributing copies becomes instantaneous.

Even for tangible goods, modern approaches like just-in-time inventory management aim to minimise inventories. The future will likely see inventories becoming less important due to the widespread adoption of 3D printing, which will transition more goods into a digital format until needed.

Regarding inconsistency, inseparability, and customer involvement, Vargo & Lush argue in “The Four Service Marketing Myths” that we should see these as positive attributes:

• inconsistency we should see as customisation
• inseparability / involvement are necessary for co-creation of value

To unlock the growth opportunities of co-creation of value (where customisation, inseparability and involvement are needed) we need to move on from value-in-exchange.

missing opportunities after the point of exchange

It’s not just before the point of exchange where value-in-exchange thinking risks constraining growth. What happens after the exchange is also not usually of interest to us.

According to the value-in-exchange model, once the exchange occurs, the customer typically begins using up or destroying the embedded value. Meanwhile, businesses are busy securing the next exchange with a different customer. Additionally, a customer using up value is a good thing, since they’ll soon need to make another exchange themselves.

Let’s go back to our car example. Once you drive away from the dealer, some of the value is immediately destroyed (the price drops considerably). Then you drive the car around using up the remaining value until the car becomes junk metal.

In reality, you’ll also try and preserve and extend value by regularly servicing the car and repairing any damage. You might add after-market parts to increase value. Eventually, you may even decide to sell the car to recoup some of its remaining value.

We should update our view of value as shown below.

Focusing solely on the point of exchange means potentially overlooking opportunities associated with repairing, recycling, refurbishing, and reselling products. Now, that might be a strategic decision; but you are leaving opportunities to someone else.

Moreover, there’s a more concerning aspect to consider: by disregarding value creation post point of exchange, we could be impeding the transition to a circular economy.

not harnessing the circular economy

The value-in-exchange model, characterised by its ’embed-exchange-use/destroy’ approach, closely aligns with the linear economy’s ‘take-make-waste’ paradigm.

This stands in stark contrast to the principles of the circular economy.

In fact in the value-in-exchange model, it’s beneficial for producers if customers quickly deplete the value embedded in products, prompting them to make new exchanges.

A sobering observation from the 2024 Circularity Gap Report highlights a 21% drop in the share of secondary materials consumed globally from 2018 to 2023.

The share of secondary materials consumed by the global economy has decreased from 9.1% in 2018 to 7.2% in 2023—a 21% drop over the course of five years.

Circle Economy Foundation (2023) “The Circularity Gap Report 2024”

This decline underscores the impact of value-in-exchange thinking, which lacks interest in post-exchange activities and thus offers no incentive to design products before the exchange for sustainability. Why invest effort in making products recyclable or repairable when it may hinder, or minimise number of, exchanges?

The Ellen MacArthur foundation recently came to a similar conclusion:

one of the biggest challenges…to transition from linear to circular is that it requires…revisiting the very notion of value creation

Ellen MacArthur Foundation (2023) “From ambition to action: an adaptive strategy for circular design”

Sometimes external parties might require us to be more circular than is necessary from a value-in-exchange model.

For example, numerous countries require cnsumers to pay deposits on plastic bottles. In Sweden this is written into law. As a producer, to sell a drink in Sweden in a plastic bottle I must be signed up to a deposit scheme. As a consumer, I pay the deposit for each drink in a plastic bottle I buy; getting that back when I recycle the bottle. In 2022, Swedes recycled 86.7% of plastic bottles and 87.8% of cans sold.

becoming shortsighted on solution space

Focusing solely on the exchange can lead us into Levitt’s “Marketing Myopia” trap, where we define customers’ problems based on our existing solutions. We currently get good exchanges for those solutions. This narrow focus prevents us from recognising broader opportunities and addressing evolving customer needs.

By succumbing to marketing myopia, we risk becoming irrelevant as other entities, initially perceived as non-competitors, emerge with offerings that provide superior value to customers.

Numerous examples illustrate this phenomenon in the business world. Levitt’s classic example of the U.S. railroad industry illustrates this well. The industry’s exclusive focus on railroad operations for freight transportation caused it to overlook the potential of air freight. Leading to missed growth opportunities, and almost obsolescence.

getting comfortable with incremental innovation

Closely related to marketing myopia is the channeling of our innovation ambitions driven by value-in-exchange thinking.

Concerns over disrupting the flow of exchanges, tempt us to limit our innovations to those we would term incremental – enhancing existing products or refining internal processes. We end up adding yet another razor blade to the shaver cartridge rather than innovate a new ways of shaving.

It’s not that incremental innovation lacks the potential for growth; rather, there’s a limit to the number of increments before achieving additional growth becomes increasingly challenging. How many more razor blades can we add, for example?

Radical innovation, with its capacity to reshape or establish entirely new market, appears too daunting and risky. As for disruptive innovation, well, that is a specific approach that may not align, at first, with what you think (Uber, for example, does not fit the true definition of disruptive innovation). Yet performing it will similarly interrupt your existing exchange flows.

New challengers to your market generally have no existing exchange flow to interrupt. Therefore they have less concern with performing radical or disruptive innovation.

fixating on limited business model

By its very nature, the value-in-exchange model favours business models that focus on either maximizing value in each transaction or maximizing the number of transactions.

Typically, these exchanges are bi-party and occur between manufacturers/producers and customers/consumers, although the model allows for multiple parties to participate in exchanges. These additional parties may engage in subsidized value exchanges, such as advertisers or entities willing to pay for access to data, sometimes facilitated by government tax subsidies.

However, the value-in-exchange model struggles to effectively encourage other business models.

For instance, streaming subscription models still operate within the framework of value-in-exchange, albeit with a shift in the balance of value. While consumers may perceive increased value through greater choice, creators may experience reduced remuneration.

Similarly, businesses may encounter psychological hurdles when transitioning from a product-centric exchange model to a Platform as a Service (PaaS) model, despite the potential for smoother cash flow. Nonetheless, there is a growing recognition of the concept of a “shift to services,” indicating a perceived trend from merely selling goods to providing goods bundled with services. Thus, while challenging, such transitions are not insurmountable.

judging value is done by the manufacturer/provider

Finally, value-in-exchange thinking sees the manufacturer/producer as predominantly judging value. Signalling this as price.

However, this perspective is risky because ultimately, it is the customer who determines the value by deciding whether to exchange for the product or not.

Common sense tells us that there should be a link between innovation, market needs and innovator’s price expectations. Indeed, more mature organisations will perform market needs analysis, perhaps apply design thinking, and often run price sensitivity activities.

But you only need to watch Dragons Den/Shark Tank, or perhaps look at your own innovation initiatives, to observe this link is all too often weak or missing. This is why you see so many pitches on Shark Tank/Dragons Den with wild valuations. Or inventors that have sunk so much money into ideas that are ultimately going nowhere.

Worryingly, it’s not only individuals who misjudge value. For example, supermarkets perceive self-service checkouts as highly valuable to shoppers, but this assumption is not working out so well. And its not just a case of innovation adoption; they are not aligned with customers’ actual preferences or experiences, leading to suboptimal outcomes.

Relating to innovation

A value-in-exchange mindset has significant implications for innovation. As discussed earlier, it tends to steer incumbent suppliers, concerned about disrupting their exchange flow, towards incremental rather than radical and disruptive innovation.

Incumbents typically aim to either maximise the size of individual exchanges or increase the number of exchanges. In classical strategy terms, these approaches correspond to the generic strategies of differentiation and cost leadership, as identified by Porter (2004) in “The Competitive Strategy: Techniques for Analyzing Industries and Competitors“. However, this focus can also limit innovation and, consequently, growth.

On the other hand, value-in-exchange frees challengers, who lack an existing exchange flow, to challenge incumbents through radical and disruptive approaches. However, these challengers may fall into the trap of assuming they determine value, a misconception that can also affect incumbent’s innovations.

The concept of value-in-exchange strongly influences our definitions of innovation. For instance, ISO’s definition closely aligns with the notion of value being embedded, realised, and redistributed.

Innovation: new or changed entity¹, realizing or redistributing value²

¹anything perceivable or conceivable. Example: product, service, process, model, method, or combination thereof.

²gains from satisfying needs and expectations, in relation to the resources used. Example: revenues, savings, productivity, sustainability, satisfaction, empowerment, experience, engagement, trust.ISO 56000 (2020) – Innovation Management – Fundamentals and Vocabulary

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While value-in-exchange has undeniably fueled significant growth in the past, the exclusive focus on the point of exchange comes with limitations and missed growth opportunities.

We should embracing an evolution of thinking: value-in-use.