The Value Proposition

Applying a formula in the nutraceuticals business to determine value.

By Adam Ismail

Value is kind of an abstract topic, and in some ways even psychological, because at the end of the day it is not based on analysis, it is based on what one party is willing to pay for an item. However, you can analyze who is creating value and who is capturing it, and for that matter who is destroying it.

There is a value creation formula that is widely used in analyzing in­dustries that might be interesting to apply to the nutraceuticals industry.

Value= (B-PB) + (PB-PS) + (PS-C)

B=Benefit to user
PB=Price user pays
PS=Price paid to supplier
C=Opportunity cost of providing a good



This formula basically says that you can measure the value created by a portion of the value chain by ad­ding up the value the customer takes in a good or service, the net margin of a manufacturer and the net opportunity cost of providing the good or service.

Things like opportunity cost and the benefit a consumer places on the product cannot be measured in monetary terms though. Instead, you can lo ok at what is going on in the industry and measure which portion of the value chain is creating or destroying value.

Buyer Power

When all of the negative press surrounding hormone replacement therapy (HRT) began to surface, consumers began flocking to soy products and others as alternatives. Consumers were suddenly more willing to pay for the supplements, but the prices didn’t adjust, which meant the buyer was capturing more value from the soy product value chain and as such garnered more power. Not many people who looked at the situation expected the sales spike that resulted from the HRT controversy to last. Certainly a lot of the sales would remain when it passed, but not the full spike. As a result, many retailers began to cut prices to keep as many of those sales as possible, which only reflects the power the consumers had in that situation.

As a result of the HRT situation, industry realized that a price cut had to be passed onto somebody—or at least a portion of it—and everybody up the value chain was forced to make concessions due to the consumer’s new power. In essence, the value of HRT alternatives was created by the controversy, in turn giving consumers new power, which caused manufacturers and retailers to shift value further toward the consumer.

Manufacturer Power

This is an area that hits home for most companies in the space because almost everybody has seen the impact of price wars and low price imports. For example, with St. John’s Wort, which was gaining significant popularity until about 1998, the market for supply was relatively concentrated and prices were inflated to reflect it. Then however, imports from China began to flood the market, causing a veritable price crash. However, for this period, manufacturers were able to maintain their prices due to strong consumer de­mand, and were capturing more value from suppliers with every lot of raw material sold.

Things changed quickly, though, as the market fell out from underneath the manufacturers when a few studies began to claim St. John’s Wort didn’t work. All of a sudden, the manufacturers were faced with massive returns on products that weren’t selling, so they began slashing prices to move inventory. This destroyed the value manufacturers were capturing and attempted to shift it towards the consumers. The only problem on the consumer end was that suddenly the benefits they received were perceived to be less valuable, so value was destroyed on their end as well. In many ways it would have been worth it for manufacturers to take one-time charges to reduce inventory and keep prices at higher levels where they could continue capturing value, although on a somewhat smaller scale.

Supplier Power

Supplier power is interesting because many suppliers do not focus on service to capture value. Instead, a lot of suppliers in the industry devote significant resources to developing pa­tents, brands and proprietary compounds in an effort gain power. Probably one of the most well known cases is Nutrition 21’s chromium picolinate. When its patent ran out, prices plunged by over 50%, and they lost much of the value they had been able to create for their customers.

A somewhat less ethical, but still interesting, example of suppliers creating value through their power happened when the members of the vitamin cartel conspired to fix prices of vitamin raw materials. By doing so they were trying to capture more value in a business that was somewhat less attractive than their other, mainly pharmaceutical, businesses. For them the opportunity cost of being in the vitamin business was high, so they came up with the price fixing scheme to overcome those costs.

Conclusion

This is a somewhat retrospective commentary on value creation in the nutraceuticals industry, but if you look at where our industry is headed there are a lot of events on the horizon that could shape the way companies capture value. The ephedra controversy has cast a gray cloud over the weight loss category; Congress is considering stricter legislation against supplements; the FTC is making its efforts against the fringe supplement makers more public and companies are devoting more resources to clinical trials. In short, a proper business strategy needs to consider how these changes are going to affect its value proposition and be able to adapt, or else it risks destroying value.NW