A Primer on Value Added   Stuart Nakamoto Revised 2/96 Keywords: agribusiness, gross value added, net value added

Today's agri-food system extends well beyond the farmgate to include manufacturers of farm inputs (such as fertilizer and tractors), food processors, transporters, wholesalers and retailers of food and other farm products. The producers' share of total agri-food economic activity has fallen over the years with continued industrialization, new technology, and consumer demands for more varied and convenient products. The agri-food system as a whole, however, remains a significant force in the economy.

As the complexity of the agri-food system has grown, agribusiness firms and policymakers have turned to the concept of value added to assess the role of agriculture in a modern economy. Value added provides a yardstick for measuring economic contribution. Value added data can be used in monitoring and evaluating the performance of companies or industries, and hence for improving their efficiency. Value added is similarly useful for assessing the productivity of different inputs.

At the level of entire economies, value added can be an important policymaking tool. It can aid in the allocation of resources among user groups when determining the appropriate level of economic development, debating issues on the promotion of export products, or evaluating the impact of different options to expand a primary sector. But there is often confusion, and sometimes misunderstanding, about what "value added" really means.

Value added is an economic accounting concept which traces the final value of goods and services purchased by consumers back through the economy to the points where the value was created. Thus, the value-added approach can identify sources of economic well-being and accounts for sources of income by tracing payments for the final goods and services. Value added places the cost of producing goods and services in perspective by comparing the cost to what is received for that cost.

In a productive activity, value is ultimately created using primary inputs, also called factors of production. These are commonly grouped into four categories:

• land and other natural resources such as water,
  
• labor of workers,
  
• capital, such as machinery and buildings,
  
• management and entrepreneurship.

Land, labor, capital and management are the fundamental sources of economic value.

Primary industries such as agriculture and mining create value from natural resources. In a few instances, the primary products created are sold directly to final consumers as primary products, or to another industry as raw materials. The second industry uses factors of production plus other purchased inputs to add value to the raw materials. This creates a final product for consumers, or an intermediate product for a third industry. There may be several more intermediaries before the product reaches the final consumer. Each adds value by combining factors of production with intermediate products or raw materials. The relationships between an industry and its suppliers (usually purchases by the industry) are called backward linkages. Relationships with buyers (usually industry sales) are forward linkages.

Thus, in a modern economy, a typical product passes through several value-adding activities before reaching the final consumer. There are five general ways by which value may be added. Value is added by physically changing the (1) form of raw materials or intermediate products. Butchering beef, milling wheat into flour, and canning pineapple slices are examples. (2) Location and (3) time values are added by transporting and storing goods so that they will be conveniently available for consumer purchase. (4) Possession value is added by wholesalers, retailers, and others who facilitate trade. Activities here include credit, insurance, and the transfer of ownership rights. Finally, value is added by providing (5) information about products. Advertising and promotion, grades and standards, trademarks, and labels are typical examples. Possession and information value are also associated with status and the image of a product as is found in Mercedes cars, Gucci handbags, and Kona coffee.

The value added to the economy by the agri-food system can be measured in many different ways, but the two basic measures are gross value added and net value added.

Gross value added recognizes that each step adds value as agri-food products move forward through the marketing chain. The cost of agri-food (raw or intermediate) products is subtracted from sales to avoid double-counting the value added earlier by other agri-food businesses. Thus, in the agri-food system,

GROSS VALUE ADDED = PRODUCT SALES less
COST OF GOODS & SERVICES PURCHASED FROM AGRI-FOOD SYSTEM

An agri-food business usually must use inputs from industries that are not part of the system. Fuel, packaging, electricity, office supplies, and legal services are some examples. Since the cost of these goods and services was not subtracted, a portion of an agri-food gross value added is actually contributed by other sectors of the economy. This outside value added can be deducted to get net value added in the agri-food system, where

NET VALUE ADDED = GROSS VALUE ADDED less
COST OF GOODS & SERVICES PURCHASED FROM
SUPPLIERS OUTSIDE THE AGRI-FOOD SYSTEM

Since net value added deducts the cost of all purchased inputs except an industry's own factors of production, it represents the total returns to all factors employed by the industry. Net value added should not be confused with producer profits, which deduct the cost of factors of production. Net value added is a legitimate and, from economists' perspective, the preferred measure of an industry's contribution to the economy. Net value added is comparable to the figures given in national or state domestic product and income accounts.

The value added by the agri-food system can be estimated for different

• products or product groupings,
  
• firms, industries, groups of industries, or the entire economy,
  
• number of intermediaries or levels separating agriculture from the final consumer.

Such comparisons can be made over time, or the value added by one entity can be compared to others as a gauge of relative importance in the same time period.

The scope of interest must be clearly defined, since it will affect value added calculations. The "correct" measure for any given case depends on the purpose and ways the information will be used.

Gross and net value added can be computed for all the goods produced and sold by an industry, or they can be computed on a per unit basis. On-farm value added can be found from farm cost of production data. Off-farm measurements usually emphasize forward linkages after the farmgate.

Gross value added measures include the aggregate marketing bill and per unit price spreads. Off-farm figures are often broken down by marketing function such as processing and transportation, and wholesaling. Other common breakdowns are gross value added by input cost category, and the shares of net value added contributed by different factors of production.

Stuart Nakamoto is a member of the Western Extension Marketing Committee and is an Extension Economist at the University of Hawaii at Manoa. This article is an excerpt from C.A. Ferguson, J.M. Halloran, and S.T. Nakamoto, "What is Value Added?", Economic Fact Sheet #14, Dept. of Agricultural and Resource Economics at University of Hawaii, June 1991.

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