Power clash - where the money goes?

Imagine a simple situation presented on the map below:

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There is a system that satisfies a user need, and that system is assembled out of two, mature components. When the user pays the company, money is supposed to flow downwards to all involved components, just like in a champagne tower.

The question is - what should be each component’s share in the transaction profit? It sounds simple, but let me bring you a real-life example - at my local university, didactics has been split up from infrastructure. The latter one charges the former for room usage, but there is on-going discussion whether it charges enough.

We observe similar conflicts all the time - it might be a conflict between business functions layer in the organisation vs underlying IT infrastructure, or between electricity producers and distributors.

The consideration here is important, as the last thing we want is to subsidy an ineffective component. If the university is not paying a market price for the infrastructure access, then not only the infrastructure team would be much better by selling service outside, but it could be revealed that the didactics is doing a poor job (yes, I do have a mixed feelings about this because it is a university, but in other cases… no handicaps should be given).

So, how to find out the right proportion? There are two options.

1. This is preferred. If possible, look for similar services in the market. This is the price that should be paid for the underlying component service.
2. Sometimes, there are no market equivalents. In such a situation you have to estimate the power and potential of each component. If they were not cooperating to satisfy this user need, what would be their fate? Could they be repurposed? Could they use some replacement? The component that has more possibilities and is less dependent on the other (to either deliver value or customers) will always get a higher share.

One thing you cannot forget is that components are a form of capital, and you want your capital to work for you no matter what you are doing. This means that your income (flowing from other components) should be always bigger than your costs, and the size of that difference depends on uncertainty (a few percent for mature components, as much as you can achieve for uncharted ones).

And if it is not a case… you have something to think about.

This is an interesting question, and the university setting has some properties that helps expose more considerations.

If the facilities team wants to set the room rental rate based on market value, there is a danger that the university will be priced out of the market, and the facilities team will want to convert the university campus into commercial office space. This would seem to undermine the university, but perhaps this is a good thing - putting the real-estate asset to the best economic use, and forcing the didactics organization to evolve.

Thinking about this in my head, I get tangled up in the idea of uprooting an historic institution, moving it to a lower cost office park outside the city, and converting the traditional property to condominiums. Economically, this seems to be healthy progress, but I worry about the impact on the community, and the mission of the university. I want to avoid an emotional decision, but I also don’t want to destroy value just because I don’t know how to put a cash price on it. Can we consider these concerns on a map?

On the other hand, it occurs to me that the facilities team are probably not real estate investors, and did not purchase that land. The value they add and should profit from is related to the operations and maintenance of the room, not the market price for the real estate.

In mapping terms, the facilities team depends on a lower-level component of real estate. However, other components of the university may also depend on that physical location. There may be branding value, access to students, staff and faculty, and research partnerships with the local business community. So the real estate component may have a large economic value, but it must be divided across multiple higher-level components that depend on it. In short, not all of its value flows up to the facilities team.

Furthermore, we may realize that the land component is provided under special rules to the university. Perhaps it was a grant from the government to foster education, or perhaps there are tax or other subsidies to encourage the university. Since these are only available to the university, the real estate component may not be a commodity - it may be a custom component that cannot be easily replaced by a market substitute. In fact, it might be an important differentiator to the university, because no other university exists or can be easily built in that physical location.

The lesson here is that the map is a useful way to think about value created at each component, but you should be careful to draw a complete map (all upstream users of a component), and to unpack lower level components that seem to hold a lot of the value.

Even more interesting :-). In Poland, you will find state universities with usually 100+ years tradition and rich infrastructure in the centres of cities AND privately owned high schools (not in the American sense) which usually rent space.