Chapter Three

The REA Enterprise

Ontology: Value System
and Value Chain Modeling
LEARNING OBJECTIVES
The objectives of this chapter are to describe the components of a typical
enterprises value system and value chain and to discuss the procedures for
developing models of enterprise value systems and value chains. After studying this
chapter, you should be able to:
1. Identify an enterprises external business partners
2. Identify the resources that are exchanged between an enterprise and its business
partners
3. Develop a value system level REA model for an enterprise
4. Identify the business processes (transaction cycles) in an enterprise
5. Identify the resource flows between an enterprises internal business processes
6. Identify the economic events that cause the resource flows between an
enterprises internal business processes
7. Develop a value chain level REA model for an enterprise
8. Explain how enterprises create value and describe Porters Value Chain Model
9. Explain how evaluating enterprise activities at the value system and value chain
levels facilitates understanding the business process level

VALUE SYSTEMS AND VALUE CHAINS

We introduced the concepts of value systems and value chains in Chapter 2; we examine
them more closely in this chapter. You may be surprised to learn that many of the critical
steps of building an information system have little to do with programming a computer.
The process begins with identifying the need for a business solution and acquiring a bet-
ter understanding of the environment you plan to support and/or improve. You must ex-
amine that environment (the enterprise) from different perspectives and at different levels
35
36 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling

of detail. We believe the first level of detail you should consider is the least detailedthe
big picture view that we call the value system level. You may have heard the saying they
couldnt see the forest for the trees used to describe those so mired in detail that they for-
get the big picture of what they are trying to accomplish. We believe that looking at the
forest level of an enterprise first and trying to develop a plan for analyzing the enterprise
a section at a time will help you keep your perspective and avoid getting mired in the de-
tail. Obviously there is plenty of detail in which to get mired, so try to keep picturing the
end goal and the plan for getting there to keep you on the path.
Examining the value system level of a firm includes thinking about the enterprises
mission and strategy. Understanding this level is crucial because later you must ensure that
activities within the enterprises business processes are consistent with its overall mission
and strategy. The REA ontology is about much more than developing information sys-
tems; it is about understanding enterprises.
Everything an enterprise does should create value for its customers according to
Michael Porter in Competitive Advantage.1 Creating value has a cost. For example, an en-
terprise that assembles automobiles creates something of value but also must pay for var-
ious inputs (e.g., materials, supplies, and time of employees). Porter computes an organi-
zations margin as the difference between value and cost. This calculation includes all
value and all cost, much of which is difficult to measure financially, but which the REA
value chain model can capture if measurements are available.
The concept of creating value applies to both for-profit and not-for-profit organizations.
For-profit organizations try to maximize their margins. Not-for-profit organizations, such as
charitable or governmental entities, seek to maximize the goods and services they provide
with the resources (funds) they receive. Over the long run, charitable and governmental or-
ganizations seek to optimize their services while matching outflows to inflows. Whether for-
profit or not-for-profit, viable organizations provide goods and services that customers value
in a cost-effective way. The main difference between for-profit and not-for-profit enterprises
is that at the value system level, the input resources and output resources are paired with dif-
ferent external business partners. That is, some of the partners who give resources to the
not-for-profit enterprises do not receive resources directly from the not-for-profit enterprises
and some of the partners who receive resources from the not-for-profit enterprises do not
give resources to the not-for-profit enterprises. The overall notion of input resources being
transformed into output resources is still valid because one would expect that if the not-for-
profit organization failed to provide the expected goods and services, its contributing exter-
nal business partners would discontinue their contributions.
Every organization seeks to create value by providing goods and services customers
want. For example:
A grocery store creates value by providing food in a clean and convenient location for
customers to purchase.
An airline company creates value by safely transporting passengers and cargo in a
timely manner.
An automobile manufacturer creates value by producing safe, reliable vehicles to trans-
port people and cargo.
1M. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free
Press, 1985), p. 12.
Case in Point Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling 37

In the late 1970s and early 1980s when gas prices were rapidly rising and our oil sup-
plies were in doubt, most new car buyers favored smaller, more gas-efficient automo-
biles. Americas automobile manufacturers had several lean years as they modified
their automobile design to smaller, fuel-efficient vehicles. Over the next decade as the
percentage of small cars increased, most parking lots adjusted the size of the parking
stalls from 8 or 9 feet wide to 7 feet wide. But since 1987 the size of Americas cars has
been getting bigger. In sprawling Western and Southwestern cities, the popularity of
sport-utility vehicles and pickup trucks can make parking a hassle. Parking lots with
larger parking stalls are now able to charge a premium price. Parking problems will
likely increase as the popularity of the Hummer increases. The Hummer is the civilian
adaptation of a military vehicle that is 8 feet wide, including the mirrors.*
*Neal Templin, Big Cars and Little Spaces Cause Mayhem, The Wall Street Journal, March 11, 1998, pp. B1, 8.

A municipality creates value by providing essential community services (e.g., police

protection, fire protection, emergency services, and utilities) to its citizens.
Enterprises that provide goods and services of value to their customers will survive and
grow while those that do not will shrink and die. Due to competition for scarce resources,
each enterprise must provide value in a cost-effective manner. Although some organiza-
tions manage to defer their demise through deceit, disguise, or political influence, ulti-
mately every organization has to answer to the final arbiter of valuethe customer.
Because enterprises need increased adaptability, effectiveness, and efficiency to remain
competitive, most organizations find it essential to differentiate between the various busi-
ness activities in which they engage. Obviously, organizations must look internally at each
of their functions and develop capabilities in each area. They also must effectively inte-
grate and coordinate all business functions. However, in todays business world, an orga-
nizations performance is increasingly affected by the world around it. You might work for
the most internally cost-effective organization you can imagine, but it might be an unsuc-
cessful organization. Why? Perhaps the organization has competitors who better meet the
needs of customers, do a good job of outsourcing some business functions, or do a better
job of creating effective strategic alliances with trading partners.2
To really understand and analyze an organization, you must understand more than in-
ternal operations and functions. You must look outside the organization at the industry, the
suppliers, the customers, and all the other parties that affect organization performance. In
other words, you must examine the enterprise at its value system level, and also consider
how the enterprises value system interacts with the value systems of the other enterprises
in its supply chain. An enterprise supply chain encompasses all of the enterprises involved
in providing a product or service to an end customer. For example, Robert Scott Woodwind
Shop purchases instruments from its suppliers as part of its value system level activities.
Those suppliers had value systems of their own to make those instruments available for

2Outsourcing occurs when one organization finds another organization to perform some work. This is
usually done when the outsourcing organization cant complete the work (e.g., they do not have the
capacity or the expertise) or when they identify another organization that can complete the work in a
more cost-effective manner.
37
38 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling

EXHIBIT 31 Porters Generic Value Chain

Source: Michael Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free Press, 1985).

Revenue

Costs

Firm infrastructure
Human resource management
Support activities

Technology development
Procurement
Margin
Inbound Operations Outbound Marketing Service
logistics logistics and sales

Primary activities

sale to RSWS. Likely RSWS buys the instruments from the manufacturers; their value sys-
tem levels would involve purchasing raw materials, labor, and manufacturing equipment
from their suppliers. Those suppliers had value systems to make those items available for
sale.
Eventually managers must look at the entire supply chain to streamline interenterprise
activities and gain efficiencies in operations. However, the best first step is to focus on the
enterprise in the context of its immediate business partners, then to focus on the enterprise
value chain and the internal business processes that comprise that chain. Once you un-
derstand the enterprise in the context of its immediate business partners and its internal
processes, examine the more distant links on its supply chain.
To complete a thorough cradle-to-grave analysis, many people use the value chain
analysis approach originally proposed by Michael Porter.3 Porter illustrated that each firm
is a collection of activities that are performed to design, produce, market, deliver, and
support its product. You can see Porters Generic Value Chain in Exhibit 31.
Although this diagram looks different from the value chain diagrams we use in this text-
book, both types of value chain diagrams encompass the same set of activities. Porters
value chain is defined as a set of business activities that add value or usefulness to an or-
ganizations products or services; the REA ontology defines the value chain as a set of
business processes through which resources flow, with the assumption that value is added
to the resources within each business process. The value chain is intended to show total
value and consists of value activities and margin. Value activities are the physical and tech-
nological activities performed by an organization. Porter presented two types of value ac-

3M. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free
Press, 1985); and Competitive Strategy Techniques for Analyzing Industries and Competitors (New York:
Free Press, 1980).
 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling 39

tivities in his generic value chain: primary and support. Primary value activities consist
of the events that create customer value and provide organization distinctiveness in the
marketplace. They are the critical activities in running a business. Support value activi-
ties facilitate accomplishing the primary activities. Margin is the difference between total
value and the cost of performing the value activities.
Porters primary value activities include the following categories:
Inbound logisticsactivities associated with receiving, storing, and disseminating in-
puts to the products or services
Operationsactivities associated with transforming inputs into the final products or
services
Outbound logisticsactivities associated with collecting, storing, and physically dis-
tributing the products or services
Marketing and salesactivities associated with providing a means by which cus-
tomers can buy products and the means for inducing them to buy
Serviceactivities associated with providing service to enhance or maintain the value
of the products or services
Porters support value activities include:
Procurementthe function of purchasing inputs to a firms value chain
Technology developmentthe know-how, procedures, or technology embedded in
processes that are intended to improve the product, services, and/or process
Human resource managementactivities involved in recruiting, hiring, training, de-
veloping, and compensating all types of personnel
Firm infrastructureactivities that support the entire value chain (e.g., general man-
agement, planning, finance, accounting, legal, government affairs, and quality manage-
ment)
In REA value chain analysis we also differentiate value activities in three event cate-
goriesoperating events, information events, and decision/management events. We define
and discuss these categories in Chapter 4.
Value system and value chain analyses are valuable because they compel you to under-
stand the internal operations of a firm as well as the forces and parties outside the firm that
affect its ability to create value. The direct actions of an organization are only part of its
overall value chain process. It is also important to look at external linkages, such as the ac-
tivities of customers and suppliers, to understand the ability of an organization to create
value. For example, some organizations may be more successful at creating value because
they elicit quality responses from their customers and use the feedback to quickly change
or upgrade their products. Other organizations may achieve success because they have
worked effectively with their suppliers to reduce costs and improve the ability to respond
to customer desires. A thorough analysis of the value system and value chain helps you to
understand all the activities that are strategically relevant to an organization, not just the
portion of activities in which an organization directly participates or controls. In Exhibit
32 we illustrate how the value system and value chain activities are linked. In this dia-
gram note that Suppliers encompasses suppliers of every type of resource, including em-
ployees, investors, and creditors, as well as those who supply products and services.
40 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling

EXHIBIT 32
Relating Value Suppliers Customers
System
and Value Goods and Payment for
Requested input Payment for
Chain Levels services for goods and
resources input resources
customers services

ENTERPRISE

Acquistion Sales
Conversion
payment collection
Provides process Provides
process process
input goods and
resources services

VALUE SYSTEM LEVEL REA MODELING

To develop a value system level REA model you must answer the question, Who are the
enterprises external business partners? To answer this question, focus on resource
flows and ask the question this way, To whom does the enterprise give resources and from
whom does the enterprise receive resources? Recall from Chapter 2 that resources are de-
fined as things that have economic value to the enterprise. Recall also from Chapter 2 that
we are taking a pattern-based approach to developing enterprise information systems. Thus
we want to consider what is true for most enterprises and then make adjustments as nec-
essary for our particular enterprise. Most enterprise resources fit into one of the following
categories:
Cash
Inventory (raw materials, finished goods, merchandise, parts, and supplies)
Labor
Property, plant, and equipment
Insurance
Services (such as advertising or government services)
Utilities (water and energy)
To determine an enterprises external business partners, a helpful step is to examine which
of these resources the enterprise provides or uses and then determine to whom they provide
the resources and from whom they acquire the resources. To make matters even simpler, in
the current economic environment cash is the universal resource for which most other re-
sources are exchanged. Very seldom do companies engage in barter transactions (ex-
changes of a noncash resource for a different noncash resource). Therefore by concentrat-
ing on identifying the various partners to whom the enterprise pays cash and from whom
the enterprise receives cash, you very likely have identified all the appropriate external busi-
ness partners. Typically the external business partners fit into the following categories:
 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling 41

Vendors or suppliers (of various types of inventory, equipment, utilities, insurance, and
services)
Employees
Investors and creditors
Customers
Sometimes examining the cash outflows of an enterprise does not reveal a resource re-
ceived in exchange. For example, when an enterprise pays cash to government agencies
(such as the Internal Revenue Service) what resource does the enterprise receive in ex-
change? Some resources the government provides are easy to identify, such as a license to
do business, or police and fire protection services. However, the amounts paid in taxes and
fees to the government often exceed an identifiable resource received in exchange and we
must simply label the resource as government services. Payments to charitable organiza-
tions pose a similar dilemma. If an enterprise donates money to a university, what resource
does it receive in exchange? The enterprise must believe it receives a resource, because en-
terprises are assumed to make economically rational decisions. The enterprise may expect
goodwill, an increased reputation in the community (in effect, advertising), or an advan-
tage in recruiting the universitys students. Based on the assumption that the enterprise
does in fact receive resources in exchange for these payments, hopefully you have figured
out that government agencies and charitable organizations would be included in the exter-
nal business partner category of vendors or suppliers.
Once the resources an enterprise uses are identified and the external business partners
with whom these resources are exchanged are determined, the information is portrayed in
a diagram. The enterprise being modeled is represented as a circle or oval in the center of
the diagram. Each external business partner is represented as a square or rectangle; these
are placed around the outside of the circle that represents the enterprise. Arrows are drawn
between the circle and the squares as appropriate to indicate the actual resource exchanges
between the enterprise and its business partners. Lets examine the RSWS example intro-
duced in Chapter 2 to determine how the value system level REA model was constructed.
The value system diagram from that example is reproduced in Exhibit 33.
The first step in constructing this model is to examine the various resources RSWS uses
in its operations. Cash is certainly used by RSWS. Lets consider how the cash is used, to

EXHIBIT 33 Cash
Investors and
Robert Scott creditors
Woodwind
Shop REA Cash
Value System Goods,
Goods, services
Level Model services Robert Scott
Suppliers Customers
Woodwind
(vendors) Cash Shop Cash

Labor

Employees
Cash
42 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling

whom it is paid, and from whom it is received. We identify that cash is received from in-
vestors (for equity financing), from creditors (for debt financing), and from customers.
Thus we draw a rectangle to represent the set of investors and creditors and another rec-
tangle to represent the set of customers. Cash is received from investors and creditors be-
cause they expect to receive cash in exchange, therefore we simply draw an arrow from in-
vestors and creditors to RSWS and label it cash to represent those cash inflows. We draw
another arrow from RSWS to investors and creditors to represent cash outflows to investors
and creditors (e.g., for interest payments, dividends, principal repayments, and treasury
stock purchases). Next we draw an arrow from customers to RSWS and label it cash to rep-
resent the cash inflows from customers. We realize that the reason customers give RSWS
cash is because they expect RSWS to provide goods (e.g., instruments, accessories), repair
services, or the use of goods (i.e., rental of instruments). Therefore we draw an arrow from
RSWS to customers to indicate that RSWS provides those resources to its customers.
We then inspect the narrative to determine what types of cash payments are made and
to whom. We identify cash payments made to employees and realize that those payments
are made in exchange for labor provided by our employees. Therefore we draw a rectangle
to represent the set of employees. We draw an arrow from RSWS to employees to repre-
sent the cash outflows to employees and we draw an arrow from employees to RSWS to
represent the labor inflow from employees. You might notice that there is no arrow to rep-
resent benefits such as health insurance paid to employees. Is it because RSWS doesnt
offer any such benefits or is it because they have forgotten to represent them? The answer
is neither. Payments made for health insurance for employees is a cash outflow to suppli-
ers made by RSWS on behalf of the employees. The actual insurance is an outflow from
the health insurance supplier to the employees and is outside the scope of RSWSs value
system model, which only examines the direct resource flows between RSWS and its ex-
ternal business partners. This leads us to the other external business partner for RSWS
the suppliers (some enterprises may call these vendors). Suppliers is the set of all nonem-
ployee individuals or organizations from which an enterprise acquires goods and services.
We draw a rectangle to represent the set of suppliers, an arrow from RSWS to suppliers to
indicate the cash outflow, and an arrow from suppliers to RSWS to indicate the inflow of
goods and services.

VALUE CHAIN LEVEL REA MODELING

Once the value system level analysis is complete, much of the initial value chain analysis
has also been completed. This level of analysis focuses on the resource flows between its
internal business processes. A business process is a series of activities that accomplishes a
business objective: adding value to input resources. Once you have identified the resources
flowing into and out of the enterprise, examine what the company does with its input re-
sources and how it generates its output resources. As business processes use up resources,
they should be producing resources worth more to the enterprise than those used up. As
noted earlier, enterprises create value by developing and providing the goods and services
customers desire. Goods and services are provided through a series of business processes.
Regardless of the type of goods or services provided, each organization has at least three
business processes (see Exhibit 32):
 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling 43

1. Acquisition/payment process: The objective of the acquisition/payment process is to

acquire, maintain, and pay for the resources needed by the organization. Many resources are
required including human resources, property, plant, equipment, financial resources, raw
materials, and supplies. Resources are acquired from external entities like suppliers or ven-
dors. These are the inputs required by the organization to provide goods and services to its
customers. Because the acquisition of financial resources and the acquisition of human re-
sources have complexities not found in the acquisition of other goods and services, many
enterprises separate these activities into additional business processes, called the financing
process and the human resources process, that we cover separately in later chapters.
2. Conversion process: The objective of the conversion process is to convert the ac-
quired resources into goods and services for customers. The raw inputs are transformed
into finished goods and services by this process.
3. Sales/collection process: The objective of the sales/collection process is to sell and
deliver goods and services to customers and collect payment. The finished goods and ser-
vices from the conversion process are sold to customers (external entities) in exchange for
their payment, usually in the form of cash.
Creating a value chain model that illustrates the linkages between these processes requires
understanding of two very important concepts in the REA ontology: duality and stockflow.
These concepts characterize the core economic phenomena of an exchange. As noted ear-
lier, enterprises are assumed to make rational economic decisions. Rational economic the-
ory precludes decision makers from giving up something with no expectation of anything
in exchange. For every event in which an enterprise gives something up we expect a re-
lated event in which the enterprise receives something. The causal relationship between a
give event and a take event is a duality relationship. Stockflow is defined as the inflow or
outflow of a resource. Stockflow relationships exist between give events and resources
(these stockflows are outflows) and between take events and resources (these stockflows
are inflows). The value chain level of the REA ontology is constructed based on these two
concepts. Geerts and McCarthy say, Duality relationships are the glue that binds a firms
separate economic events together into rational economic processes, while stockflow rela-
tionships weave these processes together into an enterprise value chain.4
The first step in creating a value chain model is to write the enterprise script to identify
the business processes that need to be included in the value chain. We use the value sys-
tem level model along with whatever other information we have such as a narrative de-
scription about the enterprises activities. The second step in creating a value chain model
is to draw the resource flows to link the business processes together. The third step is to de-
termine the economic exchange events and the duality relationships that make up the core
of each business process in the value chain. An example will clarify these steps.
Lets revisit our RSWS example. In Exhibit 23 (reprinted here as Exhibit 34) we por-
trayed a summarized value chain level that would be the result of the first two steps. After
going through steps 1 and 2 to reconstruct this model, we discuss step 3 and illustrate the
resulting detailed value chain model.

4G.Geerts and W. E. McCarthy, Modeling Business Enterprises as Value-Added Process Hierarchies with
Resource-Event-Agent Object Templates, in J. Sutherland and D. Patel, eds., Business Object Design and
Implementation (London: Springer-Verlag, 1997), pp. 94113.
44 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling

EXHIBIT 34
Robert Scott Cash
Woodwind Financing
Shop Business process
Processes
Cash Cash
and Resource
Flows
Revenue
Summarized Labor (sales/collection)
Value Chain Payroll process
View process Conversion
(manufacturing)
process Manufactured
accessories,
Raw repair services
materials Equipment
Acquisition/ Overhead
payment Instruments
process

Step 1: Write the Entrepreneurial Script

To complete this step, we examine the typical scenes of the entrepreneurial business script
to see which of the typical scenes RSWS has. Based on our value system level analysis,
the typical script pattern, and the narrative description of RSWS we write RSWSs script
as follows:
RSWS gets cash from investors and creditors
RSWS engages in value-adding activities
uses cash to buy instruments, raw materials, and overhead from vendors
uses cash to acquire labor from employees
uses materials, equipment, and overhead to manufacture accessories and to provide
repair services
sells instruments, accessories, and repair services to customers for cash
RSWS pays cash to investors and creditors
The first and last scenes together comprise the financing process; in scene 2, the subscenes
are (in order) the acquisition/payment process; the human resources (payroll) process; the
conversion process; and the sales/collection process. Keep in mind that all of these scenes
and subscenes come directly from our value system level analysis except for the uses ma-
terials, equipment, and overhead to manufacture accessories and to provide repair ser-
vices. Because the subscene doesnt involve resource exchanges with external business
partners, it is not modeled at the value system level. Thus you must be careful when de-
veloping your value chain model to include not only the scenes that you derive from the
value system level but also any business processes that add value via internal resource
transformations.
 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling 45

Step 2: Connect the Scenes with Resource Flows

Once all the scenes are identified they need to be combined to form a value chain (at which
point no distinction is made between scenes and subscenes). The resource flows provide
the link from one scene to the next. Once the cash is acquired in the financing process, it
is used as input for the acquisition/payment and human resource processes, where it is
transferred out to external business partners in exchange for instruments, raw materials,
overhead, and labor. Because the value chain model only illustrates the internal processes,
we dont show the cash outflows from the acquisition and payroll processes to the external
partners, nor do we show the related resource inflows from those external partners. From
this perspective we view the acquisition process as one that uses up cash and produces ma-
terials, equipment, overhead, and instruments; and we view the payroll process as one that
uses up cash and produces labor. We view the conversion process as one that transforms
the labor, materials, equipment, and overhead into the accessories and repair service re-
sources. The sales/collection process is then viewed as one that uses up instruments, ac-
cessories, and repair services and obtains cash. The assumption is that in each of these
scenes the resources produced are worth more than the resources used up; thus value is
added to the enterprise in each link of the chain.

Step 3: Specify the Economic Exchange Events within Each Scene

The third step in creating the value chain diagram adds more detail to the diagram that
clarifies how each scenes representation in the value chain diagram provides the starting
point for a business process level model representation. This step entails depicting the eco-
nomic exchange events inside each scenes bubble on the value chain diagram. Each scene
must contain at least one economic increment (take) event and at least one economic
decrement (give) event. You can use the resource flows to determine what events are
needed. This analysis also helps you to determine whether a scene in your value chain
should be decomposed into multiple scenes. The general rule to follow for this step is that
each process must have an economic decrement event to match up with each resource in-
flow and an economic increment event to match up with each resource outflow. The idea
is that if a resource is flowing into a process, the process must include an event that uses
it up (either by transferring it to an external partner or by transforming it into a different
resource). Similarly, if a resource is flowing out of a process, the process must include an
event that produced the resource (either by transferring it in from an external business part-
ner or by creating it as a transformation of some other resources.
In our RSWS example, lets add detail first to the financing process. Because cash is a
resource inflow to that process, the process must include an event that uses it up (i.e., a
cash disbursement event). Cash is also a resource outflow from financing, so the process
must include an event that acquired it (i.e., a cash receipt event). The cash receipt and cash
disbursement events are linked via a duality relationship. So we draw two event boxes in-
side the financing process bubble and connect them via a diamond (relationship symbol)
labeled with the word duality. We label the events cash receipt and cash disbursement.
Note that even though the cash flows from the financing process to multiple other
processes, the data attributes of all cash receipts are likely the same so we consider cash
receipts for all purposes as part of the same event set. The fact that cash got used for dif-
ferent purposes doesnt matter.
46 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling

Next we examine the payroll process. Because cash is a resource inflow, the process
must include an event that uses it up (i.e., a cash disbursement event). Notice that the en-
terprise will likely have only one cash disbursement event set that encompasses all cash
disbursements made for all purposes, but we must depict the event set in each business
process that uses cash. The payroll process generates labor as its resource outflow, so there
must be an event within the payroll process that obtains that labor (labor acquisition, an
event that transfers the labor in). So we draw two event boxes inside the payroll process
bubble and connect them via a diamond (relationship symbol) labeled with the word du-
ality. We label the events cash disbursement and labor acquisition.
The acquisition/payment process is similar to the payroll process. Cash is a resource in-
flow to acquisition/payment, so the process must have an event that uses it up (i.e., a cash
disbursement event). The acquisition/payment process has instruments, materials, services,
and equipment as outflows, so the process must include an event that obtains those things
from external sources (i.e., an acquisition event set). Here we must determine whether the
same data attributes are recorded for acquisitions of each of these types of items. For any
that are different, the events should be modeled separately and the recommendation would
be to make separate acquisition cycle bubbles. Lets say we determine that RSWS records
all acquisitions using a common set of forms and captures the same data attributes for
them. Thus we need only one acquisition event set and only one acquisition process
(scene). We draw two event boxes inside the acquisition/payment process bubble and con-
nect them via a diamond labeled with the word duality. We label the events cash disburse-
ment and acquisition.
Next we examine the conversion process. The conversion process is typically the most
complicated scene. Our value chain diagram shows input resource flows as materials,
equipment, labor, and overhead. That indicates our conversion process must have events
that use up each of those items. We determine that raw materials are used up as they are
issued into a manufacturing or repair job so we draw a box labeled material issue. We note
that employee labor is used up through the employees involvement in labor operations, so
we draw a box labeled labor operation. Equipment and overhead are used up in machine
operations, so we draw a box labeled machine operation. Next we need to determine what
event produces the finished accessories and/or repaired instruments. We determine that for
RSWS every repair service and each production run for a batch of parts or accessories is
considered to be a work in process job. Thus we add a box labeled WIP Job. We realize that
the material issues, labor operations, and machine operations are economic decrement
events (they use up resources) that are matched with the WIP job, which is an economic
increment event (it produces resources). Therefore we draw a diamond symbol to connect
all four boxes and label it as duality.
Now all our scenes are detailed except for the Sales/Collection process. We see that the
input resources are the instruments (from the acquisition process), and the manufactured
accessories and repair services (from the conversion process). The instruments get
changed into cash either by selling them or renting them to customers. The repair services
and manufactured accessories are also changed into cash by selling them to customers. As
with the acquisition process, we need to make a choice as to whether there is a common
sale event set for which the same set of data attributes can be maintained, or whether the
activities are dissimilar enough to warrant being maintained as separate event sets. For this
example, we assume RSWS uses the same set of forms and captures the same data attri-
 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling 47

EXHIBIT 35 Robert Scott Woodwinds Shop Detailed Value Chain

Cash
receipt
Cash
Financing
Duality
process
Cash
Cash disbursement
Cash
Sale

Labor
acquisition Labor Revenue
Labor Duality
operation process
Payroll Conversion
Duality
process Cash
Material WIP receipt
Duality
Cash issue job
disbursement
process Manufactured
Machine accessories,
operation
repair services
Raw
materials
Acquisition
Overhead
Acquisition/ Instruments
Duality
payment
process
Cash
disbursement

butes for each of these revenue-generating activities, so we combine them into one eco-
nomic decrement event called sale. The output resource flow is cash, indicating that the
process must include an event that produces or obtains the cash, in other words an eco-
nomic increment event called cash receipt. We draw two boxes with a duality relationship
connecting them; we label one box sale and the other box cash receipt. Now our value
chain is complete (see Exhibit 35) and may be used to facilitate creation of the business
process level models for RSWS. We discuss that process in detail in Chapter 4.

CONCLUDING COMMENTS
In this chapter we have provided a patterned approach for developing models of enterprises
at two levels of detailthe value system level and the value chain level. This approach fa-
cilitates your understanding of how business enterprises work. As you go about your daily
activities, pay attention to the business enterprises with which you interact and look for
these script patterns. When you go out to eat at a restaurant, or order pizza, see if you can
picture the value system and value chain for that restaurant or pizza place. When you go
shopping at different kinds of stores: grocery, convenience, department, or electronics, see
if you can identify the value system and value chain patterns for those stores. Consider
what they have in common and any differences they may have. Think about the possibili-
ties of using the things they have in common as base objects in an information system and
48 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling

keeping the things that are unique as nonfoundational elements in the information system.
Think about how such an approach could lead to enterprise systems that may be integrated
with solid connections rather than tied together with string.

Key Terms and Concepts

Customer, 36 Internal business Resource flow, 40
Duality relationship, 43 process, 38 Service, 39
Economic event, 46 Margin, 36 Strategy, 36
Exchange, 40 Marketing and sales, 39 Supplier, 37
External business Operations, 39 Supply chain, 37
partner, 40 Outbound logistics, 39 Support value
Firm infrastructure, 39 Outflow, 43 activities, 39
Human resource Primary value Technology
management, 39 activities, 39 development, 39
Inbound logistics, 39 Procurement, 39 Value chain, 38
Inflow, 43 Resource, 36 Value system, 36

Review Questions
LO4 R1. What is a business process? Describe each of the major business processes found
in most enterprises.
LO8 R2. What does it mean to create value? How do enterprises create value?
LO8 R3. What is an enterprises margin as defined by Michael Porter?
LO2 R4. Differentiate between the objectives of a profit and a not-for-profit enterprise.
LO8 R5. Give an example of a primary value activity for a retail store.
LO8 R6. Give an example of a support value activity for a retail store.
LO1LO3 R7. To begin creating a value system model, what does the chapter recommend as the
first thing you should try to identify?
LO6 R8. What do duality relationships consist of?
LO5, LO6 R9. What is the difference between a stock inflow and a stock outflow? What types of
events are associated with stock inflows and with stock outflows?
LO6, LO7 R10. When you are creating a value chain level REA model, if you have two resource in-
flows and one resource outflow for a transaction cycle, what do you know about the
events in that cycle?

Multiple Choice Questions

LO8 MC1. Which events in Porters value chain create customer value and provide organiza-
tion distinctiveness in the marketplace?
A. Primary activities
B. Support activities
C. Operational activities
D. Value activities
 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling 49

LO6, LO7 MC2. Which of the following is usually represented as a value activity in the REA value
chain?
A. The generation of an aged accounts receivable report
B. The sending of a bill to a customer
C. The sale of goods to a customer
D. The decision as to whether to discontinue a product line
LO3 MC3. Which level of the REA enterprise ontology represents the big-picture view?
A. Value system
B. Value chain
C. Business process
D. Task
LO8 MC4. Which of the following is considered a primary value activity, as opposed to a sup-
port activity, in Porters value chain?
A. Procurement
B. Accounting
C. General management
D. Inbound and outbound logistics
LO7 MC5. To which other internal business process are manufactured goods typically made
available by the conversion process?
A. Financing
B. Revenue
C. Payroll
D. Acquisition/payment

Discussion Questions
LO8 D1. If only enterprises that truly create value survive, how do tobacco companies stay in
business? How do illegal drug markets survive?
LO1, LO2 D2. Do some events occur outside enterprise boundaries? Should information system de-
signers focus on events that lie beyond an enterprises boundaries?
LO4 D3. All business organizations have at least three broad business processes: acquisi-
tion/payment, conversion, and sales/collection. Into which of these processes do each
of the following activities belong? Explain your response.
a. Delivering a new product to a customer
b. Hiring new employees
c. Paying for a new capital tool
d. Assembling subcomponents for a finished product.
LO9 D4. Why is it useful to try to understand an enterprises activities at the value system and
value chain levels rather than simply beginning with the business process level?
LO5LO7 D5. Is it easier for you to first think about the resource flows associated with a transaction
cycle and then use that knowledge to identify the economic events in the cycle, or is
it easier to first think about the economic events in a cycle and then use that knowl-
edge to identify the related resource flows?
50 Chapter Three The REA Enterprise Ontology: Value System and Value Chain Modeling

Applied Learning
LO1LO7 A1. Owens Farm owns approximately 50 acres of peach trees. Migrant farmworkers per-
form almost all of the work. In the late winter and early spring they prune the trees.
During the midspring they thin the fruit on the trees, and in late summer and early
autumn they pick the fruit.
The farm manager does most of the other work, such as spraying the trees, irrigat-
ing, and selling the fruit. Spray concentrate, fruit boxes, and other supplies are pur-
chased on account from the local food co-op stores. Fruit is sold on account to major
grocery chains such as Kroger and Albertsons.
Required:
a. Draw a value system level diagram for Owens Farm.
b. Assuming the various activities that need to be performed in the conversion process are
considered labor operations, draw a value chain level diagram for Owens Farm.
LO1LO7 A2. Visit a local movie theater. Observe what you can about the economic activities of
the theater (e.g., ticket sales, concession sales, movie showing). Consider what must
also happen that you are unable to observe (e.g., theaters purchase of concessions
and ingredients for concessions from suppliers; acquisition of movies to show).
Required:
a. Create a value system level model for the movie theater (as best you can tell).
b. Create a value chain level diagram for the movie theater (as best you can tell).

Answers to Multiple Choice Questions

MC1. A; MC2. C; MC3. A; MC4. D; MC5. B.