In order for a business to create value after cost it must
create and distribute that value in the most efficient way possible. It can be
considered the starting point for any and all businesses which leads to our
first question to think about: how is that value created? Simply put, it is
created through work. That work could be anything from administrative tasks
(such as filling out the right paper work for customer orders), technical (deploying
code to servers), and creative (marketing copy, product and/or logo design, etc.).
The business can then create value through that work, sell or trade it to a
customer base, and capture some of that value through profit. Based on this
definition, we can begin to clearly see that businesses add value in more ways
than just making a product and selling it. Every moving piece of that business
should be moving towards the end goal of creating and capturing that value.
Now let’s start thinking about the types of value that can
be created. First, let’s remember that not all types of value are created equal
by any means. A value that is considered a commodity is easily replaceable in the minds
of customers. For example, if your products aren’t distinguishable from your
competitors, then that competitor will be primed to take your place should your
business falter by any means. There are ways around this though; if your
company is able to create a new and more efficient process for doing business
or in possession of unique skills focused on the creation of value, then you
will be able to more readily differentiate from those trying to eat your lunch.
Having any of these things is a competitive advantage and should be fully
utilized towards the goal of value creation.
Measuring value creation is important if only so that you
understand what the value is that your business is making. The first method is
by measuring revenue. Revenue tells you that the way your business creates
value was worthwhile to your customer base since they are willing to pay for
it. Notice how I didn’t say profit. Many businesses successfully create
revenues but no profits (think Amazon), but many will not be able to do this
for very long. A business needs a profit in order to survive and sooner or
later a lack of making any profits will bring that business down, no matter how
great the product or service. (Amazon has been able to successfully navigate
this pasture by shrewdly reinvesting its revenues into future initiatives such
as AWS.)
Then there is perceived and exchange value, which are
interrelated. The exchange value is straightforward in that it is the amount of
value exchanged between a buyer and seller for a product or service. For
example, if you go to the store and purchase a pair of shoes, the price you pay
for those shoes is the exchange value. The
perceived value is defined by our perceptions of usefulness of the product or
service. In economics there is a consumer surplus (C.S.); when the consumer surplus
is greater than zero (C.S. > 0), then the customer is better off making a
purchase than not. So value is created when the perceived value of a product or
service has a certain degree of usefulness, consumer surplus is greater than
zero (C.S. > 0) and that same value is then exchanged to the seller.
As we can see, it’s incredibly important for a business to
create value. It won’t survive for very long if it doesn’t create value by
differentiating itself in the marketplace or not making a profit in the long
run. In order for a business to survive, it must capture a portion of that
value it is creating. If businesses ultimately want to succeed, they must think
clearly about how they are going to capture the value they are creating.
Businesses that don’t do this may be leaving money on the table.
There are a number of different ways to capture value with
some being more common than others. For instance, price based on value changes
according to the offerings worth to the customer. What this means is businesses
don’t set their prices based on what their competitors are doing. They might
also discontinue the process of marking up prices based on production costs.
Instead, what they are doing is looking at what their customers want and
setting their prices accordingly. What
is important is that the customers’ perception of value must be discovered.
This is obviously different with each customer but there are different models
of discovering this missing piece. An obvious example is auctioning, which
doesn’t work with all business arrangements but is incredibly effective when it
does. The most common example of an auction is with online advertising, where
each buyer sets the price and the seller can choose whether or not to take that
offer. Of course this is controlled less and less by human interaction and is
guided more efficient using algorithms to guide the software. There are some
downsides such as prices that may be less than satisfactory for the seller, but
must be honored regardless.
Another model is known as demand-driven pricing; what this
does is let the price change due to the fluctuations in demand for a product or
service. The most common example to date is Uber and it’s constantly changing
prices. Although there can be a large amount of complaints if the price is too
high, there are reasons for it, and Uber acts on those reasons with a
mechanical efficiency. The business is a money making machine. How it works is
the company raises and lowers its prices based on demand for rides. Other
factors that are taken could be day of the week, whether it is a holiday or
not, weather, and even city, etc. Using these variables (and many, many
others), the company can maximize its profitability by knowing how many cars to
have on the road and in what location at any given time. Demand-driven pricing at
its finest.
A further form of value capture model enables customers
to set their own prices. Although this doesn’t take place in most industries,
it is especially prevalent in the travel industry where buyers can decide what
price they want to pay and sellers can take it or leave it. Unlike auctions
though, this transaction is mostly kept between the buyers and sellers. Doing
this lets the seller maintain their prices even if they are discounting for
incremental sales.
Next up is for companies to capture value by using
two-sided market forces to their advantage. Although the name may not ring a
bell to most people, it is a model everyone has seen in action and is used
efficiently by media companies. For example, many publications are free for the
general public to take (think local periodicals in many major cities) and they
make their money, in turn, by charging advertisers to place ads in their
publications. The money is then used to subsidize the content that is created
for the publications and the process is continued. Although Vice Media is a
much larger entity now, when it was just a magazine, it was free to anyone (who
could find it) and the vast amount of value was captured by charging advertisers
(especially American Apparel). Of course they made money with subscriptions,
but most people just searched high and low for a free copy.
Then there are those businesses that use what’s known as the
“price carrier” in their offerings. This is the experience that businesses will
hang a price tag on while customers may not be coming through the doors just
for that in the first place; they may be coming for something else entirely.
Think about it, we will sometimes purchase a product or service to gain access
to something else the company is offering, but has no price tag on. Starbucks
is a great example of this. The majority of their customers walk through their
doors for a quick coffee before work in morning, but there are those people who
come in just for the wi-fi. Using it isn’t for sale, but purchasing a coffee or
pastry will give you access to it. So a good question to ask yourself is
whether or not your business is hanging the price tag in the right place. What
would happen if you moved it to something else?
One of the most prominent examples of value capture is
called the razor-and-blades model, which was pioneered by Gillette. It’s a
rather simple model: customers get the razor handle for free, but must purchase
blades continuously since they get dull rather easily. And charging for the
blades is where the value capture happens. This model was also utilized by
technology companies who sold printers and printer ink replacement cartridges.
The printers are always cheaply priced; the ink is not.
The final model to talk about is one we all know well since
the phone carriers are incredibly efficient at using it; it is known as
bundling. How it works is the price of the new phone is subsidized by any extra
hardware, software, and data features we purchase with it. The phone is cheap;
the options that are bundled with the purchase are where the value capture
takes place. Car dealerships also excel at this too; when you go to purchase a
car, the sales people will usually bundle in many products or services you may
or may not even need since those add-ons are where the money is then made.
Both value creation and value capture are incredibly
important to keep your business running smoothly over a long period of time;
more so than your competitors. Both are equally important; both need to be
studied rigorously for the best understanding of how the complement one another.
Value creation is the work that a business needs in order to create value to
offer to their current and potential customer base; capturing that value is
what will keep customers happy and the business running smoothly. Combining the
two will be what ultimately either keeps a business alive. And that is something to
constantly been thinking about when focusing on your own business.
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