Do you or your company have a problem to die for, a problem most people only dream of? I’m talking about being too successful – something I’ve noticed again recently with some of the companies I’m working with. And the problem? After years of hard work and struggle these business owners and senior managers have started to make substantial profits. It’s a nice problem to have, but paradoxically, it is often disturbing. Here’s my theory on why it happens and the simple changes to your thinking about value that can set you on track to share one of the nicest problems in business – and maybe even buy a Picasso or two…
At the problem’s heart are two related concepts. First, the subconscious belief that if someone’s making lots of money they must be ripping customers off or exploiting staff and suppliers; this stems from the zero-sum view of wealth. That’s the idea of a fixed money pot and the notion that if I’m richer than you I’ve taken wealth that naturally belongs to someone else.
Secondly, there’s the idea of value added or wealth creation and how increasing total wealth means everyone wins. Your customer enjoys great products and you’re rewarded for building a thriving business – so you can delight them with more great products! Everyone, as Hot Chocolate’s Errol Brown sang in 1978, is a winner.
Remember the economists’ definition of value?
While we’re back in time, do you recall your school or university economics? Remember the economists’ definition of value added as the difference between selling price and the costs of bought-in goods and services? It’s a customer-centric definition, your customer’s view of goods or services’ worth determines their value.
Let’s think about art
Now let’s consider art, the kind that, if you found an original in the attic, could change your life for ever! These are Picassos. Specifically, they’re lithographs from a series he produced in 1959. Their value? A signed version could fetch up to £5,000 at auction. And the original sketches they’re based on? More like £100k, depending on the value to the buyer. So how does a piece of paper that cost Picasso a few centimes get such value? Is it the cost of production or the time it takes to produce? Or something else?
Rarely the right way to calculate prices or determine value
The idea of Cost to Produce or Time comes from suppliers’ views of value. You’ve probably used cost-plus pricing, where product X costs £50 to produce and is marked up 40% to sell for £70. We’ve all done it, but it‘s rarely the best way to calculate prices – or to determine value. Here’s why.
Consider those Picassos again, and how buyers determine their value. I’d be surprised if they took Pablo five minutes to paint – less than the average four-year-old takes to slap some poster paint on a piece of paper and the rest over herself. Ignoring the fact that the child’s efforts will be priceless to mum and dad, what’s the hourly rate for Picasso’s creativity? In this case that would be about £1.2 million an hour. Nice work if you can get it. And in a way, we can.
You can’t ignore value to your customer
Now to software. The marginal cost of an MS Office Professional download is almost zero to Microsoft. Yet I am prepared to pay royally for it because I need it to do my job. Clearly they are not operating on a cost plus model.
What about books? why are authors paid more the more books are sold? There’s little extra work for them whether it’s 10 books or a million.
By basing value on inputs we’re ignoring the value to our customers. That’s a mistake.
Back to art and the well-publicised case of a thought-to-be Marc Chagall nude bought for £100k in 1992. Why does a painting, supposedly by one of the masters, but later assessed as fake, lose so much value that it’s now worthless?
Compare this with paintings that, once considered fake or ‘by the school of’, are now attributed to the artist. Their value rocketed.
The power of brands
In business we see this with brands. Theoretically, two identical shirts could come from a factory with different branding – say Ralph Lauren and Primark – and very different prices. Likewise Apple’s logo on a phone greatly increases what we’ll pay compared to lower-tier brands.
Brands reassure us – as the saying went, no one ever got fired for choosing IBM. We’ll pay for reassurance and we’ll pay more for more functionality – how well goods or services perform. Generally, at the low end of the market massive functionality improvements do not cost that much more. However at the high end, small functionality differences command massive price differences. We see it in most markets: tangible goods like cars or violins; services like lawyers, footballers or restaurants.
Where does a person’s value come from?
People’s value often comes from a lifetime’s hard work. Picasso could capture movement and energy with a few brush strokes. A headhunter I know earned thousands of pounds filling a post – with one call to the right person. Whether this seems right or not, his client was actually paying for the headhunter’s accumulated market knowledge.
Scarcity usually increases prices. BBC Radio 4 examined ticket prices for concerts and events. What sold for £20 at box offices is often sold on by ticket agencies for up to £800. Likewise, first-edition books usually fetch much more than later editions. If you bought JK Rowlings’ The Philosopher’s Stone in first edition you’d now have something that people would pay £50,000 for, even though you can buy virtually the same book for a fiver on Amazon. With time, scarcity value usually increases (supply of Picassos is fixed or declining). Simultaneously, people become more aware of the value and demand rises because more people can afford one. Scarcity (in the form of fixed supply) is also why trains cost more at peak time and holidays during school vacations cost multiples of the same trip taken during term.
Fashion, time and convenience
Fashion and trends mean last year’s unused, mint-condition mobile phone is worth far less than this year’s. Similarly, brown mahogany eighteenth- and nineteenth-century furniture is no longer fashionable. Top pieces may still command high prices, but prices for mid-range pieces have plummeted because this furniture doesn’t fit today’s tastes and lifestyles. And that’s despite the fact that by definition supply is limited.
Timeliness (when I need it), convenience (where I need it) and service levels play a part too. That’s why we’ll pay nearly a pound for a Mars bar from a vending machine on a station platform when they’re four for a pound in supermarkets. Or why I’ll pay a printer twice standard rate to get my job quickly (or far more if an event’s approaching and my original supplier let me down).
And the ability to make money
There’s value in the ability to make money as three examples demonstrate. We’re reminded of it every time football transfer fees push higher – or whenever a star player’s weekly salary is mentioned in the press. And why not? No one can argue, given their ability to attract more people to games and enable TV rights to be sold for astronomical sums. Books are similar, with publishers earning higher royalties the more copies sell. And on the flip side, fewer copies sold cost the publisher less – a perfect example of aligned incentives. Now think about your business. If through use of Ad Words you can get a certain value of guaranteed sales, how much would you be prepared to pay?
And a lesson for negotiators
From works of art to Mars bars, value is measured in the eyes of customers. The principle even applies in negotiation, where you should value things in the other person’s terms, not yours, and always put a price (not necessarily financial - be creative) on any concessions you make. This gives your concessions value (and a cost) and helps dissuade the other person from coming back for more and more.
How to apply this in your business
If you understand your customer and what’s important to them, you’ll design products or services to maximise the value to them – and achieve win–win. Think like this and you’ll start questioning established norms, such as how web developers make their money from creating websites but charge modestly for site maintenance. If value to their customer means generating lots of profitable traffic, shouldn’t ensuring that the website keeps doing this be worth much more?
Here’s a quick check-list of value for you to take away and think about:
- Brand – reassurance, Attribution/Affiliation
- Functionality and Quality
- Taste and trends
- Availability when I need it
- The ability to make the customer money
Which of these resonate with you? Are there other factors that make something valuable to you. Do you agree with my thoughts on the importance of value – or not? What’s important to you? Please leave a comment and share your views.
You too can have the problem every business wants
If you deliver products or provide services that give your customers value and make money at the same time, you are creating wealth. From experience, if you do something brilliantly and meet customer needs better than others, you’ll join the businesses I mentioned at the start. The trick is all about understanding what is valuable to your customers. That is not always easy. You may find yourself too close to your business to clearly see what’s most valuable to your customers. Restoring that clarity and helping businesses to act on it is one of the areas I can help with – so you too could have the problem of making more money and being ‘too successful’.
Be warned though, success can mean making a lot of money; and that's something you’ll need to prepare yourself for. You will be in the position to choose how you use that money. Whether you use it to support a cause close to your heart or invest in a Picasso or a (genuine) Chagal for the boardroom is your choice.
By: Jonathan Nicholls