Are you creating or destroying value?

Imagine a group of survivors marooned on a desert island. They are hungry. Two are chosen to forage for food. The first uses a stone to knock a coconut out of a tree. The second uses an axe to cut down a coconut tree. Returning to camp with seven, he is hailed a champion, a clever fellow and coconut gatherer-in-chief.   

Now ask yourself this question: which of them created the most value? Applying capitalist logic, it was the ‘axe man’. He gathered the most coconuts and delivered a bonus tree trunk, from which to fashion shelter or build a canoe.

Value creation is one of the most important dynamics in business. Businesses can only survive if they add value to the resources they have at their disposal. The greater the value creation, the more likely they are to not just grow, but to be profitable. There is no silver bullet for business success, but if there was, it would have value stamped somewhere on its jacket.

But what exactly is the value being created?

For most of the last century, value was measured in financial terms. Not revenues or profits, which were contributory factors, but returns to shareholders. These returns were dividends, the growth in the market value of the business they owned, or both. ‘Shareholder value’ is a well understood concept, but is now barely mentioned in start-up discourse.

Instead, the focus has been entirely on value creation for customers. This has become the holy grail for virtually every tech start-up. Find a customer problem and solve it, because in so doing, through some strange process of alchemy, value is created, recognised and translated into something else. That something else might be registrations, active users, customers or regular subscribers. This is the path to profitability.

You’ve probably already noticed there are problems here, and at least one of them has something to do with coconuts.

The first relates to definition. What exactly is customer value? The best description is a new perception of value. This still feels opaque, with much room for error as businesses interpret what different customers perceive to be valuable. Does your service create the value perception or should you create the perception of a valuable service? Can you offer too much value and devalue your service?

The second is that alchemy, which translates customer value into profits. We could accept this is the 21st century of Adam Smith’s ‘Invisible Hand’, but you wouldn’t want to bet your business on it. We need to find a way of measuring value creation so it can be analysed in relation to subsequent customer behaviour and business performance. We will be sharing a solution to this in the weeks ahead.

The third is those coconuts. While both foragers created value, one of them also destroyed value. The ‘axe man’ cut down a tree. Since there are a finite number of trees, when they have all been cut down there will be no more coconuts. If the survivors are still stranded, they will die.

This is exactly the kind of semi-destructive value creation we see in markets. Amazon’s business model, though value-creating for customers and their shareholders, is ultimately destructive. Their mantra of ‘your margin is my opportunity’ removes value from the market, making it harder for everyone to survive. What does the world look like when it has cut down all other retailers?

In contrast, Apple’s model is value-creating. They introduce new products and create new markets that change customer behaviour and create market value. They harvest a lot of this, but other companies also benefit. (Interestingly, Amazon only started making decent profits when they began selling market- enhancing hardware, content and hosting services).

This paradox of simultaneous customer value creation and market value destruction may already be evident in your sector. Look at the neobanks locked in an escalating feature-copying war. Customers benefit as they offer more and more for free. But they are in danger of both devaluing their services and reducing the amount of value in the market that customers are ever willing to pay for. They are mortgaging their future.

What is the solution?

You need to innovate to create both customer and market value. Create experiences, solve problems and help customers do the jobs they need done. But do so in a way that customers are willing to pay for or that can be easily monetised. Competitors will copy and make money as well. But that is okay, because now there are at least two of you growing the market. Customers will be ready for your next, value-creating move.

Above all, avoid value destruction. If a competitor undercuts you, don’t respond in kind. Find something new that customers want and will pay for. If you can do something for less, try to keep the value in the market by offering customers something else to spend their money on. Think premium upgrade rather than discount or price reduction. Grow rather than cut.

We have created a simple tool to help you map out your future developments and maintain a healthy balance between customer and market value creation. Get in touch and we will send it to you. It is not an axe so you won’t be tempted to cut down the next coconut tree you see.

UP AND TO THE RIGHT.