Some time ago I wrote a post that listed the 4 questions every business owner should ask themselves:
How do we create value?
How do we deliver value?
How do we capture value?
Will it be the same tomorrow?
In a recent workshop I was asked to expand on the rather brief notes in the original post. Following is a summary of the comments I made.
How do you create Value?
This is the one question every successful business on earth has in common. Success depends on them creating value for someone in excess of the cost to create that value.
There are several parameters to consider.
First: What is value? Value can be relative, as in the situation where you stick a premium brand on a pair of ordinary sunglasses, and some people who value the cachet and assurance of the brand will pay several times the cost of the identical pair unbranded. The value is in the brand rather than the physical pair of sunglasses.
Value can also be contextual. I have been considering the option of upgrading my computer recently, looking at the costs, brands, and technical performance of the available options that suit my needs. Two weeks ago, my existing computer took a powder, at which time the context in which I was considering a purchase changed radically, and the value of time became the over-riding factor. As the context of the consideration changed, so did the value, and so defining value at any time needs to consider these two differing sets of relative and contextual factors.
Second: Value to whom? Everyone defines what value means to them differently. In the sunglasses example above, there are groups who will pay significantly for a brand, and differing amounts of premium for differing brands. For some, a brand like Ray Ban might add 5 times the commodity value, for others, who would not buy Ray Ban to save themselves, Pierre Cardin might add 8 times the commodity value to their choice of sunglasses. The marketing challenge is to define the groups to whom your brand adds the value, and target your marketing and brand building activity towards them.
Third: What is your niche? The definition of a niche is always a critical but often overlooked component of your marketing planning. Without adequate definition, you are unable to find the degree of definition of customers necessary to discriminate sufficiently closely to refine your messages to a point where they resonate with the most likely primary customer without wasting resources on those less likely to buy. Often the creation of value evolves when an unrecognised or under-serviced niche is identified. Back to the sunglasses. 10 years ago there were no brands (that I can recall) targeted at sports people, who valued a light tint, polarisation, and a ‘wrap-around’ style that ensured a frame did not impede peripheral vision, and a very close fit. Oakley jumped into this unrecognised niche and built a brand based on delivering value previously unrecognised to a closely defined niche in the sun glasses market.
How do you deliver value?
It is of little use having something someone else would value without the means by which to deliver it. Your ‘Business Model’ is the means by which you deliver, a factor that is again often not considered in any real depth by small and medium sized businesses. There are a pile of questions that need answering, but are mostly left to chance, habit, and the way it is always done in that market, which is hardly the way to differentiate yourself. Are you a retailer, wholesaler, operate in a double sided market (such as EBay), fee for service, franchise operator or franchisee, and so on. While we are all sick to death of Airbnb and Uber being held up as examples, they are simply great examples of delivering an existing service via an entirely different business model making their owners rich in the process.
A great tool to use is the business model canvas articulated a few years ago in a book of the same name, and described in this post.
How do you capture value?
A business model offers some of the story about the means by which you capture value. Every model approaches the task differently. However, there are some common elements irrespective of your model that face every business.
Firstly, and most obviously, your costs must be less than your revenue, numbers captured well in traditional accounting models of the Profit and Loss account. However, what the P&L usually fails to do is clearly articulate all the costs that are incurred, particularly the last two in this following list.
Direct or marginal costs are those incurred directly to produce another unit of sale. Usually this is referred to as the cost of goods sold.
Overhead costs are incurred in every business to keep the doors open. Communication costs, rates and taxes, management wages and salaries, utilities, and so on. Many accountants use a ‘fully absorbed’ cost method that divides the total of all costs incurred except perhaps discretionary trading costs such as advertising and promotion, into the number of units sold and allocates a cost to each unit to ‘absorb’ the overhead. This is logically flawed as the less you sell the more you must sell it for to absorb the costs, so the march towards commercial oblivion proceeds.
Opportunity costs. I have never seen these captured in a P&L, indeed, am not sure of how you would go about doing it, but nevertheless, it is a cost of choosing a less than optimised allocation of resources. Consideration of the opportunity costs of resource allocation decisions should be a topic in every serious strategic discussion.
Transaction costs are the costs of managing transactions inside a business. A business with one supplier for an ingredient has less transaction costs associated with the purchase of that ingredient than if they had 50 suppliers. Obviously they also have greater risk, but transaction costs are the great hidden cost in most businesses.
The answer to the dilemma of capturing value is twofold:
You just have to understand, really understand your numbers, what drives them, and how you can influence them. Secondly, the number that counts above all else is cash. How much cash is coming in, from where, and going out, to where, and what are the timing factors that will influence that flow of cash. Every business should be forecasting their cash flow at least weekly in a rolling periodic forecasts that suits their business, but usually 13 weeks is a good number, and be watching the ebbs and flows daily.
Will it be the same tomorrow?
While a literal tomorrow may see little change, but what about next month, next year, the answer is a clear and resounding No!
The answer to this dilemma of managing for short term profitability while ensuring commercial sustainability is complex. On the one hand you have to have stable processes to optimise the productivity of resources allocated to a task, at the same time as you experiment in order to see the next thing coming, which is usually messy and risky, but absolutely necessary to survive. The classic case is Kodak who invented the digital camera and did not do anything with it, enabling the seeds of its own destruction to be sown. Most good businesses manage what they can control, and accommodate the changes necessary to moderate risk or leverage the opportunities as they emerge.
It is a cliché but time has to be spent ‘on the business’ rather than in it by at least some of those responsible for the commercial sustainability of the business.
Most will tell you that people are their greatest asset, then go off an do something that demonstrates the hypocrisy in the statement. It remains the truth however, that in all but the markets for non-critical purchases, people do business with people, not corporations, and people still do business with people they know like and trust.
Since I was a boy, I have heard the expression ‘Beauty is in the eye of the beholder’. It holds absolutely true for value as well. Value is always in the eye of the beholder, and is the net outcome of the complex set of unconscious and unseen mental gymnastics we all go through as we make assessments of options open to us. In a supermarket that may be hundreds of times in a few seconds, in a significant B2B purchase decision the considerations may be entirely different, but the processes are identical.