Balancing Value Creation and Capture

by mjfern

Companies need to do two essential things to succeed. They need to create customer value in the form of a product or service and then capture some of this value in the form of profits. [1] These profits are used for activities like R&D (to create even more value), expansion (to offer value to a larger number of customers), and for delivering returns to investors.

When firms create substantial customer value and then capture seemingly little for themselves, customers walk away feeling warm and fuzzy. Customers are happy because they just received “great value for their money.” Meanwhile, the company is building its reputation and brand, likely expanding its market share, and, if managed prudently, still capturing sufficient profits to invest in itself and provide adequate returns to investors. [2] This is a long-term strategy that results in strong and enduring companies.

There are many great companies in the world that deliver great value, at a given price, to customers. A few that come to my mind immediately include Amazon, Honda, and Trader Joe’s. [3] These are companies I’m thankful for and I am frequently sharing the good feelings with others in my personal and professional networks. I believe that if these companies didn’t exist, the world would be worse off.

On the other end of the spectrum are companies that create customer value and then capture as much of that value as possible. [4] Because these companies provide relatively little value at a given price, customers have a feeling of being “ripped off,” “nickel and dimed,” or “cheated.” Although the customer and company executed a legal transaction (i.e., a payment in return for a product or service), the customer, but not the company, is displeased about the outcome. [5]

In this value extracting scenario, the company is trading profitability for its brand and reputation. The company just undermined its relationship with its existing customers and, as a result, most are unlikely to return. And the company has damaged its relationship with prospective customers, as existing customers share their negative experiences with others. This is a short-term strategy that in some cases can be highly profitable, but ultimately destroys the companies reputation and thus its long-term prospects. [6]

What’s the lesson here for business? If you’re trying to build a great and enduring company then deliver significant value to your customers and capture just enough value for important investments, expansion, and for investors. While you may need to forgo some short-term profits, the long-term benefits will far outweigh any short-term gains. This approach has certainly paid off for Amazon, Honda, and Trader Joe’s, and it will pay off for your company as well.

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[1] More specifically, they need to create “unique” value to differentiate their products and services from those of competitors.

[2] I say likely expanding their market share because it depends on the value and price offered by competitors. Companies offering more value at a given price (or equivalent value at a lower price) relative to competitors, will increase their market share (and vice-versa).

[3] Value is subjective and therefore companies and products that provide value to me may not provide much value to you.

[4] They do this by reducing the wedge between customer value (e.g., reducing product features or services) and price (e.g., raising prices).

[5] If these companies offer little value at a given price, then why does anyone become a customer of these companies in the first place? Because either (a) customers lack adequate knowledge about these companies and their practices; (b) the companies hold a monopolistic position in their market or segment; or (c) all competitors in the same market offer similar value and pricing.

[6] The exception is for companies that hold monopolistic positions in their respective markets. However, companies that hold such a position and have developed tenuous relationships with their customers are particularly ripe for disruption in the event that an alternative solution emerges.

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