Solving the Value Equation

A brilliant idea, in the right context with a great team that excels at execution. You’ve got the first four success factors checked. Wonderful. However, there’s still one critical element that is all too often neglected. The Business Model. Most founders would say: “of course I have a business model!”. But more often than not the term business model is used too generously. As a matter of fact the detailed understanding of its elements is neglected. A business model at its core describes how you create, deliver and capture value. Solving this value equation is the fifth element for any successful business.

Cui bono?

The same way the wise roman judge Lucius Cassus had the habit of asking ‘cui bono’ – ‘to whose benefit is it?’, the first question successful founders need to understand is who they create value for. When you sell ice cream near a children’s playground, are the kids your customers or their parents? Value is hard to create.Not only because of fierce competition. But because it is intangible and hard to measure. Think of value as the ultimate reason why your customer buy your products and services. A good illustration of that concept is Ron Perelman’s description of his cosmetics firm Revlon: “we are in the business of hope”.

 Value doesn’t exist as long as it is not delivered

Truly knowing your customers and understanding the ultimate value your business creates for them is the foundation. Now you need to address how to create this value. It does not matter how brilliant your value proposition is in theory if your customers don’t experience it. Value simply doesn’t exist as long as it is not delivered. And value delivery involves every part of your business. From order processing to customer support. From product development to point of sale. From human resource development to maintenance. Everything has to be designed and aligned around making sure your business delivers the promised value to your customers. And more. The bottom line is that your business’ success directly correlates with its ability to dosomething others cannot. In practice. Not in theory.

Do you know your customer’s willingness to pay?

Fundamentally, you can only create and deliver value by making something that didn’t exist before or by making something better than it currently is. However, you can create and deliver a ton of value without becoming valuable as a business yourself. You also need to capture some of the value you create. Value capture is a double-edged sword though. You want to capture as much value as possible. But you need to be able leave enough value for your customers so they want to do business with you. As Warren Buffet puts it: “if you have to have a prayer session before raising the price 10 percent, then you’ve got a terrible business”.

Some business models focus on maximizing value capture and some on minimizing it. The key for both is to being able to precisely determine your customer’s willingness to pay – the maximum price or price range that your customer is willing to pay for your product or service. It is surprising how many startups fail to address value capture in a very systematic and thorough approach and are instead establishing prices based on assumptions and superficial market observation.

 Exploration vs. exploitation

Startups sometimes fail for the same reason large corporations succeed – their focus on a preconceived business model. But before you can exploit a business model, you need to make sure you’ve got it right. Have you clearly understood who your customers are and what ultimate value you create for them? Is the whole organization aligned around the delivery of that value? And have you determined the optimal share of value you can capture? Usually you don’t get your business model right from scratch. You’ll need to work with different customer segments. Different value propositions. You’ll need to explore different ways of delivering and capturing value. The startup world calls it “pivoting”. A less fancy way to describe what needs to be done, is solving the value equation.

 P.S.: This post is the fifth in a series of six blogs covering the key ingredients for a successful business. Stay tuned for the last one to follow! You can find links to the published blogs below:

Success Factor #1 – Idea

Success Factor #2 – Context

Success Factor #3 – Team

Success Factor #4 – Execution

Success Factor #5 – Business Model (this post)

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