Mastering the value equation

You might have heard the saying that “if you want to make millions, you need to help millions”: in other words, your business needs to make a difference to people – then the rewards will follow. But how do you convert that truism into an actionable plan for generating more revenue?

Surprisingly for someone who only passed GCSE Maths by copying my friend’s coursework, I like to think about it as an equation:

value-equation

This simplifies the whole “argh how do I make more money?” dilemma into only three possible actions:

  • Create more value for your customers
  • Reach more customers with the value you already create
  • Do a better job of capturing a proportion of that value as revenue

Let’s take a closer look at each component:

Create more value

A customer will only give you more money if you give them more value in return. In existing businesses it’s often possible to notice what extra services your customers would find useful, and make more money by starting to offer them – such as a web design firm adding value by bolting on an SEO package.

In starting a new business, it’s vital to think about how much value it will create. Some businesses are inherently more valuable than others, and picking a high-value business will make it far easier to generate good revenues.

Noah Kagan describes it as a “totem pole” – the ranking of how important different things are to the typical person.

For example, even if you have the best product in the entire world to teach people to hand-make their own lampshades, it’s unlikely that anybody is going to pay you $1,000 for it. But if instead you sold instructions on how to save $2,000 on the cost of flights every year, many people would gladly pay you $1,000.

If you’re going into a business that’s low on the totem pole and not creating much value per person, you’ll need to work particularly hard on the other two parts of the equation.

Reach more people

Reaching people either means broadening out to serve a bigger target market, or improving your marketing so you can reach a higher proportion of your existing market.

Reaching the higher proportion of your existing market is generally easier – because the more people you’re trying to serve, the harder it is to create as much value per person. Think of a product like Instagram: it creates a pretty marginal amount of value (“making photos look a bit washed out in a cool way” is not near the top of anyone’s totem pole), but it does it for a ridiculously enormous amount of people.

The opposite example would be a company that provides CRM software to property management companies in the UK. They might only have 30 clients, but those clients rely on them for the entire running of their business – and if the company disappeared, the disruption would be devastating to them.

If the CRM company wanted to reach more people, they would likely do better to focus on reaching a higher proportion of the customers in their existing market rather than dilute their offering to appeal to other industries.

Capture more value

If the top part of the equation describes the total value you’re creating in the world, the bottom part is the amount of that value you capture in terms of revenue.

In theory, if you create $1,000 of value for someone, they should pay you up to $999 for it. But in reality, you’re never going to know exactly how much each person would be willing to pay and be able to set an individual price for each customer.

In some businesses you can get closer than others. For example, an expert sales trainer could agree to a 50/50 split of the increase in revenue after they deliver their training. They would then know they were capturing exactly half of the value they created.

In others, it’s impossible to get anywhere near. Take our blog: most people are happy to read it for free, but wouldn’t pay if we started to charge. A minority of people might pay $1 per week. A tiny (crazy?) few might pay an exorbitant monthly fee because we’re giving them insights that allow them to make even more money than that.

One thing most companies could do to capture more of the value they create is to offer an even more expensive option than they currently have for the small (but profitable) minority of customers who would want it. In other words, if someone would be willing to pay you $1,000 for an hour’s personal consultation but you’re only willing to sell them the same information in the form of a $10 book, you’re failing to capture a lot of value. Perry Marshall calls this idea the 80/20 curve.

A happy side-effect is that having a high-priced option makes the middle-priced option look even better value, so can increase the average sale price even for customers who don’t choose the most expensive option – an effect known as anchoring.

Which part should you focus on?

As a starting point for a new business, I’d recommend thinking about your position on the totem pole above everything else.

Broadly speaking, it takes the same amount of work to attract potential buyers to a site about real estate as it does to get another group of buyers to a site about DIY lampshades. You’ll be creating more value in the real estate market, so the owner of the lampshade site would need to compensate by working way harder on reaching more people and capturing a greater proportion of the value they create.

Having got that right, you can alternate between trying initiatives that target different parts of the equation: so you could add a new add-on product or service one month (more value), run a marketing campaign the next (more people), and experiment with your pricing structure after that (value capture).

It might be the case that in your particular business, targeting one component is much more effective than the others – which is why it’s important to alternate. Otherwise you could be burning a lot of effort on constantly looking for new customers, when a few simple tweaks would help you capture more of the value you’re creating for the customers you’ve already got.

What do you think?

Do you think this analysis makes sense?

Which part of the equation have you worked on with the most success in your own business?

Leave a comment and let me know!