#2 What is value and why value creation is a science
It is quite basic: to make money on the long run, the price you charge for your services and products must exceed your costs. I don’t think that writing this will make me get the Nobel Prize of economy, as it is something one learns at elementary school. When I was 8 or 9 years old if I remember well, we were using kilograms of apples to illustrate this basic principle of trade and measure the gross profit of the grocery shop.
But what is often less known or often ignored is that the maximum price you can charge for a given product or service reflects the value you create. Or if we say it another way: the value for each customer is the highest price he is ready to pay. In fact, price needs to be inferior to the value as seen by him. It is therefore critical for any organization to understand what value is, and how to increase it in order to make profit sustainably.
The problem is that value is not obvious to evaluate.
Value is made of functional and emotional elements, changes over time, and depends on the place and varies from one customer to another. It can also be discounted by the launch of an innovation introduced by a competitor or by a technical or service disruption that outdates it.
As a consequence it is more difficult to measure than cost for example which is relatively linear and straightforward. It is even more difficult to forecast during the time of the development of a new product or service.
Products or services that have never achieved their commercial objectives have mainly done so because the actual value was inferior to what their developer thought it would be.
As we will see in a next chapter, it is even becoming more and more important as manufacturing costs are getting less differentiating. And, contrary to manufacturing, there is little science or even process to measure and manage value in most companies. We will also see in another chapter that there are ways to measure value and this requires a set of tools and competencies that are not necessarily the ones that are commonly taught at school.
You could argue that customers are not really paying for the real value as they might be influenced by fashion, advertising or even have to buy a given product to be accepted in a group. For example paying several thousands dollars for a luxury watch can appear as excessive just to know what time it is.
Customers paying such an amount of money for a Rolex will value their purchase as the investment it represents as measured by residual value, emotional pleasure of carrying a beautiful and “state of the art” master piece, conveying a message in a given environment with the positive consequences on their image or career in one’s milieu or sense of belonging to the happy few who can own one. French people will remember the quote of the publicist Jacques Séguéla: “if you don’t own a Rolex when you get 50 years old, you have failed in life”. An object making you show to your peers you have not failed in life can be seen by some as bringing a considerable and real value regardless of its initial function.
In summary, the value is influenced by the actual service it delivers (the functional value) the way and the sensual experience during the delivery (the emotional value) and the reinsurance of the brand (the brand value).
The same product marketed under different brands will be sold at different prices. It has been the case for cars for example that were sold under different brands as in the case of the minivan offered by PSA and FIAT in Europe during the 90’s or the JV between GM and Toyota in the US during the same period.
We will see in another chapter what brand is and how it is built and influences the customers’ perception. We will also see that brand does not come by accident but is the result of a set of coherent actions and products overtime.
As long as a customer gets in return of a given price a value he perceived as superior to what he paid, he will remain satisfied and most likely loyal to his provider unless a competitor proposes a much better alternative in the future or if the product or brand becomes irrelevant.
If a given customer pays more than the value he eventually feels he gets in return, he will become unsatisfied and complain.
In today’s world, it has become much easier to share one’s dissatisfaction through the different channels such as social networks. Eventually, if this happens too often, the reputation will be damaged and hence the real value will be reflected in the price, which will need to be reduced.
I remember that when I was at Renault almost 20 years ago, some people in the company commented that some customers overvalued Volkswagen products. At that time both brands were competing for number one position in Europe.
Based on their own rational criteria and factual data, those Renault managers were convinced that their products were in all points superior to their German competitor’s including on reliability. In reality, customers are always right. Renault employees did not understand the drivers of Volkswagen customers’ choice. In fact, Renault did not deliver on what they had neglected for years but was indeed so important in Volkswagen and German brands customers’ eyes. Those elements were such things as the consistency in the brand messaging and model names over time, the results in German press test drives including in extreme conditions or high speed, the detail in design and craftsmanship such as the aspect of what was below the hood and so on. All those things were overlooked or were not even considered seriously at that time by Renault engineers and decision makers. For Renault customers, those items were less important than those who made the strength of Renault products such as comfort, innovative versatility and ease of operation for examples.
The fact, that at that time, Renault and VW were competing for the number one position in Western Europe, shows that the value of Volkswagen and Renault products were on average similar versus their price as the same number of customers would chose one brand or the other. In 2014, VW brand occupied 12% of the European market at undisputed 1st place, which shows that, in those twenty years, Volkswagen was capable to create value as a whole in the eyes of most of the customers, whether this value was functional, emotional or based on brand image.
Again in the car industry, the Toyota Prius was in the last decade the car in which Hollywood stars wanted to be seen not that much for its functional value (the fuel efficiency which for those multi millionaires did not count for much) but for the image it conveyed of being trendy and environmentally friendly. For those customers, the emotional value was very high. Reversely, for most customers, fuel consumption was the number one purchase reason as the correlation between sales volume and gas price in the US shows. This example illustrates that value and how it is made depends on which customers you target and what drives their choice.
Still in the auto industry, the initial failure of the very compact yet relatively expensive Smart or more recently the Toyota IQ shows that for most customers the value of compactness is very low. Those products were the fruit of what we could call the “car executive’s spouse syndrome” that ignores that most customers living in city centers generally only own at most one car if they do, except car executives and their families who generally don’t pay for their cars. As a result, the number of customers who would potentially value such a type of car is very limited.
On the contrary, most customers who own 2 or more cars live in suburbs where parking in the street is not a big issue and are more sensitive to price or cargo space than compactness.
This example illustrates that it is important to start with customer before speaking of value. It is indeed critical to define which customers you are targeting, when considering value measurement and forecast. Yet, most people overemphasize function over emotion when speaking of value on the argument that emotion is not measurable or at least not measurable easily. We will see examples in another chapter. It is not because the components of value are difficult to measure that they do not exist. Ignoring them is making the assumption that their value is nil which is worse than any rough estimation.
Of course a car is the second biggest investment of most households after housing and as such can be considered by many as a symbol of one’s success or personality. As a result, the emotional and brand aspect of the value is very important. But even for less statutory purchases than cars, like a washing machine, value can be divided in functional, emotional and brand elements.
Typically, the value of a washing machine, is mostly functional: how much laundry you are able to wash, how many programs you have, how well protected or washed, the clothes will be, whether it is noisy or not, if there is a drying function. Other functional value is the quantity of water and electricity you need. Still, emotional elements such as the design of the machine, its ability to deliver its service in an environmental manner, the impression of the quality of the interface or the sound exist. At last, the reputation of the brand that will give you peace of mind for example constitutes the brand value. It tells the emotion that the purchase and usage of a product of a given brand will give you, compared another brand. For example if you buy a Miele washing machine, you will pay more because you have the firm belief that the product is more durable and well engineered than main competitors. If you purchase a Panasonic washing machine, you might be more attracted by the number of programs, the versatility and other elements such as novelty.
So, associated with a given customer or set of customers, the value is made of functional, emotional and brand elements.
Another important point is that those elements don’t add systematically.
They only add, if they are all consistent.
If your functional value, let’s say reliability, is inconsistent with emotional value and not supported by design for example, its value can be totally offset in customers, eyes. If you target a customer with a product of a brand that will never be in the shopping list, whatever you will add to functions or emotion will barely be of any importance. Your value will remain low even if your product taken in isolation is very well designed for those customers. In the same way, if your marketing activity promotes irrelevant elements for your customers, your actual value based on other factors will also be much lower. Without consistency between elements, they will not add to the expected total value they could achieve considering each element taken in isolation.
It is therefore extremely important to understand from day one of development and at each point in time the consistency of all product elements and marketing activities. It is also of an upmost importance that this understanding is shared among all functions.
We will come back in a next chapter on the tools that can be developed to ensure this consistency.
The consequence of this is that for a brand with a global presence, having a clear promise and positioning that is more or less common or consistent is also critical as communication is cross border.
We will also come back on this.
As a summary:
Value is reflected in price and value creation is a key element of sustainable profit and development of an organization.
Value creation is becoming more and more important as cost control can be more easily copied than in the past.
Value is made of functional, emotional and brand value.
Value depends on which customer is targeted as needs and behaviours are different.
It is very important to keep the consistency of the value over time and at each point in time between all elements of the product and marketing, as value cannot be independently added or easily compensated.
Having a coherent brand message across region is very important.
There are tools and methods to measure and build value in all its components.