Creating Value

I have heard many times that the key to a successful business is to “create value”. While there is truth to that, it seems inadequate. Moreover, the ways in which it is inadequate have significant implications for the types of businesses one should start, the skills one needs to be successful, and the nature of our market system as a whole.

To my mind, there are two important clarifications here.

Value for Whom?

First, I actually don’t think our capitalist system rewards those who create value; it rewards those who create value for those who have value to give in return.

This can be most obviously seen in consumer brands. Apple and Starbucks are two of the most valuable brands in the world. Why? I would argue it’s because they target more affluent consumers for whom the marginal opportunity cost of that $3,000 computer or that $5 latte is not that big.

This reality has real consequences for the types of businesses that get started, funded, and succeed. Most people would probably agree that a business that helps uneducated, unemployed, single moms improve their parenting skills is ‘valuable’. But that’s not necessarily an easy business to start because – even if the moms wanted it – they don’t have the money to pay.

Now of course that business could attempt to sell its services to the government or a non-profit — or even get sponsored by a corporation – but this really is just the same thing: convincing the group that has value to give that you are providing a product or service that they value (even if they’re not the direct recipient of that product or service).

Creating Value vs. Capturing Value

The second clarification I’d like to make is the ability of a person or an organization to create value vs their/its ability to capture value. It took me a long time to realize that these are not the same thing, and that the skills/capabilities required are often quite different. Moreover, for the purposes of becoming financially successful, I would argue that being able to capture value is more important..

Let’s say you’re a brilliant developer. You’ve worked for years developing this algorithm that solves some massive problem. And just last night, you finally got it to work. You’re telling some guy about this at a party, and he’s super interested. In fact, after some more discussion he agrees to pay you $500K for your work. $500K! You gladly take the money, and at tax time gladly pay your tax bill on that income when the time comes.

Meanwhile, this guy takes your algorithm, forms a corporation, and then turns around and goes and licenses it to big company. He’s a great negotiator and manages to get a $1M license fee – non-exclusive, of course – per year. And come tax time he’s got a bunch of business expenses to pay — marketing, business-class travel, etc., and leverages his disregarded entity’s self-directed plan to make large, pre-tax contributions to his retirement account, allowing him to reduce his tax bill significantly.

Who created the value here? Who captured it? Are the skills and knowledge required for each the same?

There’s obviously a lot to discuss here. Even my example is far from perfect in illustrating the distinctions. Perhaps I’m even thinking about it the wrong way. But they seem like important distinctions to consider.

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