The survival of a startup is determined by its ability to create something of value that enough people will pay for, before running out of steam (financial and emotional).
Ultimately that’s paying customers. However, for a large number of high-growth startups with significant upfront costs, in the short term part of this is creating something to convince people of the potential of your business so they are willing to invest money to enable you to build the thing at scale. The best way to convince someone that you’re business has potential, is by demonstrating that people are willing to pay for whatever it is you're creating.
So either way, the overall objective of a business is creating something of enough value that people will pay for it, fast.
THE SCIENCE BEHIND VALUE CREATION
The science behind turning an idea into a business is identifying what variables will create something that generates sufficient revenue. You need to create something that has enough value that someone will pay you more than it costs you to create it.
The purpose of this post is to assess value creation through a logical lens, as you would a scientific concept, removing the complexities and variabilities that arise as a result of people being the primary participants. The outputs express the relationship between the key variables and the desired outcome for a business.
Real Value vs. Perceived Value:
Before we get into it, it's important to distinguish between real value and perceived value. When you're considering the overall value of your product, you should understand both the real and perceived value.
Real value refers to how much it cost to produce the product, how useful it is to the buyer and how much value its individual components have. Drivers include production inputs and how big of a problem the product solves for the customer.
Perceived value is a more abstract measurement that represents how much customers feel a product is worth. Additional drivers (in addition to the real value of the product) include marketing and sales efforts, startup DNA, brand and customer experience.
Your customers perception of the value of your product determines their willingness to buy it at a particular price, so we use Perceived Value as the measure of ultimate value to the customer.
Note that this an expression of the variables that drive value, designed as a decision making and optimisation tool.
For a business to be sustainable, it needs to make and sell a product that provides enough value that customers are willing to pay a price (Product Price) that is higher than what it costs to make and sell the product (Business Cost).
For a customer to buy something, the value perceived by the customer (Perceived Value) needs to be higher than what it cost the customer to acquire and use the product (Customer Cost).
- Product Price > Business Cost
- Perceived Value > Customer Cost
- Product Price = How much money you can sell the product for
- Business Cost = The total cost per unit (includes the cost of producing and selling the product plus operating cost per unit)
- Perceived Value = The value that a customer assigns to your product
- Customer Cost = The cost to the customer to acquire and use your product
Customer Cost includes money (Product Price), time and effort required to start using the new product (Switching Costs) and any perceived risks associated with buying and using the product (Perceived Costs).
Switching Cost include behavioural changes that are required to acquire and use your product, including the forming new habits, and the time and effort it takes to sign up, on board, login, travel to the destination etc.
Perceived Costs take into consideration the emotional impact of buying and using the product (fears). For example, how will they look to their peer group using your product, how will their boss or colleagues respond, how reliable is your product or company, what will happen if they want to get their money out, are you trustworthy, will they feel guilty after purchasing the product. E
When there are existing alternatives, the difference between the Perceived Value of your product and Customer Cost, needs to be greater than that of your competitors.
For your customer to choose your product over existing alternatives,
Perceived value of your product - Customer Cost for your product > Perceived Value of existing alternative - Customer Cost for existing alternatives product.
The Value Exchange
When a product is bought or sold there is a value exchange between the customer and the business. In this process new value is created.
Value Created for Business
The value to the business is equal to the value the business receives minus the cost of creating and selling the product:
Created Value (Business) = Product Price - Cost of Sale
Or, where your business is not only optimising for profit:
Created Value to Business = Business Percieved Value- Cost of Sale
Product Value (Business) = Product Price + Non-monetary Value.
Non-monentary value can include social impact.
For simplicities sake, we will assume that Business Value = Product Price.
Value Created for Customer
The additional value a customer gets from your product is equal to benefits they get minus the cost of gaining these benefits. This is the additional value that has been created for your customer by purchasing your product.
Created Value (Customer) = Customer Perceived Value - Customer Cost
For the customer, the more value created the better, as any individual is trying to optimise the value they get from their time or money investments. The higher they perceive this gain to be, the more willing they will be to buy and keep using your product.
Created Value (Customer) = Customer Perceived Value - (Product Price - Switching Costs - Perceived Costs)
The Fair Value Exchange
In an equal value exchange, which arguably is a sustainable model:
Created Business Value = Created Customer Value
i.e. the amount of additional benefit that the customer gets from the product is equal to the additional value the business gets (either through the price the customer pays or through non-monetary benefits).
Your customer needs to feel like they are getting a fair value exchange i.e. they are getting enough benefit from your business in exchange for the profit you are making.
When this is not the case it provides an opportunity for competition or disruption. Obvious examples of this can be seen with banks and other large corporates that charge significant fees and don't appear to provide a high enough value to their customers in return, as they focus on maximising return to their shareholders instead.
Optimising Value Creation
To optimise the value you only need to think of the equations discussed in this paper. The variable discussed are the levers that you can alter to find the model that maximises value exchange in a sustainable way
1. Increase Real Value
What are the fundamental requirements for your customers?
- what problem(s) do they have?
- why do these problems exists
- what do they care about most in a solution?
- How can you understand these requirements better so you can provide more real value?
2. Increase Perceived Value
What are the emotional drivers behind your customers purchasing decisions, and do your brand, marketing efforts and the experience you provide maximise perceived value?
- Do you have a compelling vision and/or story, and can you communicate this better?
- What are your brand and culture values, and do you need to make these stronger?
- Does your marketing efforts add value and align with the perception you want to create for your company?
- Do you provide an exceptional customer experiences that aligns with how you want customers to feel when they engage with your business?
- Are you helping to create the desired reality for your customer? See Customer Realities post for more information.
3. Decreasing Switching Costs
How can you make it really easy for your customer to sign on, start using, and keep using your product?
- What's your sign up process, and how can you make it easier?
- How do you get your customers to start using your product with maximum benefit? Is it working? Can you make it better?
- Can you make your payment process easier, so your customers don't have to think about paying every time they use your product (e.g. subscriptions, automatic payments, saved details)
- Do your customers keep using your products? How can help to make using your product more of a habit, or align it with activities that are already habits for your customer?
4. Decreasing Perceived Costs
What are the perceived risks associated with your products and what can you do to reduce them?
- If you're a startup, then you wont have the reputation or credibility of other existing businesses. So you need to make your customers trust you, or mitigate the perceived risk that you might not do what you say you do. You achieve this through things like testimonials and reviews, endorsements, free trial, cancel at any time policy, images of relevant people using the product
- Will your customers worry about what other people will think of them using the product, or the outcome of them using the product? If so, how can you minimise this?
5. Optimising Cost of Sale
- Product development efficiencies - How can you optimise the cost of producing the product without compromising on the things your customers value most?
- Customer acquisition efficiencies - How can you optimising the cost of acquiring and retaining customer (see Business Model post)?
Pricing is hard. There is not a lot of point over-thinking it when you start out. The best approach is to set a price and see how it goes, you can always change it. As a rule of thumb, the higher your price the more marketing and sales effort required.
Once you're creating and delivering value, you want to work towards optimising your pricing. You should be optimising the relationship between Value Creation for your business and Value Creation for your customer.
If you are making more profit relative to the 'additional benefit' you're providing your customer, there is an opportunity for your competitors to develop a model to beat you. If you're creating too much value to your customers and not enough for your own business, you will find it harder to attract and retain a good team, harder to grow in the long run which also gives competitors an opportunity to build something better.
The Easy Answer
Your ability to improve the variables listed above (the levers for value creation) increase SIGNIFICANTLY the more you understand your customers. So you should invest time in finding out what your customers care about before you build anything, and continue to get customer feedback with everything you do. You can read more about this in our Market Validation post.
There is a method to the madness of building a startup, and it's called value creation. All activities should be geared towards doing the tasks that maximise perceived value. The very early stages of starting something (pre-startup) is figuring out what value you provide as an individual. The startup phase, is figuring out what value you provide as a company. The growth phase is figuring out how you optimise your value creation model and deliver value on a larger scale.
Get in the mindset of understanding and optimising for value creation, determining what activities provide the maximum value, and focus only on doing these tasks. The variables outlined in this article are the elements you should be focusing on optimising in order to maximise value creation for your company, and maximising profitability in return.
There are all kinds of ways to create new value throughout your product development and delivery model. You should continuously experiment to find out what works best for your customer base.
I hope this article helps you to understand the fundamental drivers behind how you can optimise value creation. I also hope it has provided a more substantive approach to explaining some of the common startup concepts or 'rules', and why they exist.
As always, we really appreciate feedback so if you have any thoughts you'd like to share please reach out at email@example.com
HOW MUM'S GARAGE CAN HELP
We're obsessed with value creation.
We've worked with a large number of early stage entrepreneurs and startups, and we've built our own business. By doing this, we've become pretty darn good at helping founders to work out the value behind their idea an how to deliver this to the world in a highly effective way. There are probably a number of different ways we can help, but here's what we suggest:
Sign up below and become a part of our community for free. Then you can choose how deeply you want to get involved in our world as opportunities arise. We run events, workshops, programs, a co.working space, and all kinds of other cool things for founders. Once you sign up, we'll let you know about everything we've got going on, and provide you with new content and resources (like this one) as soon as we create them.
Alternatively, check out our Event page to see what we've got coming up and if there's something that floats your boat, lock it in (spots generally fill up fast).