The Value Optimization Paradox
23 March 2009
Beyoglu is a Mediterranean restaurant on 81st and 3rd here in Manhattan. When Kelsey and I have guests, we often take them to Beyoglu for dinner, and we usually order the same dish: the vegetarian platter. Each platter comes with a wide variety of delicious spreads like hummus, spicy red pepper salad, and cracked wheat bulgar – with all the fluffly fresh-baked pita bread you can eat. A single platter ($14) will feed three people, or two with leftovers. It’s a steal, which is why we visit regularly.
Looking around at other tables, it’s clear that the platter is a best-selling dish – maybe the most popular in the restaurant. Here’s the business question: would Beyoglu make more money if they raised the price?
Most business schools teach that the purpose of a business’ management is to maximize the profitability of the company. While profit maximization sounds like a perfectly logical goal for a profit-making entity, paradoxically, it kills perfectly good businesses over time.
Imagine a fail-safe (and perfectly legal) product that would instantly increase your net worth by $1 million. Would you buy it if it cost $1 million? Probably not – there’s no point, since you’re not any better off after purchasing than you were before.
People buy from you because they receive more value than they give away in payment. The more value your customers receive in proportion to what they pay, the happier they are, and the higher the likelihood they’ll do business with you in the future.
Every business creates something of value for other people, which is then exchanged for money or some other form of value. In order to continue operation, the business must “capture” some proportion of the value that’s created in the transaction. The question is: how much?
Here’s the paradox: a profit-maximizer will answer, “as much as you can” – if they can get away with capturing 99% percent of the value created, they’ll do it. In doing so, however, the profit-maximizer is simultaneously eliminating the only reason people will do business with them in the first place.
Maximizing Value vs. Maximizing Profit
There are generally two ways a business can make more money: by increasing the value it provides, or by capturing more of the value it creates. Said another way, you can either choose to take a larger percentage of the pie, or make the entire pie bigger. By definition, you can only truly maximize one or the other. If you want to build a better business, which do you choose?
All businesses must capture “enough” value to cover operating costs and make it “worth it” for the people behind the business to continue creating value. After that point is reached, however, the best way to increase the profitability of any business is to focus on increasing the value the business creates.
The goal of every business should be to create 10x (or 100x, 1,000x, or 1,000,000x) more value for its customers than it captures in revenue. Every business that has experienced long-term success intentionally creates more value than it captures, and that’s okay. If you can consistently give away more value than you take, the world will beat a path to your door.
(For another great post that discusses value creation vs. value capture, read Work on Stuff that Matters by Tim O’Reilly.)
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