Defining Value

  With all the discussion going on about value pricing, at least half of the articles and posts on the subject seem to be seriously missing or misapplying this VERY key point:

That which goes into your product (time, materials, etc) has NOTHING whatsoever to do with its ACTUAL value to the buyer.

My VeraSage colleague, Ron Baker, posted "The Fundamental Economic Assumption" from which I quote (bolding for emphasis, and bracketed words, are mine):

Three economists, from three different countries, developed the theory of marginalism and created a revolution: William Stanley Jevons [1835-1882], from Great Britain, Leon Walras [1834-1910] from France, and Carl Menger [1840-1921] from Austria. Here is how Menger defined the true source of value in an economy in his book Principles of Economics, published in 1873:

Value is...nothing inherent in goods, no property of them. Value is judgment economizing men make about the importance of the goods at their disposal for the maintenance of their lives and well-being. Hence value does not exist outside the consciousness of men...The value of goods...is subjective in nature.

The determining factor in the value of a good, then, is neither the quantity of labor or other goods necessary for its production nor the quantity necessary for its reproduction, but rather the magnitude of importance of those satisfactions with respect to which we are conscious of being dependent on command of the good. This principle of value determination is universally valid, and no exception to it can be found in human economy.

The significance of this shift in thinking cannot be over-emphasized, especially since it hasn't happened yet among most professionals.

A coat is not worth eight times more than a hat because it takes eight times longer to make it. [RATHER] its producer is willing to invest eight times more labor into producing a coat because it is worth eight times more to a customer. [Think About That!]

You'd be willing to pay almost anything for a gallon of water if you were dying of thirst in the desert, but much less if you're washing your car. Water would have a negative value to you if it flooded your basement, as you'd have to pay to have it removed.

Value is dependent on time, place, context, and subjective judgments [OF THE BUYER] that cannot be precisely calculated. We are ruled by our theories, whether we admit it or not.

The labor theory of value is endemic in the cultures of most professional service firms, and it is past time to replace it with the subjective theory of value. We owe an enormous debt of gratitude to the Marginalist economists—let's start to repay it by at least catching up with their thinking and teachings on the true source of value.

Let's stop blabbering about billable hours being related to value. It's an idea from the day before yesterday. An idea whose time has passed.

Comments

[George Lenard]

Ultimately, there is no question that "value" is what someone is willing to pay.

However, the concept of cost sometimes does enter in. Think of all the people who negotiate new car purchases with their Internet printout of the "invoice price" in hand. Knowing -- or thinking they know -- what the cost to the dealer is, affects the buyer's concept of the value of the car.

And taking as an example the fashion industry, there is plenty of evidence of the power of branding in creating value independent of cost.

But if you knew two shirts were identical and had identical cost of production, except that one had the famous Polo player, would that affect the additional amount you were willing to pay for the famous brand?

Now in connection with professional services, the true value may not become evident until further down the road. What is the value of a legal document that leads to a negative -- for example, no contract dispute or lawsuit filed because the contract was carefully drafted?

I guess that can be reasonably well determined by people with a risk-management orientation: probability of worst-case scenario times cost of worst-case scenario equals value of avoiding worst-case scenario.

Just thinking aloud. Good post.

[Michelle]

George, your second paragraph raises three excellent points.

1) "...the concept of cost sometimes does enter in."

I agree. Where the cost to you, as the provider, should only enter in, though, is in deciding whether or not it is worthwhile to provide the service/product at the amount someone is willing to pay (i.e. if someone will only pay a hat price for a coat, you can opt not to go into the coat business...).

2) "Think of all the people who negotiate new car purchases with their Internet printout of the "invoice price" in hand. Knowing -- or thinking they know -- what the cost to the dealer is, affects the buyer's concept of the value of the car.

This example is perfect for illustrating the importance of adequately conveying the "value" of what you do to the customer at the time they agree to pay the price--which should always be at the beginning of a project. Just as the dealer relies on that piece of paper to "convince" you of the car's value, the value may be far greater to you (I've ALWAYS wanted to own a corvette) or far less (it may be a complete lemon!).

I'll talk (below) about why that piece of paper is flawed, but nonetheless, it is worthwhile to note that the seller has taken on the responsibility of convincing us of the product's "minimum value." We may decide that the "fact" it "costs" the manufacturer $28,000 to make that one car still does not make that car worth $28K to us--we may be able to find all our needs are met by someone willing to sell us a car for $18K... Even with the paper showing a minimum perceived input (as you so wisely noted "thinking they know") we may not agree the value is there for us.

3) The car example you gave in #2 is excellent for another reason. It is very important to consider the difference between the cost of supplies/materials (overhead that is tangible) and the cost of "knowledge work" that goes into a product. The factory invoice you are looking at doesn't show the many hours the automobile's designer spent conceiving the ergonomic elements of the vehicle (or going to engineering school to learn how to design vehicles!). Or the time invested to make sure the car would meet government safety requirements. Or the time spent designing the machinery that would assemble the vehicle, etc, etc.

In the very same way, your "hourly cost" doesn't consider the time you spent in law school or the many, many experiences you've had that taught you the 12-minute answer (.2) to that client's question that just saved her tens of thousands of dollars.

Thank you for posting such a thoughtful comment!

[Allison Shields]

Michelle-

This was a great post, and a good reminder of what value really means.

Another comment about cost, just building on your response to George's comment: in addition to opting not to go into the coat business, you could refocus your marketing efforts on those who would be willing to pay more for that service/product. Of course, you'd have to do some research to determine whether such people exist, but often we assume that everyone has the same price sensitivity or the same sense of value. As you indicate in your original post, the concept of value is different depending on your perspective and your circumstances. Although one customer (or group of customers) may not be willing to pay enough to cover your costs and make you a decent profit, there may be another market out there that's more than willing to do so. Marketing, positioning and properly identifying your target clients have a big impact on your value proposition.

So...yes, cost comes into play, but sometimes the answer isn't ditching the product/service because the cost of providing it is too high - sometimes the answer is finding the client/customer that values that product/service enough to pay for it.

[James Mason]

There is, however, a fundamental flaw in the reasoning illustrated above, although not by George, necessarily. The flaw is the idea that the "printout" has anything whatsoever to do with the actual value of the car, or anything else, just because it's been reduce to tangible form.

Manufacturers DO set a price, and that price is set based on a variety of factors, but waving around an invoice that "PROVES" the price of a car is even less convincing than bringing a monkey to a dealership and inviting him (or her) to wave around a banana peel. . .the manufacturer created a fiction anyway when they charged the dealer whatever it is they charged the dealer because invoices that appear on the inside of a window are adjusted on the front end, the back end, the side-end, and the other-end, and every which way but. . .oh wait, that way too.

Having said that, I, like most everyone else, have engaged in my share of invoice-waving, but mostly because it's fun and it intimidates salespeople, especially when I shriek "Run, little man, RUN to your manager. . . s/he shall not save you from my wrath!!!"

From time to time, I idly wonder why I'm not invited back to those fancy dealerships.

However, as regards the issue of charging on the basis of value, I know for SURE that neither my Surgeon (Person, Tree, nor Veterinary), my Accountant, my Dentist, nay, nor even my "Decorateur" charge me by the hour. . .they charge by the work. . .and I cannot imagine asking any one of them to do so.

Why we impose this harshness upon only attorneys, among all the learned professions that come to mind, is beyond me. Even my Real Estate mogul-in-training and vulgarian doesn't punch the clock.

Nope, just the learned men and women who, having learned the law in all its crusty gloam, now regurgitate it, with commentary, and various and sundry filings, by the tick tick tick of a clock clock clock that they punch punch punch in six minute intervals. What a life. What a world!

I have to go. . .I need a Valium!

james.