By Robert H. Hacker
This is the second post in a three part series on the natural conflicts in the objectives of every entrepreneurial company. The first post in the series discussed the conflict of revenue growth versus cash flow.
Customer versus Shareholders
Almost every businessperson is familiar with Milton Friedman’s dictum that the purpose of a company is to maximize shareholder return. To put such a strategy in effect a company would probably look to maximize the value they capture (cash) for the most possible sales. Many companies have such a philosophy. However, a sale will only take place if the customer believes that the value they receive is in their self-interest. The need to balance value such that a customer enters into a purchase and shareholders receive the desired return is the conflict between customers and shareholders for every company.
Value is an economic concept defined as “utility”. What utility theory tells us is that value for a customer is not only a function of the product features and cost but also a function of the customer’s perceptions. These perceptions are based in part on the emotional engagement of the customer with the product. In other words, the more emotional engagement between a customer and a product the more potential value to the customer available for the company to capture (and the higher the potential price that a company can charge). Therefore, if a company can increase emotional engagement through better branding, customer service and all the other parts of the customer experience there is a higher likelihood of a sale and a sale at a higher price.
At the many companies at all stages of development (from startup to mature) that I have worked with, when they achieve sales traction they tend to focus on small changes in product features that add little perceptible value for the customer or they focus on revenue growth in an effort to satisfy Friedman’s dictum. Microsoft might be an example of such behavior and their current problems are well known.
A better approach to management is to continuously focus on the customer value proposition. I define customer value proposition as: "The unique [competitive] combination of emotional and economic benefits for which a customer will enter into an exchange [sale]."
Such an approach expands the “product” to include the concepts of customer perception, emotional engagement and customer experience. Such an approach has several benefits:
- 1. Focus is continuously on the customer which reduces the risk of being blind sided by changes in technology or competitor business model
- 2. Understanding the customer at an emotional level tends to make it easier to identify meaningful changes in a product that the customer will find valuable
- 3. Constantly building value for the customer makes the customer “stickier” and less susceptible to competitor offerings in many forms including pricing
- 4. Prices may be able to be increased because the customer perceives more value in the product
TurboTax is a good example of a company that manages its product based on value proposition and has withstood the entry to the market of many competitors. Everybody who files a Form 1040 in the U.S. has varying degrees of concern about an IRS audit. When TurboTax first started they offered a step-by-step approach to filing returns. Then they offered a new feature where a tax return could be compared to the average return for the same income level and an assessment of the likelihood of an audit. Recently they have added a feature where you can retain one of Turbotax’s experts if your TurboTax return is audited. TurboTax has continuing additions of meaningful new features that speak to the user’s emotional needs.
Of course, all of this value proposition management comes at a cost that may reduce shareholder returns. However, what is the cost of a lost customer or the cost of a customer where there is no possibility to increase revenue with little selling expense through add-on sales. In my experience money spent to serve the customer better is money well spent.
Herbert Simon won a Nobel Prize for his work that showed that a company can never maximize and the best they can do is optimize. (He should have used Friedman’s public relations company.) Effectively he showed that there is no way to determine if a company is maximizing. The best a company can do is meet the expectations of shareholders. In setting those shareholder expectations few rational investors would object to “productive” expenditure to better understand the customer, thereby placing the customer ahead of the shareholder.
Next Wednesday, the next and last post in the series will be on the conflict between market opportunity and execution.
Robert H. Hacker is the Managing Partner of GH Capital Partners, a Miami-based consultancy specializing in growth strategies, acquisitions and turnarounds for entrepreneurs since 2005. Also, he is an Adjunct Professor of Entrepreneurship and Social Entrepreneurship at Florida International University and previously taught at the MIT Sloan School of Management. He is the author of "Billion Dollar Company: An entrepreneur’s guide to business models for high growth companies" and has blogged for six years at Sophisticated Finance.