Every business wants to make more money. That is why we start businesses in the first place right? So why is it so difficult to earn more?
The answer to that question depends on a lot of factors. But in this article, I would like to return to the foundation of making money. Why do your customers pay you? No matter what product or service you sell, your customers pay you because they believe that they are getting something of value from you and are willing to pay for that value. This foundational principle is important because if you don’t have anything of value to offer or if your customer does not see value in what you are offering, they would not be willing to pay for it.
What is Value?
Before there was money, our ancestors traded items to procure products and services. I could trade you five tubers of yam in exchange for your wheelbarrow. It must have been really tough carrying around tubers of yam, looking for whom to trade with.
Whenever this trade occurs, both parties would have to agree that the items being exchanged are of similar worth or value. This would depend on the negotiation power of both parties, the urgency of the need for the items, the perception others would have of us if anyone owned the items, etc. This means that the value placed on an item may vary from one person to another. The value you place on an item would determine how much you are willing to pay for that item (called willingness to pay WTP).
For instance, you may consider an iPhone as valuable because of the perception people would have of you if you owned one. This means that you would pay more for an iPhone than any other phone not necessarily because the iPhone serves you better, but because of how good you would feel if people see you with one. You may also be willing to pay more for fuel for instance if it is scarce and you have almost run out of fuel in your car. This means that your WTP increases because you have associated more value to the same item that may not have been as valuable when it wasn’t scarce.
From these examples, you can see how important value is to a business. This means that you are in business because you are creating value for your customers and they are willing to pay for that value.
Value Creation
So, how do you create value? In the most basic form, value is created when you convert the input or raw material you get from your suppliers into the final product that you sell to your customers. For a manufacturing plant, this is pretty straightforward. But how does this apply to your business?
If you sell shoes and bags, this means that the inputs to your business are the shoes and bags you sell. The output would then depend on how you sell them. For instance, do you sell them as bundles? Do you add incentive products to encourage your customers to buy? Or do you just resell what you have bought?
You would notice that the more processing that you do to the input in your business would determine the value you create. If you simply resell what you buy from your suppliers, you may not be creating enough value. But if you process your input like a fashion designer whose input includes materials and the output includes the finished clothes, you are able to create more value and determine the price you sell to your end users.
An important way you can earn more in your business is to create more value. Review the products and services you sell and determine how you can create more value from them. The more value you create, the more your customers are willing to pay for your products and services.
Value Capture
The process of creating value is very important. You need to create value before you can sell anything to your customers. The more value you create, the better your success.
After creating the value, you need to capture that value. This is where things get weird fast. You may create a lot of value and capture just a small percentage of the value. Or you may create very little value but capture most of it. The ideal is that you capture most of the value you create but here are the factors that can influence how much value you can capture
- Supplier bargaining power. You purchase the input to your business from suppliers and you have to pay for the raw materials that you process. Since you need to make profit, it is very important that you are charged as little as possible by your supplier. If you want to capture more of the value you create, you need to negotiate for better prices from your supplier. But this depends on several factors. Is your supplier more important to you than you are to them? For instance, if your supplier is the only supplier you can get the input to your business from, then your supplier would have an upper hand when you negotiate with them. But if you are their biggest customer for instance, then you have are able to negotiate better. It is important that you negotiate the best prices, where you can, to improve the value you capture.
- Buyer bargaining power. As described above, a customer would pay based on how valuable your product or service is. But this is not the only thing that determines how much your customers are paying. If customers can purchase the same product and service you offer from someone else, then they can technically negotiate for better prices from you. Just imagine what happens in a market square where different merchants sell the same product. A customer walks into the first stall, negotiates and then threatens that he would go to the next stall if he doesn’t get a better price. The seller can only negotiate better when he is sure that the product is not easily available elsewhere. How unique is the product you are selling? How easily can your customers get your product compared to your competition? If your customers capture too much of the value you create because they can bargain better, then this reduces the value you capture.
- Threat of entry. Related to buyer power, if other competitors can start offering the same products and services you offer, then this affects how much value you capture. The more competitors in the market, the higher the change of pricing wars and this eventually erodes the value you create. Whatever service you offer, it is very important that you are distinct from your competitors.
General More Revenue
In summary, if you want to improve the revenue your business you generate, you should consider the following
- Create more value. You can create more value by reviewing your internal processes to ensure that you reduce all wastages as you convert your business inputs to outputs. You may also consider other ways that you can create value. As an example, Amazon started by offering e-commerce services. Over time, they realised that their learnings as they built their datacenters for Amazon.com could be sold to others. And this gave birth to AWS, the biggest cloud provider globally. They simply created more value with the same inputs that they were processing.
- Improve your bargaining power. To capture more value, you need to get the lowest prices from your suppliers and the highest prices from your buyers. You should consider negotiating with your suppliers or finding alternatives. AWS at one point realised that one of their largest cost items was the microchips for their servers. When they could not get better prices from Intel, they decided to manufacture their own chips, giving them better control over their cost item. This automatically allowed AWS capture more value and become more profitable.
- Build moats around your business. If competitors can offer the same thing you are offering very easily, this puts you at risk of pricing wars and affects your profit margins. How can you make your business more unique and differentiated? Can you repackage your offerings or add new offerings?
These are foundational thoughts for any business that wants to improve its revenue numbers. It is a lot of work, but it is worth thinking through.
Good luck!
