Value creation

Lecture handout: Value creation*

Textbook Reading: Chapter 1 (Section 1.2, pp. 16-29)

The purpose of this session is to realise that value comes from satisfying people’s needs, and that this leads to a broad and insightful realisation that:

  • Competition is when anyone else tries to satisfy the same customer needs that you do.
  • Innovation is trying to find better ways to satisfy your customers needs.
  • Entrepreneurship is successful when you really understand your customers needs.

Once of my favourite examples of value creation is David Reynold’s model of the Brent Bravo oil rig. He used over 6 million matchsticks and it took him 15 years to create. And yet all this time and effort does not make it valuable. Unless you have a need for a matchstick model of the Brent Bravo oil rig, it is possibly worthless. (You can read more about it here and here). In 2013 Barry King tried to beat Reynold’s record by constructing a model of Salisbury Cathedral (which is a popular tourist destination for KGB agents). You can read more here. Since 2012 Steve Waller has spent around 12 hours a day to create a scale model of the St Hilda district in Middlesbrough. We may respect these creations, but that doesn’t make them valuable.

Here’s a list of items that have caused controversy over their value:

  • Among Us shaped chicken nugget sold for almost $100,000 (link)

For more on the value of saffron see here. A historic use was as yellow dye for tunics, rather than the alternative (horse urine). Since it is worth more than £5,000 per kilo (in 2021), counterfeit saffron is a highly profitable criminal enterprise. Remember that we should reason from value to cost, not the other way around. As Will Luther said, “Consider medical doctors. Some say they make a lot of money because they spend so many years in school. Wrong! That explanation gets the story backwards. They are willing to spend so many years in school *because* people are willing to pay so much for their medical services.”

Here’s an example of how Starbucks creates value for me:

This concept is closely related to “Jobs to be done“, but here’s my review of ‘Competing Against Luck‘.

A nice account of how Amazon may charge higher prices for the exact same books as their rivals, because they provide additional services, is in McMillan, J., (2002) Reinventing the Bazaar, W.W. Norton & Co. (p.50)

“The internet in fact has not made information free. If shopping were merely a matter of finding the lowest price, the internet’s comparison shopping devices would eventually force all retailers to match their lowest-priced competitors. But a book offered by one retailer may be distinguishable, in a shopper’s perception, from the same book offered by another retailer, even though they are physically identical objects. The shopper is not buying a book, but a package of services of which the book is itself a part – the main part, to be sure, but just a part. In addition, the buyer is getting assurances of various kinds: that the book will be delivered as quickly as promised; that it will be delivered in good condition; that the retailer will allow it to be returned if it is not what was expected; that the retailer’s employees will not fraudulently reuse the buyer’s credit card data. Buyers willingly pay a little more to reduce their uncertainty. Information costs include not only the costs of locating a seller but also the costs of getting assurance. The retailer’s reputation can convey such assurance. A brand name is a device for providing information.” [Emphasis added]

Steve Job’s famous advice was to not listen to your customers. This is in contrast to Tyler Cowen’s “law of interesting content” – which is that interviewers should have the conversation that they want, not what they think their listeners want.

Here’s my bleaker application of value to Apple’s iPhone innovation:

There is a fascinating interview with Rory Sutherland on the links between Austrian economics and marketing, on how value is socially determined and praxeology is the foundation of behavioural science.

For a more traditional, textbook treatment of demand curves, see here:

Interactive practice: Change in demand vs. change in quantity demanded

Audio: The Diamond-Water Paradox, NPR, July 2015

A great application of consumer surplus is here:

Can you think of something that delivers a lot of consumer surplus for you? What’s the most consumer surplus you’ve ever received?

Finally, here’s a quick quiz on understanding value.

Learning Objectives: Link a thorough concept of value with implications for competition and innovation. Derive demand curves.

Cutting edge theory: Jobs to be done

Focus on diversity: Economists typically take preferences as given, but we can provide a theory of demand reflecting “the individual’s commitment to an intelligible universe” (p.52), where goods are considered to be a visible reflection of culture. Mary Douglas (1921-2007) was one of the world’s most admired social anthropologists, and her 1979 book, ‘The World of Goods’, provided a rich and compelling illumination of consumption patterns. 

Spotlight on sustainability: Plastic packaging

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