Value Creation vs. Value Capture

Whether you’re the CEO of a company or the CEO of your career, it’s your job to create value for others and to capture some of the value you create.

In the case of running a company, you create a product that customers value.

Customers are so excited to receive the value your product provides that they gladly pay the product’s price.

The product creates value.

The price the customer gladly pays is the value capture mechanism.

When you’re managing your own career, the work you do for your employer is the value you create.

The salary, bonuses, or commissions you receive in exchange is your value capture mechanism.

In terms of growing companies' revenues or increasing your personal compensation, there are two ways to go about it.

The first is to create more value.

The second is to capture more of the value you create.

Most people focus on the second mechanism... getting customers to spend more money or getting your boss to give you a raise.

The problem with this approach to value capture is that only one person wins.

Here are two examples.

Your product creates $100 of “value" for your customer.

You charge customers $50 for the product.

After subtracting the product’s price, the “net value” the customer receives is $50.

Let’s say you raise your prices from $50 to $75.

In this case, it’s a zero sum game.

For you to get $25 more in price, the customer loses $25 in price.

You win, but your customer loses.

This becomes an adversarial dynamic.

In order for you to win, your customer must lose.

In order for your customer to win, you must lose.

The same idea works between employee and employer.

Let’s say as an employee you create $100,000 in value for your employer each year.

Assuming your salary is $50,000, your employer receives $50,000 in “net value” each year from your work.

If you ask for a $25,000 raise, your employer loses $25,000 in value in order for you to gain $25,000 in value.

You’re proposing you keep $75,000 of the value you create, leaving your employer with $25,000 in value.

Once again, this is a zero sum game. For you to win, your employer must lose (and vice versa).

As you can see, focusing only on value capture has two downsides.

First, the value you capture can never exceed the fixed value you create for others. The amount you’re negotiating over is finite.

Second, the relationship becomes adversarial. Only one of you can win and does so at the expense of the other.

Instead of focusing only on value capture, the far more interesting approach is to focus on creating value first, then value capture.

If you create a new version of your product that delivers $200 in value to the customer instead of $100, they aren’t going to balk if you raise your prices from $50 to $75.

With the product that creates more value, even after subtracting your higher price of $75, they receive $125 of value ($200 price - $75 price = $125 net value received).

This is a much better deal than the original product ($100 of value - $50 price = $50 net value received).

Suddenly the customer is quite happy to pay you more when they, in turn, receive way more value than what they paid you.

Similarly, let’s say you’re an employee that landed a new account, created a new product or found some cost savings measure such that instead of delivering $100,000 in value to your employer, you deliver $200,000 in value this year.

Suddenly there’s no resistance in asking that your $50,000 salary be increased to $75,000.

Even after giving you this raise, your employer now receives $125,000 in “net” value ($200,000 in value - $75,000 in salary = $125,000 in net value).

This too is a better deal than before your raise, where your employer only received $50,000 in net value ($100,000 in value - $50,000 in salary = $50,000 in net value).

The great thing about the “create value for others first” approach is that the absolute level of your compensation is not finite.

If you create $1 million in value for your employer or client, you can earn $100,000 or more very easily.

(Or you can easily switch to another employer who will gladly take your $1 million in value for your $100,000 in compensation.)

If you create $10 million in value for your employer or client, receiving $1 million in personal compensation is very acceptable in comparison.

When you focus only on value capture, there’s a limit as to how far you can go.

Most people’s income tends to hit a ceiling at some point.

Most people tend to focus on value capture, rather than value creation.

These two observations aren’t a coincidence.

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