176. Peter Lewin and Steven Phelan: How Do Entrepreneurs Calculate Economic Value Added? Subjectively.

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At the core of the entrepreneurial orientation that is the engine of vibrant, growing, value-creating, customer-first businesses, we find the principles of subjectivism and subjective value. Subjective value embraces not only the value the customer seeks, but also the value that entrepreneurs establish in their companies: capital value. Once businesses master these two principles in combination, they can open new horizons of innovation and growth.

Key Takeaways and Actionable Insights

A fundamental advantage of Economics For Business over traditional business schools is the understanding of subjective value.

It’s hard for conventional businesses, and for the traditional instruction in business school, to fully embrace all the insights of subjectivism and the subjectivism of value. The traditional bias is towards numbers, quantification, prediction, and financial control.

Value is conflated with price and profit. Value is what customers will pay, cost is what the producer pays for inputs, and profit is the difference. Value is inherent in the thing that is produced. Finance and accounting are the numerical tools for computing these relationships.

When business embraces subjectivism, the value is not in the thing. Human minds bring value to the thing. Value comes ultimately from the consumer or end-user. They evaluate the offerings available to them and make value decisions, to part with their money (or not) to claim the value that’s offered.

Value is better thought of as a verb rather than a noun. It’s an emotional driver of decision-making.

Firms can’t impose their concepts of value on customers.

A key difference for the subjectivist approach is that customers alone determine value and producers can’t create it and sell it. Value is experienced by customers and, of course, experience lies entirely with them and can’t be reproduced or projected or simulated by producers.

That doesn’t mean that there’s no role in value generation for businesses. Steve Phelan broke down the firm’s value role into 3 parts: value imagination, value delivery and value capture.

Value imagination is a belief about the future — entrepreneurs imagine (or have a “hunch” about) a future in which a target customer experiences value from the producer’s offering, the goods and/or services they make available to customers. This imagination step is a major component of the entrepreneurial journey construct we employ at econ4business.com to help businesses generate value and grow. It’s creativity at work — where value creation starts.

Value delivery is implementation of the imagined value: designing the goods / services for commercial offering, assembling all the components required for implementation (including people in team roles as well as production assets) and taking the offering to the marketplace with a price and a value communication bundle.

Value capture concerns how much of the value experienced by the customer flows back to the producer. Typically, value production takes place in a system — perhaps including retail channels, or a wholesale partner, or a bank of financial partner. How much of the value flow do they take? Or how about competition, who might copy and undercut. Or suppliers who violate contracts or under-perform on contracted services. Entrepreneurs must pay close attention to value capture.

Subjective value thinking extends to business investment decisions.

Subjectivism applies not only to value but to the assets of a producing firm. The subjectivist approach understands assets as providers of potential services that customers might value. Most classes of assets (including people) can be assigned to multiple different uses and multiple configurations for the provision of different services. Entrepreneurship weighs up — evaluates — all the possibilities and assigns the assets to their greatest value generating uses.

Value calculus assesses the value-producing arrangements inside the firm.

Entrepreneurial producers of value face in two directions: outward to the market and customers, and inwards to the firm and its internal organization.

Looking inwards, producers must calculate which assets — including both human capital assets and physical assets — in which combination result in the greatest value for customers at the least cost. This requires an evaluation that assesses value flowing to the customer from the firm. Since value is subjectively determined by the customer, this calculation is extremely challenging. Peter Lewin called it subjective quantification, and Steve Phelan used the term value calculus. It’s a combination of qualitative and quantitative assessments that’s learned over time. It’s highly contingent on the (changing) value preferences of customers.

Internally, managers must combine their people assets and physical assets in a way that produces most value based on this uncertain and changing value calculus. Entrepreneurs and owners can’t be the decision-makers for everyone, and so the organizational technology must be designed for greatest value generation. Instructively, that organizational technology has been changing over time — from highly structured and divisionalized organizations to today’s more open, networked, and interconnected organizations.

The tool for capturing this value calculus is EVA — economic value added.

Capital is a value. In fact, Ludwig von Mises remarked that it was unfortunate that business ever coined the term capital goods, because it tends to make us think of capital as something solid and fixed. It’s not — it’s the result of the value calculus that Steve Phelan talks about.

Capital value can be measured, but not in the way that is captured on a P&L or a balance sheet — creating numbers that appear to be exact, and fixed and fully determined. Entrepreneurs must estimate capital value and the estimate is that of the valuer. They do so algorithmically — there’s a process and a routine but it’s not necessarily mathematical. It includes breaking down the asset combination into smaller and smaller components — perhaps individual people or teams, or perhaps divisions versus the entire company, or perhaps some set of components that can be thought of as an integrated grouping — and assessing their relative capital value contribution. Money values can be used since this helps the expression of relative value, but the algorithmic computation is never exact. Its validity is always in the eye of the valuer. The goal is to find costs that don’t add value, or don’t add as much value as other costs.

Accounting and finance — one looking to the past to measure what happened and one looking to the future to predict what will happen — offer objective-looking numbers, but they truly reflect the subjective value calculus of the entrepreneur in trying to allocate economic value added as accurately as possible.

Additional Resources

“An Austrian Theory Of The Firm” by Peter Lewin and Steven Phelan: Mises.org/E4B_176_PDF1

Austrian Capital Theory: A Modern Survey of the Essentials by Peter Lewin and Nicolas Cachanosky: Mises.org/E4B_176_Book

“Entrepreneurship in a theory of capital and finance — Illustrating the use of subjective quantification” by Peter Lewin and Nicolas Cachanosky: Mises.org/E4B_176_PDF2

What Level Of Return Are You Providing To Your Customers On Their Emotional Investment?

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Happy customers are a goal for businesses. Customer satisfaction, customer trust, customer loyalty – these are all assets that corporations and brands work hard to build. They’re emotional assets. When a customer is satisfied with their purchase and with the experience that results from it, that’s a feeling, not a number. When a customer comes to trust a vendor or supplier or brand, that’s a perception or intuition rather than a cold, reason-based assessment. When that trust translates to loyalty, it may be expressed in behavior (such as repeat purchasing) but it’s nevertheless based on sentiment as much as analysis.

Seen from the perspective of business, happy customers represent purpose. The purpose of a business is to create and maintain happy customers. The business methods and tools for achieving this purpose are not found in the numbers of finance and accounting, and they’re not in the bureaucratic processes of business administration. They’re not in the footnotes of the Annual Reports and 10K’s that the SEC demands that companies spend fortunes on to produce and file.

The business tools that produce happy customers are emotion-based. The most important is empathy: the ability to understand the customer’s mental model – see things from their perspective and with their perception and emotion – and to operate within that mental model when designing products and services for them. One definition of value creation and innovation is the solving of problems that have meaning for others. To even get started on this track requires an understanding of what’s meaningful for customers, an understanding that can only be gained from their perspective.

Think of any successful service, product or business. Why are its customers happy? How do they feel and why? What feelings motivate them? What are their values and how does the business or brand complement those feelings? To take just one example, why are Tesla owners willing to pay as much as they do for their EV? Do they find personal meaning in contributing in some way to the climate crisis (which, itself, is highly bounded by feelings)? Or do they take pride in the green credentials they can display to their neighbors, peers and friends? Does the simplicity and austerity of the car’s design complement and embody these feelings? Elon Musk and his team are able to do this analysis. They have a highly developed feel for their customers.

This is not to imply that business is all “touchy-feely”. In fact, this feeling that the customers have for brands, products and services becomes capital on the business’s balance sheet, as well as becoming revenue and profit on the P&L. The customer’s feelings that a brand will make them happy and result in a feeling of satisfaction becomes revenue through the mechanism of willingness-to-pay. After assessing the potential value and utility of any brand offering or any value proposition, the customer decides (based on emotional, subjective valuation) whether or not to buy. Are they willing to pay to find out whether their experience of the brand will be as good or better than they expect? If they are a repeat buyer, they’ll be more confident. If they’re a new buyer, they’ve developed some tentative trust. If they’re feeling affluent and they’ve already met their more basis needs they may feel a little more relaxed and uninhibited about their willingness to pay. In any of these cases, they’ll assess again after their experience to weigh whether it met their expectations or not, and on this basis, develop their future evaluation for the next opportunity to buy.

These customers are making an emotional investment in the business’s offering. They’re expending their own emotional energy in thinking through their internal problem to solve. They’re trying to anticipate their own future emotions that will arise after the purchase. They are taking a value risk – it might not work out. This is a considerable emotional investment. There are only so many times they’ll be willing to repeat the investment, whether for this product or for the category from which they choose it. A disappointing Tesla can be traded in at some point. A disappointing fashion choice can be discarded and never repeated.

The customer seeks a return on their emotional investment – ideally a high one. When they choose between two different ways to spend their money – to exercise their willingness to pay – they’re weighing two potential returns and they’ll select the higher one.

The customer’s emotional investment becomes the company’s capital. When they buy, revenue flows back to the company. What we know as capital value on a company’s balance sheet is the flow of revenue back to the company, minus the cost of generating that flow, expressed as a single dollar value. If customers are happier, or more customers are happy, more revenue flows, quite possibly at a higher profit since the willingness to pay might be higher, and the company’s capital value increases. This is what becomes stock market value – a stock price can be expressed as a Price / Earnings ratio. The earnings in this equation are those flows coming back from customers. It’s really a Price / Happy Customers ratio. Similarly, in financial analysis, Economic Value Added (EVA) is a similar calculation: the flow of revenues from customers minus the costs of generating them.

Economic calculation for a business requires both numbers and feelings, quantitative analysis and qualitative analysis. It’s necessary to empathize with and assess the emotions of customers, and to translate these into projected revenue flows. It’s equally necessary to identify their willingness to pay as a number (i.e. pricing) and then to choose costs of production that are both consistent with their emotional needs and consonant with the accounting analysis of profitability.

In a book called After Steve: How Apple Became A Trillion Dollar Company And Lost Its Soul, Tripp Mickle contrasts the mindset and approaches of Apple’s Chief Design Officer Jony Ive and CEO Tim Cook. Ive was the design aficionado who sought flawless perfection in Apple’s products as the way to earn the love and loyalty of customers, always surprising them with what was possible and with the degree of elegance and beauty that was achievable. Tim Cook was more of the numbers-based efficiency aficionado, seeking cost discipline to achieve profits at price points the customers indicated they were willing to pay.

Both are necessary, of course. But even costs must be emotionally and subjectively judged as supportive of customer happiness. What, for example, is the cost of Apple’s beautiful packaging which evokes such pride of ownership and delight at the unpacking experience? It would be easy to choose lower priced packaging. But what would be the cost in diminished customer delight? What would be the capital cost of reduced revenue flows from a diminishing army of Apple fans?

All-in-all, it’ a feel for business that’s more important than excellence in business administration, and it’s this feel for business that reveals more of the secrets of the success of great entrepreneurs, great brands, and great corporations. Business schools won’t tell you that, and won’t help you develop that feel. Trust emotions, practice empathy and exercise judgment.

175. Curt Carlson: Value Creation as a Life Skill

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Curt Carlson has devoted his life to value creation and innovation — VC&I as he sometimes characterizes it. He has been CEO of SRI, a “pure innovation” company where the business model was to create important new innovations that positively impacted the lives of many people. Examples of his innovations are Siri (ultimately sold to Apple) and HDTV (the technology that enables the streaming so many people enjoy today).

He started a consulting company called Practice Of Innovation, which established methods of innovation available to everyone and every firm. Now he teaches at University, aiming to develop a new generation of innovators.

He talks to Economics For Business (econ4business.com) about value creation and innovation as a life skill.

Key Takeaways and Actionable Insights

Value Creation is a complex adaptive system.

Value creation is a system of many agents, components, arrangements, technologies, constraints, and unpredictable emergent outcomes. There are a challenging number of variables, and there’s a requirement for highly integrated collaboration and recursive and iterative process, utilizing adaptive feedback loops and continuous readjustment. It’s hard — and quite rare — to get right and easy to get wrong.

The essential element of value creation is the mental model.

The mental model for value creation is solving important and meaningful problems for others. It shouldn’t be about launching a new business or a new technology, but about helping others. And, since people don’t think in terms of “I have a problem to solve,” the value creator must also understand the customer’s mental model. They experience dissatisfactions. They wish things could be better. They make trade-offs. They can’t always articulate what they want. They have to learn what to want, and value creators can help them to understand what they can want in the future.

Mental models are fundamentally important to the creation of value. We all have mental models of the way we’d like the world to work. The value creator is able to identify — “get inside” — others’ mental models and see the world the way others see it. This perspective is vital — the critical first step in the value creation process.

The calculus of value is subjective.

Value can only be defined by the individual who experiences it. Individuals make a mental calculation of value – it might include some numbers and some thoughts, feelings, preferences, and ideas. They are able to make this calculation in their own mind, even though the potential costs and benefits lay in the future.

The dimensions of value are many. When evaluating the purchase of a car, for instance, the price is part of the calculation, but so is the appearance and pride of ownership, the comfort, the gas mileage, the color of the seats, the cost of maintenance, and many, many more features and attributes and functional and emotional benefits.

Despite the difficulty and complexity, people are agile and adept at making this complex calculation. Value creators must be able to appreciate how customers make the subjective calculation — the calculus of value.

The removal of barriers to the experience of value is a good way to create it.

Convenience is often highly valued by customers. It represents the removal of barriers to value – easier to operate, less time taken, less physical or mental effort required. These are all valuable. The iPhone provided a more convenient way to enter data (responsive touch screen versus traditional keypad), and this played a big part in its adoption and success. The mental model is that people want to do things that are easy to do. They don’t want the clumsiness of a tiny keyboard on a phone. They don’t want to read a 20-page user guide for a new piece of software. They don’t want packages that are difficult to open or retail stores that are crowded and hard to shop. Identifying and understanding mental models like these gives skilled value creators their competitive advantage. If barriers are perceived negatively by customers, then create value for them by getting rid of barriers.

A need is not a problem to be solved. A need is a mental model. Reframing is the tool for understanding.

Curt uses the example of the slow elevator in a prestigious office tower. Residents complain. Engineers might try to solve the problem by re-engineering the elevator for greater speed. A value creator would try to identify the mental model of the complainers. That’s reframing. They are annoyed because they feel that their valuable time is being wasted; they’re bored for a few seconds. Understanding this mental model opens up the possibility for new value approaches. Add a digital screen in the elevator with a news feed so that people can use the time to catch up on the latest headlines. Or add a mirror so that they can use the time to check their clothes and hair before going into the meeting.

Most value creation challenges can be better addressed through reframing. In fact, Curt describes his innovation method as “relentless reframing”. The art of value creation is teasing out the customer’s mental model. Do it again and again, back and forth between the value creator and the customer, to get the understanding of the customer’s mental model right.

Value creation is coupled with innovation: VC&I.

The definition of innovation is not just the new idea or new product or new service. It’s the sustainability of any new solution once it’s delivered into the marketplace. Customers use it and prefer it, they pay enough for it to sustain the financial business model, they repeat their purchases and provide supportive comments and assessments. To be truly sustainable, the innovation must appeal to a lot of people, not just a few early adopters. The benefits must be greater than the costs to the user, based initially on their value calculus, and subsequently on their actual experience. And the offering must be better than competition. To get customers to change from a competitive offering, Curt says the degree of superiority must be 2X to 10X.

Curt uses the N-A-B-C process tool as a methodology for innovation teams.

On previous visits to the Economics For Business podcast, Curt has laid out the framework of his N-A-B-C model and how to use it. See our E4B graphic tool (Mises.org/E4B_175_PDF) and the Key Takeaways summary from the podcast #37 (Mises.org/E4E_37).

N = Need: Identifying and understanding the customer’s mental model, and perceiving the world as they perceive it, getting to their perspective of how the world can be improved. This is where relentless reframing applies.

A = Approach: Designing an innovative solution with a sustainable business model. The temptation is always to jump straight to the approach without truly understanding the Need, according to Curt. This always leads to error and requires a pivot.

B>C = Benefits Per Costs: This is the customer’s value calculus, very hard to get right as a result of its multi-dimensionality and combination of qualitative and quantitative measures.

C = Competition: What are the alternatives among which customers are choosing, whether direct or indirect – remembering that not buying anything is an alternative they’ll consider. Overcoming inertia requires a high degree of superiority.

Our econ4business.com toolkit (Mises.org/E4B_175_PDF) includes a full explanation of how to apply this tool.

Value Creation and Innovation is a life skill that can be taught to everyone.

Solving others’ problems is a deeply human activity. We’re all wired to do it for each other, every day. Value creation can be taught to kids of any age in school, and it can become a life skill. It can be taught to people studying any discipline in universities and colleges, from humanities to hard sciences, so that they can apply it in their field. It can be taught in every firm, whatever the line of business.

The resultant life skill is the mental model that life is about solving meaningful problems for others. It’s about understanding and appreciating others’ mental models. Reframing is the tool for gaining this understanding. Value creation is a fundamental capacity for everyone. They can make an impact on society by solving problems that matter.

Additional Resources

“N-A-B-C Innovation Process” (PDF): Mises.org/E4B_175_PDF

Curt Carlson on Innovation Champions: Mises.org/E4E_91

“Answering the Million Dollar Question (Part 1)—How Value Creation Forums Help Create Winning Research Proposals”: Mises.org/E4B_175_Article

Climbing The Value Ladder.

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Value is the energy that powers the economy and its growth. People relentlessly pursue better experiences in the future than are available to them in the present and their attainment of that future experience is what is meant by the term value. People assess – or e-value-ate – their experiences after the event and decide whether they were valuable to them. They anticipate better experiences in the future, and look for goods and services they believe will be able to bring them that better experience.

It’s because people demand that the future should be better than the past or present that there is any economic activity at all. It’s the reason for innovation. It’s the reason for interest rates. It’s the reason for economic growth. It’s the reason for supply chains and retail stores.

The experience of value is a good feeling. It’s satisfaction. It’s the replacement of one state of well-being for a better one. It’s calmness in place of anxiety and contentment in place of desire. It’s also a never-ending question, because value can always be improved upon and satisfaction can always be higher.

In pursuing success in markets, businesses can improve their prospects if they bear in mind the primacy of experience. Engineers are often wrapped up in products and services features and performance. Sales and marketing often focus on these same elements when making their pitch to customers. But customers don’t want features and performance or even product attributes. They want that experiential feeling of value.

Value propositions and sales pitches will be better when the experiential value is incorporated. Instead of selling today’s features, sell tomorrow’s feeling. “When you select us as your supplier you’ll feel confident in the level of service we provide. All your information requests will be immediately fulfilled, and your customer service rep will always be available. You’ll always feel that we are here, standing by to respond or help, and proactive in bringing you new ideas, and innovations.”

  • A large financial services customer would send e-mail requests to a service provider late at night, and would keep score of how many same-evening responses they received. The providers with the best response scores were graded higher. If you are in the customer service business, it pays to check your e-mail before going to bed!

How can you add more experiential value to your value proposition?

  • Would your potential client enjoy the drawing on the special knowledge level and career experience level of your team? How would they feel in the future to be in a monthly call with your top analysts or top site foremen so as to be able to learn about the latest market conditions, especially in the midst of market turmoil?
  • Is your client frustrated with the service levels or lack of responsiveness of any of their current providers? How can you make them feel like it will be better with your company’s greater commitment to service?
  • Are there any higher values that the client is pursuing above and beyond current functionality and performance? Every client – and every individual at every client – has a ladder of values they are climbing. Have you asked them about it? Do you know their higher value preferences?
www.econ4business.com

Value is always ascendant from lower to higher. Customers seek out the functional value that reassures them that a product or service that is offered “works” for them. Then they can move up to less functional attributes – like style and aesthetics, for example. At a higher level still, they think about the longer-term future: not only how will the product perform now, but how will it fit in with their future plans. Once they believe that there’s a future fit, they’ll think about high values like relationships and ethics. Ultimately, they are seeking a better world, or a more meaningful career; if you and your company and its products can help, you’re contributing to the highest level of value. The best value creators climb the ladder and find the strongest route to the top.

174. Sterling Hawkins: Discomfort Is Your Most Valuable Feedback Loop

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Negative feedback loops are the ultimate source of value. Mises called it “uneasiness and the image of a more satisfactory state”. Bill Gates said that “Your most unhappy customers are your greatest source of learning”. Negative feedback loops give us the opportunity to improve our service delivery capacity, and the value proposition behind it. Sterling Hawkins has identified the ultimate feedback loop for personal performance. He calls it discomfort. We should seek discomfort, analyze it, understand it, and utilize it as an ultimate tool for improvement. His book is titled Hunting Discomfort (Mises.org/E4B_174_Book) and we talk to him about it on the Economics For Business podcast.

Key Takeaways and Actionable Insights

Discomfort is a feedback system.

There will always be physical, mental, emotional, or even spiritual discomfort in our lives. It’s necessary and useful. It signals to us how we are interacting with our environment. It keeps us oriented. Sterling’s case is that we shouldn’t try to avoid it, we should embrace it – he recommends that we actively practice hunting discomfort. Once we find it and embrace it we work our way through it, and the result is personal growth. We get better.

First, face reality.

The first discomfort Sterling outlines is facing reality. In business, we often say that it’s a great challenge to align the firm’s internal assessment of reality with what is actually going on in the external environment, especially in times of rapid change. We may just not see reality accurately. Our product may not be as well-liked by customers as our research tells us it is.

We can’t change reality, but we can change how we see it. We can change our belief structure. One way is to run many experiments where we can objectively and empirically measure results, and expand on what works and discard what doesn’t. We might find some things that work that we didn’t believe could. And we might find that we thought worked simply does not. Both represent valuable learning and provide us with a reality we can grasp.

Eliminate self-doubt.

Self-doubt is mentally wrestling with questions and beliefs and insecurities. It’s the world of “I might” rather than “I will”. Sterling’s advice is that self-doubt can be a gift. It indicates an unwillingness or inability to commit. And yet commitment is often associated with entrepreneurial success. It’s part of what Professor Peter Klein calls entrepreneurial judgment: the capacity to choose which action to take and to follow through with it.

Choose your commitment as wisely as you can – which includes choosing those actions not to take. Sterling’s metaphor is Get A Tattoo. It’s an irreversible commitment everyone can see.

Some people find discomfort in exposure.

If you commit, you might feel more exposure than you’re comfortable with. You might have to raise money, when it’s not your skill. You may have to make a presentation about which you’re not feeling 100& comfortable. You might be the only one expressing disagreement in a meeting full of groupthinkers.

Sterling’s recipe is to assemble a support group — he calls it your street gang. They’re supporters, subject matter experts, mentors. You’ll make your commitment to them, and they in turn will give you honest feedback, trust, and loyalty. You’ll still be committed but you won’t feel so exposed.

We take on greater and greater challenges — and that’s uncomfortable.

As businesses take shape and grow, the challenges only get bigger. We might get to the point where we want to avoid some of the big challenges. But that’s the wrong viewpoint. The alternative is to turn challenges into an opportunity to find new ways to utilize our resources — to use them as a portal to advance from the status quo to a new reality. The method is reframing. What if you tried the opposite of the status quo solution? What if you looked at the challenge through someone else’s eyes, using their mental model rather than your own – what would they do? What if you change the assumptions about the way you’re addressing the challenge? There are many ways to reframe challenges, and reframing can release you and give you new energy.

The greatest discomfort is uncertainty.

Economists talk endlessly about uncertainty in business. It’s a consequence of the unknowable future. But you own your own uncertainty — for entrepreneurs, it’s a feeling, not an economic concept. It’s subjective. We’re not only uncertain about outcomes, but about resources, about financing, about our capacity, about our partners. Uncertainty is multi-dimensional. It’s also guaranteed — we can’t avoid it.

Economists, therefore, say that entrepreneurs bear uncertainty. It’s what they do. It comes with the job. Sterling’s word is surrender: don’t fight or fear uncertainty, but accept it willingly as a cost. Give up resistance. Get into your discomfort zone. Entrepreneurs need to be doing hard things most of the time, however uncomfortable that might be.

Additional Resources

Hunting Discomfort. How To Get Breakthrough Results In Life And Business No Matter What by Sterling Hawkins: Mises.org/E4B_174_Book

Visit SterlingHawkins.com

Customer Value Is All That Matters In Business.

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Value creation is – or should be – the number one concern of every business and everyone in business. The term means value for customers. If a firm does not generate value for customers, it is not in business and can’t possibly serve other constituencies like employees, shareholders, stakeholders, and local communities.

Businesspeople must think deeply about value and understand it fully, and it’s not always the case that they do. Let’s start at a higher level than the business firm, at the level of the economy. What is an economy? It’s how well-off a group of people make themselves with the resources they have available to them to work with. It’s the shared well-being of that group of people. It’s their quality of life, their enjoyment, and their satisfaction. In other words, the economy is not just the goods and services we produce or the dollars we exchange with each other to buy and sell goods and services. The economy is value that is generated for people – feelings of satisfaction, of joy and reassurance, and security, of meeting not just functional but also emotional and spiritual needs. The pursuit of economic value takes on purpose and meaning when it’s viewed through the eyes of people – and people are customers for business.

If we now return our focus to the level of the individual firm and its customers, we realize that value generation at this level in the economy must embrace and address the same feelings of satisfaction, joy, emotion, and spirituality. These feelings must be present in the value propositions that businesses make to customers. Each individual customer’s current state is a dynamic function of multiple values that they are trying to balance. You can refer to various analytical models for people’s value bundles. Here’s one called the Schwartz Theory of Individual Values. A quick look tells you that people are integrating values as diverse as pleasure, conformity, and security (and many more) into their everyday decisions and choices. The balance changes in every situation and from moment to moment.

Any business engaged with any customer at all must be conscious of the range of individual and cultural values that are in people’s minds and consciousness. If your customer is part of a firm in a B2B relationship with you, then you need to take account of the shared values of the firm you are dealing with, which will color and shape the decision-making of the individual you are engaged with.

From this perspective, value creation can be seen as pretty complex. Quite forbidding, even. How do businesses manage? There are a couple of simplifying approaches.

Get the direction right.

Value is a process. Your customer is continuously learning about value – what they themselves value in any specific situation and at any specific time. Their evaluation is changing. But they are seeking one direction, which we can call betterment: improving their feelings of satisfaction. Value is a change in status from one of less well-being to one of greater well-being. It is an increase in well-being. That means that you may not need to understand every nuance of the balance of the customer’s multi-functional values system. You just need to measure and monitor whether their feeling of well-being and satisfaction is moving in the right direction, towards betterment.

Get aligned.

While it is probably too demanding to try to identify every position of every customer on every vector of the Schwartz Value System or one like it, there is a less demanding way of value mirroring, and that’s alignment. If your position on your own value system is reasonably well aligned with your customer’s (you’re not in conflict, at least), and perhaps even better aligned than your competitor’s, then there’s a good chance of forming a value partnership: you make a value proposition that they can feel good about accepting. Alignment comes from an analysis of what matters. What matters most to your customer? You can ask them; it’s often very hard for them to articulate their values, but they might be able to answer a question about what’s important to them, at least at this time, in this situation, and regarding this deal. (Bill Sanders told us how just asking the question can “expand the value pie” in any contract negotiation with any customer.)

If what you think matters is close to what the client thinks matters, then there is the opportunity to become value partners, to make a deal or make a sale or make an exchange.

Empathy And Knowing Your Customer.

The business skill that underpins the generation of customer value is empathy. This is not a casual “get inside the customer’s head” routine. Value empathy is a product of the rapidly advancing knowledge of neuroscience that is spreading into business methods, combined with an understanding of complex adaptive systems thinking. Empathy starts from the concept of a mental model – a way of seeing the world and processing the information gleaned from sensory inputs – hearing, seeing, touching – into an individually cogent perspective. Every individual operates a unique and different mental model. The process of empathy is first to construct someone else’s mental model – the customer’s – and then run new information through it – the new value proposition that the business wants them to consider. If the business has constructed the customer’s mental model accurately, it should be possible to make a reasonable prediction as to how they will react to the value proposition. It’s not infallible, but it’s also not guessing, not projecting, and not wishful thinking. It’s not even marketing – that comes later if the business wants to attempt to change or modify the customer’s mental model. There’s a learning process, and humility is called for in thinking about customers’ complex mental processes.

Empathy is knowledge-based, unlike sympathy, which is emotional. Therefore, the more a business knows its customers and the more they know about their customers, the greater the potential for an accurate empathic diagnosis of the customer’s mental model. The first step in value creation is selecting the right customers for your business – customers you can know well and will enjoy knowing.

A Value-Dominant Business Culture.

Many of the criticisms aimed at big corporations today are the result of businesses’ failure to understand value. The claim to maximize shareholder value, but this is a financial calculation, not the generation of valued experiences for customers which is the true purpose of business. They claim to pursue stakeholder value, where the term stakeholder is amorphous, but generally taken to include employees, the population of the communities in which offices and factories are located, sometimes the environment, and sometimes even the government. None of these business activities fall under the true heading of value creation – only customer value fits. All else follows: profits (signals from the customer that they fully approve of the value they receive), stock price appreciation (reflecting the discounted future cash flows from satisfied customers), and stakeholder benefits (profitable companies with a loyal customer base are more likely to support all of their other constituencies).

Customer value takes care of all the other values. That’s why it’s all that matters.