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Bob Luddy Is A CEO Who Applies Principles Of Austrian Economics In His Business Every Day.

One of the things that I really like about the Austrian economists, regardless of the subject, they work hard to get to the truth of the matter. So they’re not hung up in formulas or things that happened in the past or general beliefs. They’re looking for the truth and the best methodology, and that’s the methodology we use in CaptiveAire, and it’s proved to be tremendously successful.

Podcast Transcript: Conversation With Bob Luddy of CaptiveAire; September 22, 2020

Listen to the full episode here.

Hunter:

Bob, welcome back to Economics for Entrepreneurs.

Bob Luddy:

It’s my pleasure to be here today.

Hunter:

You were our guest very early in our series of podcasts, in episode number four. You talked to us about specialization, which is important for entrepreneurs: choosing your specific target customer and your specialized market and becoming uniquely superior in your offering in that market. You’ve done that with your company, CaptiveAire. It’s the out-and-out leader now in commercial kitchen ventilation systems, which your website calls a complete solution of fans, heaters, duct work, and HVAC equipment. But you also talked to us about systems thinking, selling solutions, customer service, cashflow management, and a host of other things that are really elemental to your success and others too.

You mentioned briefly in that discussion that you’re a student of Austrian economics. Austrian economics has been a companion for you on the road to success. You apply the principles of economics directly in your business. You actually contribute time and resources to teaching everybody in your company some of those principles, both executive management and employees. So we’re going to talk today about how Austrian economics is applicable in business and some of the specific principles you’ve applied.

So I thought I’d start with Say’s law, Bob. You summarize it to me as supply creates demand, and every business wants to create demand, obviously. But tell us how you interpret Say’s law, because it’s not all that easy, and then we’ll talk about how you’ve applied it.

Bob Luddy:

The way I interpret Say’s law is if you bring a new product or service to market, the assumption is that you’re bringing a product to market that someone needs at a price that makes sense. So that’s the underlying assumption. But when new supply comes on the market, it may solve existing problems that are not currently being addressed, or it could be a new piece of clothing that’s attractive, and you may not need it, but you’re compelled to buy it because it’s an attractive offering. In our case, we’re primarily dealing with engineering. So the products we bring to market, while they have to be aesthetically acceptable and pleasing, they’re primarily solving problems within the restaurant or commercial building.

If we can bring products to market that solve those problems in the simplest way possible, at the best possible price, we’ve got a good chance of both creating new markets and also attracting customers from existing suppliers.

Hunter:

So that would imply that the typical words that get used in business writing, which are that firms create demand, are not quite right. It  sounds like identifying potential problems, then making the production leap, you design and produce, and then demand is a result of that. Is that a good way to summarize it?

Bob Luddy:

Yes. That’s exactly correct. I can provide some examples in our kitchen ventilation business. If you went back to the 1980s, many of the harmful effluents from cooking in a restaurant were escaping into the kitchen and sometimes even into the dining room. So that’s a serious problem because those effluents could contain carcinogens, and at the very least, they’re very unpleasant. That was the state of the art. So my thought was, if we could solve that problem at an acceptable price, we’re going to have a lot of customers. That turned out to be exactly right.

Bob Luddy:

Now, you might say other people did the same thing, other companies, and that would be true. But our vision and our target of how to solve that problem was superior to theirs, is that it’s really just that simple. So it’s not just a matter of solving the problem. It’s solving it with an acceptable idea, technology, or service, and also, again, it applies at an acceptable price, not at any price.

Hunter:

Right. But you’ve got to produce, right? Do you take that entrepreneurial risk that you’ve identified the problem correctly, you’ve designed the solution correctly, but you’ve got to produce before you create the market result, or you create the reward?

Bob Luddy:

I can give you countless examples of competitors that had some methodology of solving the problem, which we deem to be either deficient or actually didn’t solve the problem. So many people take a stab at this. But it’s only the ones who have a more precise vision of what’s acceptable to the market. So there’s market risk – that’s Say’s law – and there’s the uncertainty, so to speak, as to whether your product will win and actually create a new market. We know the greatest example of all time: the iPhone literally created a new market. In that case, they did it at a relatively high price. So that would break the CaptiveAire rule, whereas we try to be the low-cost producer. So visions can vary pretty widely. But in the end, the entrepreneur has to be very correctly aligned with that user.

Hunter:

You used a great term there, Bob, which I’ve never heard before, but it’s very evocative. You said precision vision, getting to a precise vision. How have you learned to do that over the years? How do you get to that precision? What’s the secret?

Bob Luddy:

Well, for example, just kind of a mundane product that people don’t maybe put a lot of thought into, but duct systems are fire protection systems, and they tend to be difficult to install and not as effective as they should be. So we developed a duct system that could be put together like an erector set. It’s got a good set of instructions. It actually ships like an erector set. Over time, we were able to buy highly automated equipment. It can produce this at a very low price. So we have price. We have quality. We have sustainability. We have ease of installation. We have guaranteed fire protection with the assumption that it’s installed correctly. All those bases are covered within the product design manufacturing process and installation.

Bob Luddy:

That’s supposing that we had seven of eight requirements, perfect, but one not. If a competitor was able to perfect that last requirement, we might be out of business. So that’s where I came up with the term, you have to be fairly precise and understand all the requirements, meet all those requirements, and meet them in the best way possible, based on technology that exists today.

Hunter:

I was reading an analysis the other day that said… It used the term small details, and it said, “In today’s customer experience, small details are not only important. They’re critical.” Because service and competition are so good these days that it’s the small details that make all the differences. Would you agree with that?

Bob Luddy:

We stress that continuously. So pretty much, you could look at any of our manufacturing engineers, managers, et cetera, and they are very engaged in the very fine details of everything that we do. Many times managers get to a level where they feel like the details are left for other people, so to speak. That’s a completely wrong headed idea because it’s the small details that usually trip you up. So we put a very high focus on those details.

Hunter:

In all that process, when you’re talking about production and design, Bob, what’s the role of feedback from the customers? Is that something that’s going on all the time, or is it something you actively go out and collect with a piece of research? How do you feel about customer feedback?

Bob Luddy:

First, we do our research to ascertain what the problem is. Then we determine how we’re going to solve it. Then once we put together the product, we put it into what we call a beta. So we go to some select customers and saying, “Let’s install this unit in your restaurant and see if it solves your problem.” Then over time, we widen that beta because as you get a wider beta, you get more commentary, and you can figure out some nuance that potentially could have been missed. So we found that to be a very effective process.

Bob Luddy:

But keep in mind in engineering, the end user or the customer, they can be very clear as to what their problem is, but they don’t know the solutions. So if you are able to bring a solution to them that solves those problems, they’re going to intuitively know, is this a good solution, an acceptable solution, or are there some things about it that are not acceptable? So it’s very important to get that user commentary because no matter how brilliant your engineers are or how well thought out your process, nuance is going to be missed, and that brings us back to the point of details are extraordinarily and absolutely important.

Hunter:

But the feedback is to a beta product. It’s not to a survey question or asking an opinion. You’re getting feedback, and it’s feedback about a specific product, not a concept or idea.

Bob Luddy:

For the most part, I find surveys and small groups, et cetera, to be not very useful because all you’re going to learn from them is a status quo. If we’re doing our job correctly, we better know the status quo.

Hunter:

Let’s move to another subject, which is subjective value. It’s one of the core elements of Austrian economics, understanding the value created by the customer. But we tend to associate it, I think more easily with consumer businesses. In fact, at the outset, Bob, you talked about fashion. We understand that people have different subjective tastes and attitudes to fashion, or their attitudes to food might be different. Some like fresh nutrition and others like fast food. Those are subjective values. I think a lot of our entrepreneurs have a little difficulty in dealing with subjective value in business to business. But that’s your space. So tell us about your understanding of subjective value and how it’s helped you.

Bob Luddy:

Mises made some comments about this. So for example, if we bring an integrated system to a restaurant, and if we were successful in explaining all of the problems it’s going to solve, the sustainability of it, then it still comes down to the user saying, am I willing to pay X amount of money to solve these problems? The user very well could say, “No, I’d rather live with some of the problems and depart with that much money. So Mises makes it pretty clear that’s where the decisions are going to be made.

Bob Luddy:

So our strategy is we solve all the problems. We clearly communicate to the user how we solve this problems, and then they make the decision. Now, if we don’t communicate well, the value of the product in the user’s mind may be lower. So part of the issue of getting a higher subjectivity of value is to have a full understanding of what the product does. But in the end, even if we think we’ve established a good price point, and we solved all the problems, the user can just simply say, “I’m not willing to pay that amount of money to solve those problems.”

Bob Luddy:

So the subjectivity is very, very clear, and it’s reinforced in the market every single day. It could be that if the user said, “That’s simply too much money for the problems you’re solving,” he’s sending us back to the drawing boards to say, “Yes, you have an acceptable solution, but the price is wrong. You’re going to have to figure another technology.” So I think the same concept comes into the industrial world and commercial world just as it does in fashion or food or anything else.

Hunter:

Sometimes the trouble that people have thinking that way, Bob, is you’re often not dealing with a single decision-maker, a single buyer. It’s not an individual. It might be a procurement committee, or it might be a decision that has to go up the hierarchy. So people are confused about, whose subjective value is it? Is it the CFO who signs off on the cost, or is it the engineer who signs up on the functionality, or is it the owner who signs off on the decision itself? What’s your experience about dealing with multiple customers in one sale?

Bob Luddy:

Yeah. You’ve just brought up a very important challenge for the entrepreneur. Anything that goes to committee is going to be a challenge. People tend to default to the status quo. So if you have a new type of solution immediately, a committee is going to feel more comfortable even with a poorer current solution. So within groups of that nature, you have to have an advocate, even if it’s going to be a committee decision. I’ve seen cases where you have eight people on a committee. You completely convince seven, and the eighth one is just dead set against making any change or doing anything differently.

Bob Luddy:

We had that occurred recently, and thankfully, we were able to win the day. But that’s a big challenge for entrepreneurs. I gave you an example. There was a company some years ago that had a new type of street sweeper. Of course, they were going to sell it to government. They were convinced that it was vastly superior to what was on the market, and I think they were probably right. But nobody in government ever bought the solution, and they went out of business.

Bob Luddy:

So it’s a prime example where a company says, “Well, we have the right solution at the right price.” People are going to line up a door and buy it is simply not true. You have to convince those buyers or decision-makers that this is the best choice. That is a formidable challenge, even with the best product and best pricing. So it should be always on the mind of the entrepreneur.

Hunter:

You said something really interesting, that communicating better actually raises the value of your offering. I think one of the things that we Austrians believe is that communications – call it advertising, call it marketing, call it sales, whatever you call it – is part of the offering. It sounds like you agree with that. Is that right?

Bob Luddy:

It’s absolutely imperative, particularly with new technologies that users do not understand. In the case of the iPhone, since it was so intuitive, and say since they are good marketeers, they were able to pull it off. But many products that we buy, we don’t have a full understanding of the technology, all the things it can do, and the future value to us. So if we’re not informed, we’re going to make a lot of bad decisions. So I think an effective entrepreneur has to be able to communicate with the user what the advantages of this product are and why they should buy it, and failure to do so essentially devalues their product in the marketplace.

Hunter:

One of our contributors here, Bob, Dr. Mark Packard has divided this subjective value process into components that take place over time. So he says that your customer first anticipates value. So you do the communication. They’ve got to say, is there something in it for me? It’s kind of an absolute judgment. Then they make a relative judgment compared with other choices. Then they make what he calls the exchange value judgment. You called it, do they part with the money? Then they have the actual experience. They use the product and service, and then they assess it afterwards and say, did it meet my expectations? Did it function properly? Is that helpful, do you think in thinking about your relationship with a business-to-business customer?

Bob Luddy:

Absolutely. You’ll probably notice with a lot of consumer products, when you open the box, there’s a little note in there, and it says, “You just made a great choice.” So they’re continuing to reinforce the value of their product. In that regard, if we hear even the minor’s complaint from a user, we take immediate action to make sure that’s resolved. In some case, it could be a software issue that could be corrected. It could be misuse of the product, any number of things. But we’re very tuned into after the fact, and we use the word sustainability in the context that we want our products to last 20 years or longer.

Bob Luddy:

There’s very few manufacturers today that talk about a 20-year lifespan. In some cases, we even have limited warranties that are 20 years. So the idea of having a permanent relationship with the user is very important in this whole process, and very often, manufacturers think in terms of, once they bought it, I’m done with them. I’m moving on. We’re the exact opposite of that. We want that customer for life. Even the most minor thing they’re not happy with, we’re going to fix it, and we’re going to resolve it.

Hunter:

Yes – small details. Talking about Apple, it reminds me about one of the innovations they introduced, which was the beauty of the box and what they call the unpacking experience. So as you said, you get this beautiful box, and you open it, and there’s a so carefully constructed, and there’s communications in there. I bought a pretty industrial product the other day on Amazon. It was shipped to me. It was the same thing. It was in a beautiful box, and you unloaded it, and it had this great piece of communication in there and had the little Apple-like indents in the polystyrene. So you pick everything up carefully. It was beautifully done. Does that come to your business, the unpacking or delivery experience? Is there anything there for-

Bob Luddy:

Oh, absolutely. Maybe not as much in the end packing, although we try to ship things in the most upscale way possible. It comes in if the outside crate is all messed up or the box is a problem. Immediately, you’re going to have a poor perception of that product. But we also are very conscious of aesthetics. So you can have a high function product with poor aesthetics, and just right out of the gate, the user’s going to say, “Well, this is just a piece of junk. They’re going to have a very poor perception of it.” So aesthetics count, and you’ve just iterated how that box counts a lot, even though it has nothing to do with the product. Again, you’re pointing to the details. People fail on these details.

Bob Luddy:

If you look at very complex systems that we’re engaged in, the smallest detail can shut that system down. One short wire out of place can cause a major problem. So if anybody involved with that product is not into the fine details and not executing at a very high level, we’re not going to be as successful as we should be.

Hunter:

I want to turn next to comparative advantage, Bob. We’ve had Dr. Peter Klein and Dr. Per Bylund and others on the podcast. They stress the difference between competitive advantage – I can perform better than my competitor – and comparative advantage, which is something more inherent in the company itself and its leadership. So how do you think about comparative advantage?

Bob Luddy:

I think of competitive advantage as essentially ephemeral for the most part. So you can gain advantage, but it’s very hard to hold that advantage in a highly competitive market. Whereas comparative advantage, you have a very distinct advantage that’s much longer term, maybe not absolutely invincible, but very hard to overcome. So outside of our field, I would say, if you looked at Napa Valley making wine, if you decided you wanted to make wine and compete with Napa Valley, it’s going to be a hard way to go. In our case, over time, we’ve been able to develop those design technologies, techniques, automated equipment software, and when you marry all those things together and you integrate them, we gain a major competitive advantage. It’s very hard to overcome because it’s not one thing. It’s many things, and they’re all well thought out and have been developed over a number of years.

Bob Luddy:

Whereas the competitive advantage is something that can be again, ascertained and overcome in some period of time. So you can gain these advantages, but they’re going to be ephemeral. So the goal of the entrepreneur should be to try to gain a long-term comparative advantage if possible. In many businesses that’s really difficult. In very competitive businesses, you’re lucky to gain a competitive advantage much less even thinking about every gaining comparative advantage.

Hunter:

Let me pick out one word you used there because it’s a fascinating one, and it’s a place where you can perhaps get comparative advantage over time. You call the techniques. Unfold that a little bit for us, Bob. What’s a technique, and how do you gain advantage with techniques?

Bob Luddy:

Well, for example, we have to bend a lot of sheet metal for a product. The way it’s been traditionally done is manufacturers will bend a lot of metal, and they’ll have it ready to go. So when the product comes in, they’ll pull the bent metal off the shelf, and then they’ll assemble it. Well, that requires a lot of storage anticipation of what you’re going to sell – a laundry list of challenges. So over time, we were able to buy automated equipment that will bend that metal in real time and dynamically stack it right up on the assembly line rate to be assembled and all that’s done in hours.

Bob Luddy:

So we can have a very rapid turnaround time. We eliminate all the inventory. We eliminate all the losses for inventory put together that can’t be used, and then we get into the actually assembly of that product, and we have our own unique methodology of assembly that doesn’t require traditional manufacturing jigs and devices. It’s what I call self-jigging. So it’s coming off these high-speed machines, is hitting that line, and then we have a whole series of techniques of how the product is assembled.

Bob Luddy:

So in a matter of hours, it’s the end of the assembly line ready for checkout, and it’s going to be shipped. All that has taken many, many years to develop, but that gives us a very strong competitive advantage that’s not easy to overcome. Many companies have tried it. But they don’t get all the details right, and they may miss some important steps. So it’s very hard to replicate. So I would consider that more than a competitive advantage, it’s a comparative advantage.

Hunter:

Do you design your way to those techniques on a drawing board, Bob, or do you just work your way towards them through trial and error and learning? How do you develop techniques?

Bob Luddy:

Actually, it’s both. So we design our way through initially design. We build prototypes. We revise the design, and we get that product ready for our production process. But once we get in production, we find components that are less sustainable than we wanted. We find a better technique. We may find a component that we could design better. So it’s in a constant state of renewal, looking for again, a better way to do it. We call it Kaizen from the Japanese word for continuous improvement. So our engineers are very connected to those assembly lines, and they’re also very connected to the field, primarily through software-delivered data, which is being fed to them all day long. Any minor problems are aware of, and they’re working on to fix them. So yeah. Our whole team is totally engaged in that process.

Hunter:

One of the techniques I know in Kaizen on continuous improvement is to identify what the Japanese call waste, either wasted time or wasted effort or wasted energy, and then you eliminate the waste. Is that part of the process?

Bob Luddy:

Absolutely. Yeah. That waste could be human, it could be time, could be components, could be any number of things. That’s a constant that we’re working on that process, and our design engineers and our manufacturing team, they’re all on the same team, and they’re working very closely together. Even though we are radically decentralized company, we’re tied together with software, with visits, with telephones. So we function like we’re all in the same building, but in fact, we’re all over the country.

Hunter:

Is the software feeding back from operating machinery and the restaurant or from inspections and people or both?

Bob Luddy:

All the above. So we get inspection reports. We have real-time data being fed from restaurants that will give us any aberration in performance. It also allows the engineers to look at restaurant operations and see if that equipment is performing the way it was designed. Field service is constantly feeding back any concerns they have to the manufacturing plants on a daily basis. Sales teams have software that they communicate with us. If a customer has any complaint, any issue, it’s tabulated on a software program. So the engineer in charge is very cognizantly aware of when, how often this happened. So the information we receive is extremely good, but more importantly is we’re working on it every day.

Hunter:

Do you call it big data? That’s a fashionable term these days.

Bob Luddy:

We don’t use a lot of the conventional terms. We just call it data.

Hunter:

Information.

Bob Luddy:

Yeah. Information.

Hunter:

I’ve got one more item on my list here, and that’s opportunity cost. You said that’s one of the concepts that you apply. I know that I personally have a little bit of difficulty in thinking of that through in application. I understand that the concept is that any choice that, say, your customer makes has an opportunity cost, which is they reject something else, or they don’t take another course. That sounds a bit theoretical. How does it apply in your business?

Bob Luddy:

Well, I’ll give you an example. We bought a make-up air company (see CapitiveAire website for technical explanation) in the year 1999. These companies and the controls for air coming into the building, being heated or cooled, there tended to be a lot of customization from engineering, sales reps, customers. That customization requires an enormous amount of engineering, and it’s fraught with problems because you buy a new component, you don’t know if it’s going to work under the right terms and conditions. There’s endless number of problems. So we decided in 1999, we would move toward what we call high standards. So we would a very high standard product that would suit 95% of all users. There’s flexibility within the ordering software to customize voltage and phase and certain aspects of the product. But it’s all done in software. Whereas our many of our competitors same time said, “We can be all things to all people. You tell us what you want, and we’ll figure out how to make it.”

Bob Luddy:

Most of those companies, 20 years later don’t exist any longer. So it’s an important thing to understand that opportunity costs also means turning down opportunities, getting the best utilization out of your human resources possible, making the most sustainable solutions, which are going to save time and money over a period of time. Companies tend to get these things wrong. So we’re more in the range of, we call it a category killer. We make 10 major categories of products. To keep those products at the right price, at a high level of performance and sustainability requires all of our time. So if we divert any of that time, i.e. opportunity costs, onto something, it better be something really important, or we’re failing at our most primary mission.

Hunter:

Is that an active piece of analysis, Bob, every time you look at something like that, a new opportunity that you also look at the downside, you look at the opportunity cost? Do you actively make that AB decision?

Bob Luddy:

Absolutely. Every single time.

Hunter:

So opportunity cost is an active process for you.

Bob Luddy:

Yes. Entrepreneurs, you’ve heard the term serial entrepreneur, which I don’t like. I think it’s very bad because we’ve been at this business for 44 years. While we’re really good, we’re not as good as we want to be after 44 years. So what does that tell you?

Hunter:

That you always keep going?

Bob Luddy:

That there’s always ways of improving, and the higher you get in perfection, the more and more opportunity costs. The more opportunities arise that you can get to another higher level. That’s not necessarily intuitive because people think in terms of where they want to arrive, and we don’t look at it in those terms. We just know where we’re at today, and we have laundry lists of things that we want to correct and resolve for the long term.

Hunter:

That’s an active list that you keep?

Bob Luddy:

Yes. Yeah. Well, we have long lists of things. If I went to our engineer in charge, he might have a list of 50 items that they’re working on at any given time. He’s got a lot of engineers working on these processes and products. A lot of them are, back to your word, details. They’re small details that make that product perform better, more sustainably, more useful to the end user but unlocking kind of scientific information is a slow arduous process. But every time you make that breakthrough, that product becomes more viable, and it’s gonna have a higher perception with the user. That’s pretty much how we operate the business.

Hunter:

That’s very impressive. I’m going to try and squeeze in one more topic, Bob, if you’ll bear with me. You might not be able to do it justice, but it’s one that entrepreneurs, especially B2B entrepreneurs, I think have a real challenge with, and that’s pricing: getting the price right. You always quote Bill Peterson on this topic whom you’ve mentioned before is as a mentor. So distill for us in just a few minutes, as I say, we might not be able to do it full justice, your experience about price and pricing.

Bob Luddy:

From the very beginning, my idea was that we would price under the market, which would be our primary means of gaining market share. Very interesting, if you went back into the 1980s, very often, people were telling me you’re leaving money on the table. I said, what does that mean? Well, you could charge the customers more money and get away with it. I would continuously say, “That’s just not how we operate.” We want to have the best price we can bring to that user, gain market share and grow as a company. If you fast forward 35 years later, we are still the low-cost producer. We have the highest market share, and virtually no manufacturer can get to our price because we spent 35 years figuring out how to do it. Again, we talked about our comparative advantage.

Bob Luddy:

I hear people make comments where price is not that important. Value is what counts. So my retort to that, which maybe came from Peterson, well, why put prices on anything, just go to the store, buy what you need and put it on the credit card. Well, that undermines their argument very quickly. So when Peterson said, “Price tells us a lot about the product, and it informs us and helps us make a decision if we want to pay that price for that particular product.” So I would say, of the most important strategies for CaptiveAire over a 44-year period, price is number one. Now, obviously, it has to be connected to quality execution service and so on. But pricing is a primary strategy, and our senior engineer and myself, we do all the pricing. We have an ultra short way of pricing, all the products that takes virtually no time and is definitely accurate.

Hunter:

So one of the statements that Dr. Bylund and others have made is that the entrepreneur doesn’t choose the price. The market chooses the price, and the entrepreneur chooses the cost so that you make a profit based on the price that the market gives you. So it sounds like maybe you are in that process. When you say you’re going to price under the market, that means the market’s telling you what that price level is, and then you choose your cost. But would you agree with that, or is that too facile?

Bob Luddy:

Yes. Now, most manufacturers couldn’t price the way we do if they didn’t have a comparative advantage. So we actually price based on cost, which if you go to B schools, they’ll tell you that doesn’t make any sense. As a matter of fact, many of the things they tell you in B school we don’t use as it may not make sense to other people. But us, if we can price based on costs and have a defined profit level, we don’t want to try to make more than that, even though the market may allow it because we’re looking very long term at growing the business every single year.

Bob Luddy:

So this is kind of back to a Peter Drucker argument. Yes, we could price higher, but we would have lower sales. So what does Drucker say? You should price as high as you can, but still have the highest amount of sales possible within the market. There’s obviously no formula for that. My strategy is more simple. We’re going to price based on cost. We’re going to continue to drive costs down, and therefore, we are going to be the low-cost producer, and most of the time, we are going to be the low-cost producer.

Hunter:

But you’ve achieved that without any compromises in quality and service, obviously.

Bob Luddy:

Now, in most cases, our quality is vastly superior to what people could buy. People have what I call bad buying habits. They just keep buying from the same user. So you may have a better product. But until you convince the user you have a better product. You’re not making sales. But our strategy is we’re going to have the best product, the best service, most sustainable, and the lowest price, and that attracts a large volume of customers.

Hunter:

Then you referred earlier to the integration that makes that possible. Every element is so integrated that you can have that combination.

Bob Luddy:

It took us 20 years to fully integrate kitchen ventilation systems. It’s taken another 20 years now here in 2020. We can fully integrate the mechanical systems in a restaurant or most commercial buildings. So it’s taken a long period of time to get there. But futuristic integration is absolutely critical, and even the smallest detail you miss in that integration are very, very critical and may allow a competitor to take the business away. So our long-term commitment is full integration, continuous improvement, Kaizen, figuring out ways and means of driving down price, and that’s where I would say the value proposition comes in. But just to announce that you have the best value in the market, well you know the answer to that. The user will make that determination.

Hunter:

The value is always in the customer’s mind, not in your proposition.

Bob Luddy:

Absolutely. I think manufacturers and developers, people get that very confused. They think in terms of absolute value. We think in terms of subjective value. That puts a burden on us. We have to convince the user, and we have to be right, to begin with, that this is the best value they can buy in the market today.

Hunter:

Bob, you’ve been very generous with your time today, and we really appreciate it. There are so many lessons to learn from your long experience and your great achievement, and we thank you for showing us how these concepts of Austrian economics can be applied in business, and that’s what we’re trying to do with our new economics for business platform is to share those connections between theory and practice, and you’ve shown us how it’s done. So we thank you very much for your time today.

Bob Luddy:

Can I add one last comment?

Hunter:

Yeah, please do.

Bob Luddy:

One of the things that I really like about the Austrian economists, regardless of the subject, they work hard to get to the truth of the matter. So they’re not hung up in formulas or things that happen in the past or general beliefs. They’re looking for the truth and the best methodology, and that’s the methodology we use in CaptiveAire, and it’s proved to be tremendously successful versus when I went into B school, so versus going to B school and learning certain things, and then spending your whole life trying to apply those principles, some of those principles are going to be good, and some of them are going to be, as Dr. Bill Peterson would say, the conventional wisdom is either wrong, or it’s going to be wrong.

Bob Luddy:

So it’s wrong we have to change it. But we also have to aware that someone else may have a better way of doing it. But we’ve got to be paying attention to the market. The Austrians do an excellent job at that, and that’s why I think Austrian economics is critical to every single entrepreneur.

Hunter:

We’ve developed this tagline for our project, Bob. We call it Think Better, Think Austrian.

Bob Luddy:

I love it.

Hunter:

Distilling  that, how do you think better I think is one of our challenges. We’ve got to help people to do that. So as you said, getting to the truth, a lot of that is Carl Menger’s first sentence. Everything is cause and effect. Is that one of the ways you get to the truth?

Bob Luddy:

Absolutely. Clayton Christensen made this comment in his book, the Christensen Reader. If you look at the technology companies that were founded around the same time as CaptiveAire, so these are companies that are well financed, smart individuals, good technology. Virtually every one of them is gone today. Just a couple of exceptions. Either they’re gone, they merged, they were bought out, or they went bankrupt. What does that tell you? They simply did not look ahead. They were enamored with the technology they had. When someone came along with a better technology, they were gone.

Hunter:

There’s a great example of that, I always think, which is Bill Gates at Microsoft when he made the pivot to the internet. That was a really bold decision. It was forward-looking. It was controversial, but he was the boss, so he could make it happen. But that’s one example why Microsoft is right up there now today with Amazon and Apple and so on.

Bob Luddy:

They definitely have pivoted over the years. They’re one of those companies, one of the few that did survive for that reason.

Hunter:

Well, we’ll continue to try and figure out how to think better and think Austrian, and your example will be the leading one, Bob. So again, thank you very much for your time today.

Bob Luddy:

Hunter, it was a pleasure to be with you today.

Hunter:

Thank you.

 

What Is A Business Model? It’s Not What You’ve Been Told.

What is a business model? It’s a question asked frequently on Google Search, so there must be doubt in businesspeople’s minds.

The reason for the uncertainty is clear. The term business model sounds like a thing – a completed canvas, a written document, a spreadsheet with macros. But it’s not a thing, it’s a lived experience, for both business executives and their customers.

The Austrian Business Model

In a recent edition of the Economics For Entrepreneurs podcast with Dr. Per Bylund of Oklahoma State University, we described a very different kind of business model framework we called the Austrian Business Model, based on principles of Austrian economics. It’s a recipe for business success. We chose the term “recipe” purposefully, to communicate these features:

  • A recipe is a non-linear process: there are inputs and outputs, there are many different sub-processes progressing at different rates designed to integrate at critical points, and subject to adjustment by the operator as new information is revealed (“the oven’s on fire!”; or, “this tastes like it needs more salt”).
  • A recipe is dynamic. All parts of it are in motion all the time – assembling, combining, mixing, cooking.
  • A recipe is adaptive. If the chef does not have all the ingredients at hand, he or she may substitute or leave out some elements. If a guest does not like some ingredient, the chef might work around it. New methods of cooking may lead to a better outcome with the same ingredients. There is learning from experience about what techniques work best.

Like a recipe, a business model is also a non-linear process, dynamic, always in motion, adaptive and improved with experience and learning. And, like a recipe, it unites multiple lived experiences. There is the chef’s lived experience, operating the recipe this time, as well as applying accumulated experience from previous times, and perhaps the inherited experience of family members from past time. And there is the lived experience of the recipient who tastes the output, in the context of a dinner party or a family meal. An experience is always shared.

In fact, the focus on experience is critical in a business model. Its end result is a value experience – value perceived by a customer, sufficient to justify the price they’re willing to pay for anticipated value, sufficient to deliver value in the use experience, and sufficient to support an assessment of value after the fact, looking back on whether the experience met expectations.

The experience-centric business model

An experience-centric business model traverses four phases of value learning for the entrepreneur.

Understanding Value

The foundation of a business model is an understanding of value for a specific set of customers. There are conventional business models that talk of “creating value” – whether that is the economic value of returns on capital that are higher than the cost of that capital, or shareholder value in the form of higher stock prices, or even brand value and product/service value. But all of these routes to “value creation” are misdirections. Firms can’t create value. It is customers who create value through their experiences. Value is something customers experience after they have made the economic calculation to buy a product or service, used it, and then stepped back after usage and assessed the experience compare to their going-in expectation. Value is formed in the customer’s domain, and not by the producer.

That’s why economists refer to value as subjective. It’s a perception that varies with each individual customer, with changes in context, and with changes in time and circumstances. The task of the business model developer is to understand the subjective value preferences of a specific set of customers in a specific context at a specific time.

Value Facilitation

Producers can suggest to customers that they can help them bring about the value experience they seek. The word “help” is important. Operating a business model is not an exercise in “making things happen”, it’s the art of helping them to happen.

In the business literature, there is talk of the design process – designing experiences for customers based on listening to their feedback. That is all very  well-intentioned, but it doesn’t quite capture the art of value facilitation. Customers form value through cognitive, mental and emotional processes, consciously or unconsciously, interpreting interactions and information and constructing an interpreted and experienced reality within which their feelings of value are embedded. Value is formed in people’s life experiences and it’s not the role of the producer to act as designer.

Producers and marketers must ask, how does the customer live their life? What is the life context? What are the challenges the customer faces? These and many more questions prepare the producer to humbly request to fit in and contribute to the customer’s life. If invited in, there is the possibility of value facilitation.

Value Exchange

Your customer is going to undertake a complex subjective balancing of the value they perceive based on your proposition and their own willingness to pay, in the context of all their alternative choices and any historical experiences they have had, either with your proposition or others. You can try to understand their process, but you can’t direct it. For example, you can’t set pricing. The customer determines the price they are willing to pay, and the producer’s job is to discover that price, through testing. Therefore your revenue model must balance the price the customer decides upon, with the costs you choose to include in assembling your offering. Costs are never forced upon businesses – they are always chosen. In the Austrian business model, entrepreneurs buy as many inputs as possible on the market, where costs are known and are rendered efficient through competition, as opposed to keeping costs internal, where they can’t be known exactly and may be unstable or hard to control. Your margins are emergent from this equation of customer-chosen pricing minus entrepreneurially-chosen costs. Don’t try to set margins in advance.

The best metric to monitor is not margin or profit, but cash flow. Keep it positive, monitor it weekly, and adjust to its signals.

Value Agility

Once invited into the customer’s experience, the producer has an opening to act as the value facilitator-on-the-spot for the customer. As the customer lives the experience – operates the recipe – there will be questions, unexpected occurrences, errors to fix, context changes, and many more unanticipated twists and turns.

The entrepreneur’s business model secret at this stage is agility. Business models that talk about strategic pillars and similar unchanging elements risk failure in the light of customer volatility and change.

A key to success lies in good feedback loops. Your business model must prepare your firm to be dynamic in response to customer preference changes and all the new information coming to you from the market every second, minute and hour. If you don’t maintain dynamism, your business model will weaken and your grip on competitive advantage will loosen. Your value proposition must strengthen and improve continuously. Your model of customer preferences must be kept fresh. Your value facilitation must demonstrate continuous improvement at a faster rate than the customer’s value experience erodes.

Empathy, humility, adaptability, and agility. These are the components of the contemporary business model. There’s a framework you can use to shape these components for your own unique application of the model, in The Austrian Business Model video.

Per Bylund Introduces The Austrian Business Model.

Podcast Transcript: Conversation With Economist Dr. Per Bylund; August 11, 2020

Listen to the full episode here.

Hunter:

Per, welcome again to Economics for Entrepreneurs.

Per:

Thanks for having me on again, Hunter.

Hunter:

You’re very generous in the consulting help that you give to entrepreneurs and all kinds of businesses and in your student teaching, so you’re shaping the next generation of business leaders and innovators and you gave two presentations at Mises University 2020. We’ll highlight some of the content today and we’ll link to those lectures on YouTube, which are accessible to everybody. One was called Austrian Economics and Business, and the second one was How Entrepreneurs Built the World. We’ll cover the essence of both of them today, but I’m going to start by laying out a proposition that it sounds to me like you’re putting the final touches to something we can call the Austrian Business Model. Is that correct?

Per:

I think so. That’s a pretty accurate way of putting it, I think. I mean, what I did in my lecture was basically talk about how first mainstream economics is not very helpful for businesses and business owners and those starting new businesses. Even though there is a subject and usually a course called Managerial Economics, what you learn there is simply to maximize curves and to put marginal revenue equal to marginal cost and things like that, and when you don’t really have those numbers and you don’t have equations in your business it’s not very helpful at all.

Per:

And then economics tends to not look inside the black box that is the firm, they just assume that there are firms. So it’s not strange that it’s not very helpful, but Austrian economics is different. We look at human beings and human action, and that is what is going on within a business and their businesses in a sense of organized action towards a specific end and the businesses try to satisfy their customers. And how do you do that? Well, we have plenty of answers to that in Austrian economics.

Per:

So an Austrian Business Model would simply be a way of structuring your business and following guidelines to make sure that you avoid errors and mistakes.

Hunter:

Good. So we could call a business model applied theory, applied theory to generate what you called in one of your lectures unceasing innovation and improvement at the level of the firm on behalf of the customer, obviously. We could call it process logic for continuous and sustainable value generation which then results in revenue generation and profit for the firm.

Hunter:

One of the interesting things in your lecture was you said that experienced entrepreneurs are generally Austrian even if they don’t know it and successful businesses are Austrian by definition. So the Austrian Business Model works, you would say.

Per:

Yeah, exactly. And what I mean by that is simply what I’ve learned from experience that talking to experienced entrepreneurs they have learned how the economy works, how the market economy works, and they have learned how to avoid the common mistakes and how to structure your business so that you have the greatest chance of survival. And the way they’re doing that is pretty much the same thing as we do in Austrian economics, but we do it in terms of theories. So we generalize it and we have general ideas and rules in a sense for how the economy works. Well, by applying those we can help businesses succeed to a much greater extent. And there’s, of course, a golden opportunity here because you have all these experienced entrepreneurs and business leaders who have this gut feel or this intuition that they’ve generated through just accumulating experience, but they don’t really have a terminology or words for it. They don’t have it well formulated, but we do in Austrian economics. We have the theory so we can provide them with this language and such things as putting the customer first, that value is subjective and what that means, the implications for the business, and so forth. So there’s a lot that we can really learn from each other, both practitioners and Austrian theorists.

Hunter:

Good. That’s exactly what we’re trying to do here. The place to start, you’ve mentioned it already, but it strikes me that it represents one of the true differences of applying Austrian economics in businesses, this understanding of value as subjective, and it creates a very different perspective on value because it takes place in the mind of the customer. It’s an experience of the customer, so that the true locus of value generation is in the customer’s domain when they use an experience the entrepreneur is offering.

Hunter:

So let’s start there. What are the business model implications for entrepreneurs of subjective value?

Per:

Well, that’s what we said. I mean, value is really created in consumption, so it’s only in the use of a product or service that you actually get the value from it. That’s why we consistently talk about not entrepreneurship as value creation, but it’s value facilitation. So the only thing you can do as an entrepreneur is to provide a good or an experience to a customer, and then what the customer makes of it is really out of your hands. You can’t really do much about it. What you can do is sort of nudge the customer in one direction or the other and try to help them figure out that there is something valuable to them on their own terms from using your product. But that’s all you can do. So value in that sense is personal and it’s subjective, so you can’t really put it in any type of objective measurement.

Per:

So we talk about profit in dollars, for instance, but the value of having something is it’s not… You can’t express that in dollars. You can’t express that in anything else and mainstream economists, when they teach these things they talk about utiles as a sort of measurement of utility you get from something. I mean, it’s like having a fancy meal with a loved one in a restaurant, for instance. I mean, if you get great service and a great meal and a great atmosphere and everything, the whole package there, what is that worth to you? Well, it’s worth to you… The whole experience is worth some degree… You get a good feeling inside, and you have a memory that you can live off for a very long time and so forth. Of course, you might be able to pay a certain dollar amount for it, but the value to you is your experience. It’s really nothing else.

Per:

So we have to understand this when we run a business, when we start a business, and when we study businesses, too, that what you’re doing is trying to help them get the best experience possible. So the customers should experience something that they value on their own terms, whether or not they can actually put the actual words on it.

Hunter:

Right, and that’s something that tends to be neglected in business school and their models, which are very mathematical. They look at things objectively, they try to engineer the results in terms of numbers, and they miss that subjective value description that you’ve just so eloquently made.

Hunter:

So we start the model there, and then you mentioned that we help the entrepreneur think about understanding the customer and their subjective value, and then they can create a value proposition. So let’s describe what a value proposition is in the Austrian Business Model.

Per:

Well, sure. It’s the complete offering. It’s the complete experience that the customer gets out of what it is you’re offering. And there are many, many ways you can tweak this, of course, but how do you tweak it? Well, the only way of doing this is to know who the customer is to begin with, and it includes all aspects of what it is you’re offering. It’s a time and place, and it’s the price, and it’s the type of language used just introducing it. It’s the actual quality of the thing or the service, and it’s how you follow up on it and how you treat your customer. And all of these things are really part of it. And whether it’s valuable or not, that’s completely in the customer’s own eyes.

Hunter:

Yeah. And this picture of the, I call it the longitudinal multifaceted variable of the experience. It’s really complex. You’ve also mentioned that to think of it through the customer’s eyes, it’s always relative. They’re always thinking, “Well, where else could I get a better experience?”, and it’s always comparative: “What else could I spend the same amount of dollars on?” So the entrepreneur is always going to be thinking about those two elements of the experience, relative and comparative.

Per:

Exactly. And that’s where you try to find your own niche as an entrepreneur and try to provide something unique that is really, really valuable to a certain subset of the market. I mean, in mainstream business, and we talk about market segments and so forth and you’re supposed to find your beachhead market and all of these things, but it’s really important that you really understand the customer and what type of experience they might enjoy and that they might get extra value from. It might be a really, really narrow one or it might be a broad one, and depending on what you want to do as an entrepreneur and how you think that you can get the most value out of it for yourself and provide [inaudible 00:10:35] value, you might choose one that is really specific for just a few customers, but really valuable to them, or you can provide something that is sort of general and not super valuable to anyone where you rather compete on price. But what you are selling is always the complete experience. So if you’re doing something, let’s call it shallow. I mean, this doesn’t sound all that good, but if you have a shallow offering, meaning that basically you just sell stuff and you don’t provide a whole lot of additional experience, no fluff, you don’t provide an experience.

Per:

So any type of retail would be this type of business, like a Walmart or something like that. You don’t go to Walmart because of the experience. You don’t consider paying extra when you go to Walmart because you get special treatment or you get superb customer service or anything like that. You’re just interested in getting the product and getting out of there. That’s basically what you’re doing. So they’re catering to a lot of people who are price sensitive, but they’re not treating you as king, as I said, customer, whereas in other more highly priced retail stores or grocery stores, they might greet you in a different way. They might have music on and all these things, but you’re also paying for it. But it’s a much more narrow market segment, where this segment specifically really value that it is super clean, that they always have a certain number of each product available, that they only have products of a certain quality or a certain brand or whatever it might be. And everything that is part of this experience is part of what you’re selling. So for Walmart it’s keep prices low, but don’t give anything extra like that. But for other goods, pricing might be part of the thing or it might be part of the offering.

Per:

So luxury sports cars, for instance, or yachts or something like that, they might sell those for a price that is really ridiculously high not simply because the cost of production is high because the cost of production might not be high, but because it excludes those who are not rich enough and thereby makes the product much more valuable to those who can afford it. And so the price itself can be part of the experience and part of the good that they’re offering.

Hunter:

Yeah. I think of places like Louis Vuitton stores, which my wife occasionally takes me to, and that’s a totally different experience than Walmart. The prices are extremely high. There’s very little inventory, but the decor of the store is meticulously designed and the members of the staff, of which there are many, are highly, highly trained. They treat you like you’re a member of the elite, and it’s an experience itself. Even if you don’t buy there, it says something about the Louis Vuitton brand. So those are kind of the two ends of the spectrum that you’re talking about.

Per:

Yeah, exactly. That is an interesting example, too, because it’s so obvious that they are catering to one of the two entering. So when you and your wife enter, they might cater to her as the person who gets the experience and makes the decision to buy, but not as much to you even though you might be the one writing the check, right? So you need to know as a business owner what type of customer will I target and what is the actual value to them? Is it usually a couple where one has the income and the other makes the purchases or is it a different constellation? You need to know these things because that’s how you position your offering and how you… You mentioned the decor in the store and things like that, how this works, how it looks, how it feels for the customer. The whole experience is really important.

Hunter:

Right. And it highlights another point you always make, Per, that in designing these value propositions and delivering them, the two firms aren’t competitive. It’s possible that you can buy handbags in Walmart but Walmart and Louis Vuitton, while they’re both retailers and they’re both selling handbags, they’re not competing. They’re designing totally unique value propositions for different people at different times in different states of demand. So we don’t think so much of firms competing with each other as firms designing unique experiences.

Per:

Yeah, exactly. That’s exactly what they’re doing.

Hunter:

Good. So we’ve mentioned another element which is different in the Austrian Business Model and that’s pricing, and this is fundamental and you covered it in your lecture where we’re taught traditionally in the business school to think about cost plus pricing. We’ve mentioned it before in the podcast, but let’s cover it again in the sense that that’s the wrong way to think about it, that the customer decides what the price is that they’re willing to pay for the experience you’re offering and then the entrepreneur chooses the price. Can you go over that again for us because it’s really important?

Per:

Yeah. Yeah. I would love to. And you mentioned the cost plus method of pricing and this is sort of one of my pet peeves, and I really, really hate that concept. It’s actually a good reason to not get an MBA at all because they teach that stuff. It really balances out any type of value you might get from any of the other courses because they teach you this BS, really. So I mean, the way to think about it is that when you start a business or when you pivot a business, you need to figure out who the customer is, which we already talked about, and how valuable the experience might be to this customer. From there, you can guesstimate a price that they will be willing to pay for this. And this probably shouldn’t be as much as possible as we often teach it and as economic models suggest. It should be a price that helps you sell the product.

Per:

We already talked about how the price is part of the offering, right? So the price could be really high if that adds to the product, or the price should at least be much lower than the value for the consumer. So the consumer… Well, of course, as you already mentioned, look at the balance, the trade off, okay? What type of value do I think I get from this company for this money compared to what they can get for my money elsewhere? And that’s perfectly subjective from their own point of view, and the entrepreneur needs to figure out what type of price is the best price for my niche or for my market segment, for my preferred customers. And then from that price, you need to figure out how am I supposed to produce something that gives them this experience, this value, where I can still keep my costs per unit produced lower than the price that I can charge for this. So in a sense, the only thing you can do as an entrepreneur is to choose the cost structure of your business. You don’t do anything else.

Per:

If you figure out who the customer is, because you already have an idea of what you want to produce and what you’re good at, perhaps, or what type of market do you want to be in and all of those things, but when you have figured out who to cater to, who is your customer, then it’s pretty straightforward in a sense that what makes these customers find real value in the experience. Well, that’s where you need to go. And then that gives you an indication of what price they’re willing to pay, and your job is to get them the experience at a cost that is lower in price. And, of course, the difference between those two, that’s your profit.

Hunter:

Yep. And there’s a surprising implication of that, Per, which you covered at Mises University 2020, which is to make those costs, to assemble the cost structure that they want, the best thing for the entrepreneur to do is rely on market prices, which means buying the components, the resources outside of the firm, and then just focusing on inside the firm the things that only that firm can do uniquely. So you got to make it inside, and that has huge implications for organizational design. So take us through that use of market prices for us, please.

Per:

Right. So one way that I think a lot of entrepreneurs… It’s a mistake that they make is that do you want to control everything? You want to make sure that you have things in house, because if something happens then you need to be able to just redirect resources or make sure that you have this guy on the staff so that you can use them more or whatever it is. And we all feel this, and this is sort of a human instinct to whenever something is uncertain we go for control. Well, control is pretty worthless. When you’re dealing with value generation and trying to create an experience of value to others, you will do this under uncertainty. There is no other way. And control is pretty worthless in this case. What you need to do is figure out how can you contribute as much as possible to whoever is on the other end; that is, your customer. So what you need to do is bear that uncertainty and make sure that you are focusing on where you contribute to value.

Per:

So the implication of this is to keep as little as possible in house. And this sounds counterintuitive simply because you want to control as many bits and pieces as possible so that you don’t stand at the end with only half a product or can’t complete your production and you can’t offer the customer everything that you wanted and so forth. But the thing is that the market has this fantastic mechanism for allocating resources toward the greater benefit for consumers, and it’s the price mechanism. And it sounds like very abstract economic theory and it is, but if you apply it what this means is that the more stuff in your business you can put on others and thereby contract them out, you outsource to others who are experts in those areas, the easier it is for you to focus on your core contribution. And today, most startups you wouldn’t hire an accountant. You also wouldn’t hire an IT guy. That’s not the first thing you do because this just seems like a waste of money. But if you really want to be in control of your books, if you really want to be in control of your technology, that’s where you should go. But now it’s become so obvious to all businesses that no, you’ll have an accountant and you just send your receipts that way and they take care of it, right? And the same thing was with IT.

Per:

You can buy consultant hours or you can buy services from there, and you might even get some service with the hardware when you buy it and things like that. That’s the way to think about your business, and that means that you don’t have to… The more you outsource you don’t have to struggle with or deal with potential problems with all those parts because you have already outsourced those problems in a sense to others and you’re just paying the bill.

Hunter:

Yeah. And it seems like today, the world is catching up with that kind of applied Austrian theory because the interconnectivity that you can get through the internet to global supply chains and other kinds of suppliers and buying in resources that others have made, and so on. That’s very contemporary, so Austrian economics was ahead and will keep ahead with this business model of new thinking about organizational design.

Per:

Yeah. And it’s really fantastic when you have a really good theory that is universally applicable and it’s not really sensitive to different times of civilization or the market or the economy or the world, of course, but it always applies. It is held in very general seemingly abstract terms, but it should be always applicable. And then that’s the case with Austrian economics, and that’s why [inaudible 00:24:14], like you said, it’s valuable to apply it over and over again because it provides insights into any of these situations even if the situations are different.

Hunter:

Yep. And technology enables more and more application, right? If that’s the right way to say it. The internet wasn’t around when Carl Menger wrote his principles, but today you can apply them in an internet-powered world.

Per:

Oh, exactly. And I mean, the more information and communication technology we have the closer we all are, meaning that we can outsource more and more, meaning that we can do less and less and focus more and more narrowly on our value contribution.

Hunter:

Which brings us to the next point. It’s overlapping, but it’s about Austrian capital theory which says that your capital structure should reflect the way in which you best serve the customer, and the assets that do that will be the ones that generate your customer revenue, and you should be constantly inspecting them and perhaps changing them up as customer preferences change. So you got to examine your assembly of assets and keep inside the ones that are most contributing to customer service. Is that the right way to think about it?

Per:

Yes, it is. And I mean the way you use resources right now, you bought them for a reason, you put them in place for a reason, and so forth, so the best approach to adopt an Austrian Business Model when you’re already up and running a business is to think about it probably in terms of investing and divesting. So when you’re buying new, if it’s machinery or computers or moving to a new location, whatever it is, all of these investments, you should think as an Austrian would think of the customer first. How does this contribute to the consumer’s value experience and can I do this differently so that I contribute even more to the consumers’ value experience? Because if you can change up your business by investing in different types of capital, which just means any type of resources but basically [inaudible 00:26:33] labor and you can enhance the consumer’s experience by doing this, it’s not impossible to raise the price. You can very easily sell your product, let’s say, and it’s a next-generation enhanced type of product so you can raise the price there, but you should always direct everything using your own customer, that targets customer, as your guiding star. That’s where you should always direct everything you do by that person’s value experience.

Hunter:

Right. And just one last point on that, Per. The other thing that strikes me that Austrian economic theory makes us think about is the dynamics of the economic situation, and there’s no equilibrium. Things are always changing, and the entrepreneur and the firm that they’ve set up need to be set up for those dynamics. Everything is going to change all the time, your competitor, your consumer, your environment, and so setting up for dynamics is one of the pieces of direction that Austrian economics can help with.

Per:

Absolutely. I mean, it’s important to be agile and be flexible and be able to adjust to changing circumstances, and it’s your job as an entrepreneur to figure out what those changes might be. So it might not be wise probably ever to maximize resource usage at any point in time. Sometimes you might need to do that in order to satisfy your customers but maybe temporarily, but it’s often a good idea to have additional resources, have a plan for pivoting your business because you expect something to happen. So as an entrepreneur, you should always think ahead and think of how can I satisfy customers in a better way. That’s your job as an entrepreneur. You’re not supposed to run the business as much as figure out how this business can satisfy the consumer in a better and better way.

Hunter:

Yeah. I recall Jeff Bezos at Amazon saying that now his job is thinking three to five years ahead and leave the everyday execution of the business model to others.

Per:

Exactly. And I mean in Austrian economics, we distinguish very clearly between the roles of the entrepreneur and the roles of the manager. It doesn’t mean that you as an entrepreneur has to do only the entrepreneurial things and you should never manage. It could be the same person, but those are two different roles with two different purposes and two different goals that they’re trying to achieve.

Hunter:

So let me sum up the elements of the business model that we’ve covered, and then perhaps I can ask you to summarize the implications for business people and entrepreneurs.

Hunter:

So we’ve said that the model is distinctive in its understanding of value, in helping entrepreneurs construct a value proposition, to design a production capability that delivers that value proposition. We recognize that values and experience and delivering end to end completely in depth that extended experience. We’ve got a differentiated understanding of pricing. That cost is an entrepreneur’s choice after the customer has chosen the price, and we’ve talked about the implications for organizational design and embracing and managing for change. So we’ve got the elements of a model. Let’s have you talk about the implications for people in business from this new way of looking at things.

Per:

One is to always think about the customer and then really be obsessed with the customer. Another is in entrepreneurial terms to think of how can you best serve the customer, and that should be a decision for the whole business and, of course, all the parts, too, but the whole business. Can this business and all those investments made in this business serve customers in a better way doing something else? Well, then you should probably pivot the whole business even if you are in a profitable situation, even if you have a reputation, and so forth. If you can do something much better elsewhere, if you can do something much better for a different customer segment, whatever it is, maybe you should consider doing that. And that’s sort of the role of the entrepreneur in the whole market system is to direct resources to the better value experience for customers.

Per:

So it’s really your job as an entrepreneur to do this, to figure out how to best serve consumers overall by figuring out which consumer do you with your special skills and expertise can satisfy in the best way possible. And then in the business, of course, when you have already established what the business’s goal is and how the business satisfies consumers, then you have management of this sort of collection of resources and employees. And in that business, the role of management is really to try to strengthen the value proposition, trying to tweak it one way or the other, trying to tweak all the parts, figure out some changes here and there, make some adjustments in order to make sure that what you’re offering is as highly valued as possible. It’s not really about pivoting the business anymore when you’re doing it.

Per:

So the role of the manager is really to take the idea from the entrepreneur and try to make as much as possible out of it. And of course, part of this is efficiency, trying to operate as efficiently as possible. Don’t use any resources that you don’t actually need, don’t have any waste, [inaudible 00:32:52] cut that off, don’t have extra overhead. And those sort of efficiency things that managers do are also important, especially for profitability, but those are important only after you have as an entrepreneur figured out what the actual value is.

Per:

So there are plenty of implications by applying Austrian economics in the business, and it allows you to think about the business in a different way and it also takes all those parts fit together in a very different way. And we talked about before the role of the price mechanism in the economy actually has a role in determining what we as scholars would call the boundaries of the firm, meaning simply how many different things are included in the firm that are under the manager and how many are you buying from others in the marketplace? Excuse me. And very often, this is sort of whatever the manager feels like, but also economics teaches us that well, no, you should probably use the price mechanism as much as possible because that gives you an indication of both where your actual value contribution is because if you can outsource all these other things that is not your value contribution. If you can do those things more effectively and cheaper than others can do in the marketplace, then maybe you should get into that business instead of that business that you think that you are in now. And it allows you to focus on where you contribute real value and get rid of all the other things so you don’t have to try to solve so many problems all the time, but only focus on your actual contribution.

Hunter:

Good. Excellent. Well, thank you, Per. As a team with your help and input, we’re going to try and capture the Austrian Business Model in a graphic. We don’t do mathematical models, but we do graphic models that help people with process and design and decision making and, as you say, resource allocation, organization, management, principles, and so on, and we will provide a first version of that along with the release of this podcast and we’ll attempt to refine it with the input of all of the economics business community.

Hunter:

So thank you for helping us to think this way, and it’s really exciting to see how the Austrian Business Model, the application of Austrian theory in business, is going to help our community of entrepreneurs succeed. So thank you as we started out for your generosity in helping with that. We appreciate it very much. Thank you.

62. Mark Packard: The Customer’s Value Learning Process

Innovation and marketing are the two most important functions of entrepreneurial business: bringing innovative new goods and services to market, and convincing customers of their value. On the E4E podcast, we are providing a detailed exposition of Professor Mark Packard’s deep analysis of exactly how customers arrive at, and act upon, their assessment of value.

Key Takeaways and Actionable Insights

Mark’s insights provide entrepreneurs with a powerful tool to fine-tune value propositions for maximum marketplace results.

Value is a process.

Value is a feeling that the consumer experiences. To arrive at that experience, consumers actually follow a process — a learning process. This process is actively conducted by the customer — it’s conscious, subjective, sequential, and continuously fine-tuned. There are 5 process steps:

  1. Predicted value (what will the experience be like?)
  2. Relative value (comparing that predicted value to existing solutions)
  3. Exchange value (putting a price on willingness to pay for the solution)
  4. Experienced value (what was it actually like?)
  5. Value assessment (comparing experienced value to predicted value).

In other words, it’s a cycle.

The first overview of the cycle was presented in E4E episode #44. Next, in Episode #55, Mark provided two tools for entrepreneurs to manage the process: the High Knowledge Customer Tool and the Mindfulness Tool. The first one ensure entrepreneurs talk to the right customers to gather knowledge, and the second helps them focus on the right things.

In the current episode, Mark helps entrepreneurs to identify and gather the right data for the management of the Value Learning Process.

Value Ethnography

Ethnography can sound a bit like it’s the activity of explorers in safari suits. But it’s actually the most modern data collection method for the new digital economy. The term is used to describe the process of embedding oneself in the situation that is being studied — in this case, the actions the customer is taking, and the decisions and choices they are making, regarding your value proposition and your business. Why do they do what they do? Why do they choose how they choose? Can they even explain it to themselves? In many cases, the answer is no. Ethnography doesn’t attempt to ask for an explanation or accept the one that’s given. Ethnography observes — it’s a journal record of behavior. And today, ethnography can be conducted via video and clickstreams as well as physical presence. The data streams are rich and deep.

Mark’s lesson to entrepreneurs is to be constantly observant, to watch and monitor what customers do, how they act, what they choose. At every step, ask them why they did what they did. But they might not be able to explain. Some actions may be made without too much thinking. Some may be habit. But, Mark explains, “The reasons are embedded in the behavior.” The reasons people do the things that they do and make the choices they make are embedded in the behavior itself and the observant entrepreneur is able to dig out those embedded reasons.

Therefore, there’s a next step after ethnographic observation: interpretation. And Mark offers us another tool to help us.

City Of From / City Of To

Customers are engaged in a continuing journey. Where they start from is their current experience. Call this starting point “the City of From”. And they are always dissatisfied, always seeking something better, aiming at some improvement in their experience. Call this new experience “the City of To”, the destination they want to reach.

The tool Mark calls “City of From / City of To” maps the customer’s journey. To understand where they are now, the entrepreneur as observer collects data or deduces findings about the customer’s current place — current experience – and their reason for being there. Then the entrepreneur as analyst projects the customer’s desired future experience in the City Of To. Why would they move there? Why do they like it better? What was wrong with the City of From and how is it fixed in the City of To?

Download the CITY OF FROM / CITY OF TO Toolkit at Mises.org/E4E_62_PDF.

CITY OF FROM CITY OF TO
Attraction Why am I here? Why did I move?
Doubts What am I unsure about here? How are my doubts overcome?
What Changes Why is this better than before? What will be even better in the future?
Dissatisfactions What is missing here? What is better here?
Motivations to change Why should I move? Why did I move?
What would I say? The case for moving. The justification for having moved.

Empathy and The Customer Knowledge Generation framework.

The core skill for entrepreneurs in the analysis of the customer’s experience in the value learning process is empathy — being able to feel what they feel. In fact, as Mark points out, that’s literally impossible. You can’t feel another’s feelings. But the brain is capable of amazing feats of imagination and projection — what Mark calls counterfactuals. You can imagine what another person feels and project that feeling onto your own experience so it’s as if you are experiencing it yourself. You create a mental model in your own mind of the feelings in theirs. It’s a skill you can practice and one that is crucial to unraveling the customer’s value learning experience — to experience it the way they do.

Mark provided a framework that helps you with sharpening your empathic diagnosis capability: Customer Knowledge Generation. There are 5 components, which are actually 5 pitfalls to avoid:

  1. Talk to the right customer — “high knowledge” customers who can truly help you understand value experiences that are most relevant to your business success. We discussed these high knowledge customers and how to identify them in episode #55.
  2. Make sure these customers are intrinsically motivated to share the right information. Don’t pay them to participate in your ethnography, but make sure they know there’s something in it for them – a better experience in their future.
  3. Assess your own motivation to learn — you must be sincerely committed to the learning process. Don’t “just ask”. Don’t just go through the motions.
  4. Be conscious of and actively seek to identify distortions in the information you are receiving from the customer — misstatements, inexact vocabulary, information loss, inattentiveness, looseness in communication. Interpret with rigor.
  5. Be aware of your mental model — the experience that you are imagining the customer is having — at all times to make sure it remains congruent, and that the information you are receiving is important and fits the model.

Next: changing the customer’s mental model.

If you practice ethnography and Customer Knowledge Generation, you’ll allocate a lot of time and effort to construct a model in your own mind of what the customer is experiencing in theirs. The next step is to flip the switch. You are going to adjust their mental model. You want them to consider your value proposition. That’s new for them. They don’t yet have a model of what it feels like to choose your service, or what it might feel like to experience it in the future. They haven’t formed a picture of relative value versus other options. You must provide them with that new model. We’ll talk about that in the next episode with Mark.

Free Downloads & Extras

“City of From — City of To”: Our Free E4E Knowledge Graphic
Understanding The Mind of The Customer: Our Free E-Book

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55. Dr. Mark Packard On The Tools You Need To Make The Value Learning Process Work For Your Business

In this week’s Economics for Entrepreneurs podcast, Dr. Mark Packard tells us more about his research into the value learning process, and reveals two tools he has developed to help business teams to learn from customers and prospects.

Key Takeaways and Actionable Insights

The Austrian economic principle of subjective value – placing value entirely in the mind of the customer – helps Austrian entrepreneurs analyze value creation from a unique viewpoint. One of these is the value learning process, a new way of thinking about how to be a critical catalyst for a customer’s value experience.

Customers learn intentionally over time, endlessly looking for new and better ways to satisfy their various needs.

Mark’s research has identified 5 stages in this value learning process, depicted in the graphic below.

Value Is A Learning Process Knowledge Map Graphic

Click on the image to download the New PDF

The 5 stages are: Predicted Value, Relative Value, Exchange Value, Experience Value and Value Assessment. Mark describes each stage at the beginning of the podcast.

Because the customer’s value learning process is intentional, it’s one the entrepreneur can monitor, measure and influence.

It’s an example of entrepreneurs learning from their customers, as those customers are conducting their valuation.

The customer is intentional, but not necessarily paying attention, when engaging in valuation.

Entrepreneurs have some work to do to track the customer’s learning process. They’re not taking note as they go. Mark talks about representationalism: how experience is a mental representation that our minds create from the stimuli that senses pick up. That could be going on while the brain’s attention is elsewhere. We’re not thinking consciously about wearing clothes or sitting on a chair, but we are experiencing those activities and we might defer our learning from them to the future, when thinking about buying new clothes or chairs.

For the entrepreneur to learn from the customer, it’s important to listen to the customers who are paying the most attention.

Don’t do your market research with customers from whom you can’t learn because they’re not paying enough attention to your value proposition or to the value experience you are interested in. Find the customers with the most highly developed need, and who are most dissatisfied with the status quo.

Dissatisfaction is a feeling that draws attention away from other distractions. It’s important to customers because it’s disconcerting, unwanted. It’s a high-learning event. In dissatisfaction, customers are finding something new about their need and how to (not) satisfy it. It’s a good time to ask them.

Dissatisfied customers are motivated to share their learning because they are searching for a better solution.

Customers are in the learning process and, if they experience dissatisfaction, they know they need to search for an alternative. Sharing dissatisfaction might result in some new learning for them. They’re willing to talk to you because you are trying to solve their problem.

Focus your research on the highest need, high dissatisfaction customer.

They’ll yield the richest research results, most likely to help you develop an effective value proposition.

When talking to these customers, it’s critical to utilize mindfulness: ensuring customers are in full experiential mode and ignoring all other distractions.

You might think of mindfulness techniques as helping with meditation. But we are able to adapt them for use in our processes of Austrian entrepreneurship. Mark uses step-by-step instructions to talk customers through a mindfulness technique to get the best information and understanding of their needs and satisfaction/dissatisfaction experiences. Entrepreneurs can use the tool at many stages of the value learning process, both at the early development stage for new concepts, and at the marketplace learning stage to tap into their experience of competitive products and services that are making them dissatisfied. We’ve created a new graphic indicating a couple of stages where they could be employed.

With the High Knowledge Customers Tool and the Mindfulness Tool, we’re providing business teams with important equipment to harness the value learning process and reap the developmental benefits of new customer knowledge.

Here is an illustration of where these two tools can be applied in the Value Learning Process. We’ll release Dr. Packard’s teaching course in the coming months, as part of our resources platform for entrepreneurs. These tools and several more will be featured in full in Dr. Packard’s new course. Give us your email address if you’d like to receive information about its release.

Items Mentioned In This Episode

Waiting List Signup for Dr. Packard’s Tools –  Click Here
Austrian Entrepreneur’s Journey Course – Click Here

Free Downloads & Extras

Tools for the Value Learning Process: Our Free E4E Knowledge Graphic
Understanding The Mind of The Customer: Our Free E-Book

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45. 2019 In Review: Four Principles Of Austrian Economics You Can Usefully Apply To Your Business

In an attenuated Christmas Eve podcast, we highlighted four of the useful principles we covered during 2019.

Principle 1: Customer Sovereignty – Which Means Putting Your Customer First.

The economists call it customer sovereignty – the principle that it is the consumer who ultimately decides which businesses are successful and which are not, as a result of their purchasing (or not purchasing) entrepreneurial offerings. Stephen Denning calls it The Law Of The Customer. John Rossman calls it Customer Obsession.

Entrepreneurs who understand the leverage of customer sovereignty do everything they can to know and understand their customer’s goals, values and feelings. They seek out negative emotions – disappointments, unease, a feeling that things could be better – because these are the inputs for designing new offerings that customers will welcome to make their lives better and relieve their unease.

The method of Austrian Economics in this regard is empathy. It’s a soft skill you can nurture and develop with practice. Use the empathic diagnosis tool that we provided earlier this year (link below).

The techniques for empathy include the Means-End Ladder (understanding customers’ goals, or ends, and why they select the means they choose to attain them) and Listening From The Heart, a market research technique given to us by Isabel Aneyba.

Check out these episodes and PDF resources for a deeper understanding of Customer Sovereignty:

Principle 2: Avoid Competition.

The mainstream economics concept of competition considers firms competing to sell identical goods to an identical audience. Entrepreneurs take the opposite tack: they choose a select group of customers whom they understand deeply, and they assemble a unique set of capabilities to deliver unique, customized solutions.

The tools we presented during the year include differentiation and branding. Differentiation is the pursuit of uniqueness in your offering. It requires providing your customer with a means to achieve their goals that is different and better than any alternative. That can be faster, or easier to use, or more comfortable, or more personalized, or some other attribute or combination of attributes that the customer prefers. Differentiation is not achieved through pricing. It’s achieved by superior understanding of your customer and their subjective goals.

Trini Amador demonstrated how to capture differentiation in a brand. A brand is a promise – a unique promise only you can keep to help customers achieve their ends. It’s a promise that customers can embrace emotionally, and that you can deliver consistently, every time with certainty and without exception. Promises must be kept. Trini provided us with a templated process for brand building.

Check out these episodes and PDF resources for a deeper understanding of competition:

Principle 3: Dynamic Flexibility.

Austrian economics has always been on the leading edge of dynamically flexible resource allocation and capital assembly. Austrians see the worth of capital purely in the future revenue streams that it can generate from customers. If customers change, and the revenue stream changes, the worth of the capital has changed. The capital structure of a firm must change to reflect changes in the marketplace.

This applies to hardware, software, human capital, processes and methods and organization. Old capital must not be allowed to eat up resources that could be better used to serve customers in new ways.

With the arrival of the digital age, dematerialization, interconnectedness that can support rapid assembly and disassembly of global networks and supply chains, practitioners are now able to apply in practice what Austrian theory has been saying all along.

Dynamic flexibility is well-captured in the methods of the Agile revolution, as Steve Denning explained. And the ultimate expression of dynamic flexibility is innovation – the dynamic flexibility to supplant old technologies, old services, old organizational structures with new ones. Curt Carlson gave us his formula for successful innovation, and it’s very Austrian: always start with the customer’s need.

Check out these episodes and PDF resources for a deeper understanding of Dynamic Flexibility:

Principle 4: The Economics Of Value.

We finished the year with three episodes on the new economics of value. It’s the opposite of traditional economic thinking for entrepreneurs – the economics of scale and cost reduction. The economics of value entail selection of the smallest customer group to serve in the best possible way, so that they can experience maximum subjective value. It involves scaling down – personalization, customization, scarcity, limited availability, and high differentiation. We published a simple guide to the economics of value.

Mark Packard shared his latest research on the economics of value and specifically how customers experience it. They do so as a learning process, one that takes place entirely beyond the entrepreneur’s line of visibility – in the customer’s perception. Mark explained the neuroscience as well as the economics behind the process, and introduced a 5-part cycle of customer value learning. We published a flow chart and a set of explanatory slides, using pizza as an example.

The power of the value learning cycle is that it replaces the concept of the funnel for entrepreneurs. The funnel has built-in inefficiency – wide at the top and full of costs, with revenue at the end where it’s narrow. There’s a lot of waste. The value learning cycle, when used effectively, engages a small group of customers well-known to the entrepreneur, and guides them logically to an experienced benefit that they assess positively.

Check out these episodes and PDF resources for a deeper understanding of how customers experience value:

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