Let’s start this lesson by thinking about saffron:
As the video explains, it is tempting to think that we value saffron because it requires lots of labour to produce. However this is treating value as some sort of inherent or objective property. But value is subjective, and based on satisfying needs. We don’t (typically) have a need for things that are hard to make. Rather, our need is for appealing food, and saffron satisfies this because it improves the colour and flavour of certain dishes.
The extent to which one considers saffron to be a key ingredient for paella will determine how valuable you find it. This will be different for each of us. Factors that relate to the difficulty of creating something can affect the price, and make them more expensive, but they don’t explain why people are willing to pay so much. It isn’t the case that we enjoy the taste of saffron because it is hard to produce. On the contrary, it is because people value the taste that makes it worth the effort to produce!
Aside: The use of saffron as a cooking ingredient isn’t its only source of value. A historic use was as yellow dye for tunics, which richer people prefered to the alternative, which was horse urine! In fact, this BBC article refers to saffron as “red gold”, and counterfeit saffron is a highly profitable criminal enterprise.
So remember that we should reason from value to cost, not the other way around. Similarly, as Will Luther points out,
“Consider medical doctors. Some say they make a lot of money because they spend so many years in school. Wrong! That explanation gets the story backwards. They are willing to spend so many years in school *because* people are willing to pay so much for their medical services.”Will Luther
In economic terms, demand is the value we place on satisfying our most pressing needs, and goods are the means by which we achieve this. But there is nothing inherently valuable about them. Indeed the distinction between tangible products and intangible services is somewhat false, because the only thing we value is the service of satisfying our pressing needs. For example, a tacky miniature statue of the Eiffel Tower isn’t valuable because of its craftsmanship, but because it says “I went to Paris and I thought of you”. The need being satisfied is the need to give a gift. The value of the product derives from the service being provided, and not the good itself.
The lesson for management is to lead on benefits (i.e. how a product helps to satisfy the customer’s pressing needs) rather than features (i.e. a description of the physical product). Intuit are a company that provide accounting software and their key product is called QuickBooks. When rivals tried to add more functions and additional capabilities to their products, Intuit realized that less was more. Instead of focusing on the product they focused on the needs of their customers, and were able to satisfy a need for simplicity.
If I asked you to think of what needs are being satisfied by a flat white from Starbucks, what would you say? Maybe the following:
And yet to see the needs that I have, please watch this short video:
Notice that our pressing needs can be different to each other, therefore value is subjective.
Here is a nice account of how Amazon may charge higher prices for the exact same books as their rivals, because they provide additional services:
“The internet in fact has not made information free. If shopping were merely a matter of finding the lowest price, the internet’s comparison shopping devices would eventually force all retailers to match their lowest-priced competitors. But a book offered by one retailer may be distinguishable, in a shopper’s perception, from the same book offered by another retailer, even though they are physically identical objects. The shopper is not buying a book, but a package of services of which the book is itself a part – the main part, to be sure, but just a part.
In addition, the buyer is getting assurances of various kinds: that the book will be delivered as quickly as promised; that it will be delivered in good condition; that the retailer will allow it to be returned if it is not what was expected; that the retailer’s employees will not fraudulently reuse the buyer’s credit card data. Buyers willingly pay a little more to reduce their uncertainty. Information costs include not only the costs of locating a seller but also the costs of getting assurance. The retailer’s reputation can convey such assurance. A brand name is a device for providing information.” [Emphasis added]McMillan, J., 2002, Reinventing the Bazaar, W.W. Norton & Co. (p.50)
If you would like to understand some of these concepts more deeply, then in this optional video I explain my own thoughts on the value creation of Apple’s iPhone, and how that has evolved over time:
In fact, I still have the box for my first edition iPhone in my office drawer. It’s a shame the iPhone isn’t in it though – an original one sold for $39,000 in October 2022. 😞