Is it fair that teachers earn less than bankers or that nurses earn less than CEOs? The value you get to take home may have no correlation with the value you create in the world. What if you could capture what you really deserve? What if you could turn your unique capabilities, assets, and passion into more profit or income, while still doing what you love? If you understand just a few strategic principles, you can. Here is how.
The value chain
You can think of an “industry” as being a generic business model. If you are a bank, you monetize financial expertise and operations by taking deposits and lending them out at a higher rate. If you are in software, you take programming skills and the resulting IP and monetize it through licensing fees. If you are a building contractor, you rent staff with expertise (plumbers, carpenters, electricians), coordinate them, and then sell them at a higher margin.
You are always taking some input, adding value to it, and then selling it at a higher price to extract part of the value you added. Indeed, the economy is fundamentally composed of long chains of agents adding value. Ray Dalio, arguably the most successful hedge-fund manager alive, offers a compelling example of this in a video titled “How the Economic Machine Works”.
The timber company adds value to the wood by growing, cutting, and shipping it. The lumber yard adds value by storing, displaying, and getting it to builders. The builders add value to the wood by cutting, hammering, and shaping it into walls and window frames. The contractor adds value by coordinating the carpenter with other trades to create a house. The real estate agent then adds value by marketing that house to find a buyer. Each takes an input, adds value, and then sells it to the next agent in the chain.
The formula for creating value
However, the value you add in your link of the chain does not correlate cleanly with the value you get to extract. As Pete Thiel, the PayPal co-founder, put it:
“I’d like to start by saying something about the basic idea of when you start one of these companies, how do you go about creating value? What makes a business valuable? And I want to suggest there’s basically a very simple formula, that if you have a valuable company two things are true. Number one, that it creates ‘X’ dollars of value for the world. Number two, that you capture ‘Y’ percent of ‘X.’ And the critical thing that I think people always miss in this sort of analysis is that ‘X’ and ‘Y’ are completely independent variables, and so ‘X’ can be very big and ‘Y’ can be very small. ‘X’ can be an intermediate size and if ‘Y’ is reasonably big, you can still have a very big business.”
That X and Y are independent is unfair. Teachers add far more value to society than they get to capture in their salaries. Many civil servants, firemen, nurses, and academic researchers should be paid more. And many investment bankers, hedge-fund managers, and large corporate CEOs should arguably be paid less.
In fact, as my research in Driving Innovation from Within shows, 70% of society’s most transformative innovations have come from employees, and yet the workers’ share of the value created has been steadily declining since 1975 (at least in the US).
3 factors of capturing the value you deserve
So what determines how much value YOU get to capture of the value you create? How can you ensure that the value you capture is more in line with what you deserve? There are three primary factors: cost, value, and competition.
The key then to maximize the value you get to keep (i.e., “X times Y”) is to pursue to lowest cost, create the greatest value, and separate yourself as much as possible from the competition so that your customer will not be tempted to leave.
The business model you choose will influence all three of these drivers. For example, if you take your expertise in healthcare management and put it into a model in which you provide support services to hospitals, you will get to keep about 15% of your revenue. But if you instead turn that expertise into software and IT, you will get to keep almost 50%. Click here for a list of margins by industry.
Rethinking our business model
At Outthinker, we have long thought of ourselves as a consulting firm. We sort of defaulted to this because this was the business model we knew. After about decade of (slowly) growing our firm, we came, exhausted, to a conclusion that:
- Delivering consulting is costly because you need to pay a lot for manpower.
- The value we were able to create was limited because we didn’t have the capacity to serve nearly as many customers as we felt we could help.
- There was a lot of competition.
We also were in the training business. While we felt that the cost was lower because we could drop in for one-day workshops rather than 60-hour per week consulting engagement, and the value we could create was greater because we could impact a room of 30 or 100 people in one day, the competition was just so aggressive that we were not able to capture much Y.
Don’t lean on the business model you know
If you want to create more “X times Y” – if you want to capture the value you deserve – then think of yourself as sitting at the end of an economic chain in which you have some kind of input and want to find the best way to create Y. Don’t default to the business model you know. Instead look at what business models will give you the largest Y. You can either design the business model from scratch or adapt an already existing business model.
For example, in our case at Outthinker, we have IP (books, processes, workbooks) and a brand. We had been monetizing these with a consulting and training model. About 18 months ago we started shifting to a “member” model, in which people, mostly heads of strategy of large enterprises and consultants who wanted to apply our processes, pay a membership fee to belong.
Such business models carry 40-50% profit margins vs. 10-15% for consulting and training companies. We also shifted from training to public speaking, in which I speak to a large audience and earn a fee that is 4-5 times what we could expect to charge for a training (cost is lower, value is higher, and competition is more scarce).
As 2020 came to a close and many of our members wanted to pay their dues before the fiscal year ended, I got daily pings from our accounting software that a new payment had come in. I was in my kitchen with my kids rather than at my desk rewriting a consulting proposal or client presentation. I spent the week delivering virtual speeches in the studio we set up in our office to global banks, industry associations, medical device companies, and others, earning in one hour what would have taken 16 hours of consulting or training to earn.
So, as you decide what business to be in in 2021, consider these five questions:
- What are your unique inputs, assets, or gifts that you are using to create value in the world?
- What is the current business model you are using to capture the value you are creating?
- What other business models, industries, or sectors might you play in? Think broadly – don’t look for a logical one.
- How do these business models or industries compare across three factors: cost, value, and competition?
- What would it mean to take your unique inputs and monetize them with the business models that score the highest in the previous question?
By answering these questions, you can be well on your way to capturing the value you deserve and separating yourself from your competition.