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HANNA BATES: Welcome to HBR On Strategy, case studies and conversations with the world’s top business and management experts, hand-selected to help you unlock new ways of doing business. To many people, strategy is a total mystery. But Harvard Business School professor Felix Oberholzer-Gee says it doesn’t have to be complicated, if you focus on creating value. In this episode, you’ll learn how to focus on two key value drivers: customer satisfaction and employee satisfaction. You’ll also learn where profits come in and how to visualize the value you create. This episode originally aired as part of the HBR Quick Study video series in February 2022. Here it is.
FELIX OBERHOLZER-GEE: For many people, strategy is a little bit of a mystery. Often, we have a sense, in order to know what strategy is, you have to be super senior. If there are a lot of job experience, it seems very complicated.
Nonsense.
Strategy’s simple. It’s a plan to create value. The way a company plans to create that value, that’s the strategy of the company.
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Of course, it’s natural to look at financials. What are your margins, what’s profitability, what’s the return on invested capital, and that, of course, shows the result of strategy. It’s an endpoint. It’s a consequence.
It’s not actually where we start. The strategy is about looking forward, seeing the future, planning for the future. We want to start with a sense of how much value do we create in the first place. Value for customers, value for employees, and value for suppliers.
Value is the difference between willingness to pay and willingness to sell. There’s a really straightforward and simple way to show this in a figure. The figure is called a value stick, and literally imagine at the top, we have willingness to pay. At the bottom, we have willingness to sell, and the difference between the two is the value that the company creates.
If I’m more successful, if I create more value, I can only do this in two ways, either by increasing willingness to pay or by decreasing willingness to sell. Now, I’m going to ask, OK, so what is willingness to pay? What is willingness to sell?
Willingness to pay describes customers. It’s the most a customer would ever pay for a product or a service. Charge me once cent more, and I’m better off not buying. Now, the company is not going to give away its products, of course, and so over charging a particular price, the price has to be below willingness to pay, otherwise people will not buy.
The success for customers is just a difference between willingness to pay and price. I don’t know about you. I have a hard time waking up in the morning. My willingness to pay for that first cup of coffee, $7, $8 easily. I go to Dunkin’ Donuts every day. They sell me coffee for $2.
Big difference between my willingness to pay and the price. There is a lot of value created for customers. Customer delight, the difference between willingness to pay and price, is significant. Willingness to sell is a little less intuitive than willingness to pay. Willingness to sell is the least amount of compensation that an employee would accept and still work for this particular company.
So think of a person trying to sell. I could sell my work to company A. I could sell my work to company B. How do I choose between the two? How fabulous is the job? How interesting is it? Will I like my colleagues?
Value for employees is the difference between compensation and my willingness to sell. It’s a measure of the quality between what the person is looking for in work and what the company can offer.
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So total value created is the difference between willingness to pay and willingness to sell, and then it gets split three ways. Some of it goes to customers. That’s the difference between willingness to pay in price. Some of it goes to employees, that’s the difference between willingness to sell and compensation, and the middle wedge.
That’s the margin of the company. That’s financial success. In the end, how profitable an organization reflects the amount of overall value creation. So one natural question is, what are the ways I can raise willingness to pay? And there are really three buckets.
The first one is the quality of your product or your service, where quality can mean very different things to different people. But the higher the quality, more appealing the product, the more appealing to service, the higher is willingness to pay. And then there are two different ways to also increase willingness to pay that are a little less obvious.
The first one is with the help of complements. A complement is a product or a service that supports willingness to pay of something else. Think razor, razorblade. Think printer and cartridges, think espresso and espresso machines, and espresso capsules.
And the third is network effects. For some products in some situations, the more popular the product is, the more widespread its adoption, the greater my willingness to pay. Social media is a great example. If all my friends are on Instagram, oh, it’s so much better to also be on
Instagram.
My willingness to pay will increase as the adoption of Instagram increases. There are really two ways to be more attractive in the market for talent. The first one is I should pay you more money. The moment I pay you more money, of course, I’m going to be more competitive in the marketplace for talent.
The second option that seems similar is I make the job a better job. I create more attractive working conditions. Maybe I have a better training plan. Maybe I have more generous promotion rules. Maybe you can work three days from home.
Whenever I make the job a better job, willingness to sell is going to go down. And so at the beginning you might think, these things are really the same. If I pay more money, I create more value for my employees, and if I make a job a better job, I lower willingness to sell, and that does the same thing. It creates more value, but there is a big difference.
If I pay more, that just shifts value from the company to the staff, to the employees. There’s no value created. Value is just redistributed between the company and the people who work for the company. If I make work more attractive, if the job is a better job, willingness to sell goes down, and that actually creates value.
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Let’s talk about the specific example. You might know Best Buy, the electronics retailer in the United States. And if you go back say, 10 years or so, everybody, including myself, everybody was convinced that Best Buy was going to go out of business. Why? Many other electronics retailers had gone out of business, and with roughly 1,000 stores, it just seemed impossible to compete against Amazon.
At one point in time Best Buy lost $1 billion in a single quarter, and then a new CEO comes in eventually, and remember, strategy is not complicated. It’s all about either increasing willingness to pay or decreasing willingness to sell, and that’s exactly what he does. Instead of building big distribution centers, big warehouses from which you ship online, he starts thinking about every store as a warehouse and they start shipping from each individual store typically from a store that is just down the road from where you are.
We increase willingness to pay by having better shipping times, and then a second idea has to do with the retail store environment. He goes to Microsoft, he goes to Samsung, he goes to Lenovo, and he says, well, you can go down the Apple route and you can build really beautiful freestanding stores at millions and millions of dollars or you can have a store in a store inside Best Buy, where people are shopping for electronics products in the first place at a fraction of the cost, lowering willingness to sell for the vendors to Best Buy. Now, what does it mean for employees?
Instead of selling innumerable products, now, I’m dedicated to the store in a store that’s the Microsoft store or the store in the store that is the Sony store. I know so much more about the products I have. I can do a much better job helping customers figure out which products are exactly right for them. My job is easier, I feel more successful. Willingness to sell drops, and if you look at employee engagement surveys at Best Buy, they are at an all time high after these big changes.
So what they Best Buy do? It increased customers’ willingness to pay and we have fewer pricing pressures. Next, they lowered willingness to sell and costs fall for Best Buy. The middle portion of the value stick, we have less pricing pressure, we have lower costs. Not surprisingly, the company is more profitable.
They go from losing $1 billion in a quarter to having a return on invested capital that exceeds 20%. Amazing. Why? Because we started with ideas about how to create value before we thought about how to capture a fraction of the value that we created.
HANNAH BATES: That was Harvard Business School professor Felix Oberholzer-Gee on the HBR Quick Study video series. He’s the author of Better, Simpler Strategy: A Value-Based Guide to Exceptional Performance. We’ll be back next Wednesday with another hand-picked conversation about business strategy from the Harvard Business Review. If you found this episode helpful, share it with your friends and colleagues, and follow our show on Apple Podcasts, Spotify, or wherever you get your podcasts. While you’re there, be sure to leave us a review. We’re a production of the Harvard Business Review – if you want more articles, case studies, books, and videos like this, find it all at HBR dot org. This episode was produced by Scott LaPierre, Anne Saini, and me, Hannah Bates. Ian Fox is our editor. Video and animation by Dave Di Iulio, Elie Honein, and Alex Belser. Special thanks to Rene Barger for his notes and his support. And thanks, as always, to Maureen Hoch, Adi Ignatius, Karen Player, Ramsey Khabbaz, Nicole Smith, Anne Bartholomew, and you – our listener. See you next week.
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