Increasing efficiency doesn’t always add more value. Doing things faster, producing greater quality, and being more flexible are all great, but if they do not represent utility to customers, then they do not represent value.
To earn profits in excess of the industry average, a firm must strive to be superior to its competitors in the industry. A key to superior performance is creating more value for customers than one’s rivals by exploiting some competitive advantage. the aim of strategy is to create such a comparative advantage.
For each product or service, there is a maximum value the customer is willing to pay. This is the customer’s “willingness to pay.” The difference between this value and the product/service price is the consumer surplus, or utility. In order to maximize utility, firms must offer value that is superior to that of rival offerings.
A problem arises when firms make the assumption that consumers will value things that, in actuality, they don’t. Consumers don’t always perceive additional value in higher quality, faster deliveries, added convenience, and many of the other things that firms assume constitute superior value.
It is always good to remember the following formula:
Total value created = consumer surplus + producer surplus
or, u – c = (u – p) + (p – c) where u is utility, p is price, and c is cost.
This formula simply outlines the necessary conditions for market exchange to take place: the value (utility) that the product/service represents for the consumer (u) must exceed the price (p) and the cost of producing it (c). Only by meeting these conditions can firms create superior value through which both the consumer and the producer gain.