We build software in order to create a highly profitable business. We come up with a business model to achieve these results from a market opportunity that we believe exists surrounding an unmet or underserved need. Core to this model is the product we have decided to build and the way we intend to extract revenue in the process.
Economists refer to this revenue generation as customer value capture.
At first, many software developers focus on the customer problem and how to best solve it. Many SaaS companies today, even start out without capturing any value in exchange for the value they provide.
Over time, good product management practices will lead to a product that provides increasing value to its customers.
That value may be in the form of increased revenue, reduced costs, risk avoidance, improved reputation, or any other benefit the customer receives as a consequence of the use of the product.
Customer Value Capture
As the customer derives value, it is time to determine how you will get value back in exchange. This is not simply about what price you charge, but how your entire business model is defined to build a sustainable and highly profitable business.
What tends to happen at this point is that businesses begin to try to continuously minimize the gap between the value provided to customers and that captured back into the business.
// Consumer Surplus is the amount of excess value that customers get above the amount they pay for a product or service.
The reason for this is that it is often relatively inexpensive and fast to tweak your business to reduce the consumer surplus. The most straightforward way to close the surplus is to raise your prices. However, there are other indirect ways, such as selling your products to non-ideal customers. Sure, they may still benefit from your product, but they will not derive the same scale of value as your ideal customer.
As soon as your customers believe the price they pay exceeds the value received you will create churn. Moreover, it will make attracting new customers impossible.
Maximizing Customer Value Capture
So the question arises, what is the ideal way to grow your customer value capture over time? The answer is not to attack the customer surplus. As discussed, that only achieves short-term gains and has a hard upper bound.
The best way to grow significant revenue for your business then is to focus on increasing customer value. Enhancing your product is the most sustainable way to achieve positive results. Balancing investments across different planning horizons ensures continuous customer value gains over the long-term.
An alternative, but less growth oriented approach is to narrow you target customer definition. Simply, find that segment of your customer base that are the most delighted and objectively derive the greatest benefits. Double-down your sales and marketing efforts around attracting more customers that match this segments attributes.
By focusing on this segment, over-time, you will increase the average customer value received from your product. This can be done without any additional product investment. The downside, is that this approach narrows your addressable market, which can be counter-productive to a longer term growth plan. However, over-time, as you accelerate your business through increased value capture (aka revenue growth) you can funnel more of that back into product development to expand your ideal customer segment.
Increasing your revenue can be done in two basic ways. The first is be clawing back some of the consumer surplus value. This is a good approach when you need to urgently increase your business metrics. However, you have an upper bound of revenue you can capture based on the value that your customers derive.
A more sustainable approach is to focus on continuously increasing the customer value of your product. Build this value now and reap the revenue rewards for a long-time into the future.
Recommendation: This article was very much inspired by an outstanding new book called Build What Matters: Delivering Key Outcomes with Vision-Led Product Management by Ben Foster & Rajesh Nerlikar. This book is full of really good advice for leading your product initiatives with a solid vision.
In the book, the authors specifically cover Customer Value Capture and apply their vision-led approach to maximizing value. I highly recommend adding it to your product management book collection.