What does ‘value’ mean to you? Why is it that we say ‘Oh, this hotel only costs $20 more’ and then find ourselves rejecting a tin of tomatoes in the supermarket, because it costs 10 cents more for the can?  This is the first in a series of blogs around the concept of ‘value’ and how we should think about value, not just cost.

Rational thinking would say we should focus on the $20, not the 10 cents. But consider your own behaviour. I bet you spend more time on saving the 10 cents than on the $20. (Obviously you need to fit your own specific examples in here.)   Behavioural economics might suggest that 10 cents on a $1 can of tomatoes is a bigger percentage (10%) than $20 on a $230 hotel room (8%) and that it is the anchoring or framing effect at work that makes us act this way.*

Value: Same benefits, lower cost

But I think that it has more to do with what we value than either the absolute dollar amount or the percentage. We are not at all sure that the more expensive can of tomatoes will taste better or cook better than the cheaper one, so we use the price (the cost to us) to make the decision – the ‘value’ of the tomatoes is the same, so we choose the cheaper one. It is better value, since the benefits are the same.

Value: Different benefits, different price/cost

In the case of the hotel room, the location, the room size, the room amenities, the view, the perception of hotel quality all mean that $20 extra could seem a bargain, because this hotel has a better location, is newer, the room is bigger or any of a host of other benefits that we personally might value.

Unpacking ‘value’

The problem is: how much are we paying for each component of the purchase, or how much are we prepared to pay? For example, we might put a value of $100 on the base room, $ 50 for the better bed, $ 25 for the large bathroom, $30 because it is quite new, $10 because the brand of the hotel is appealing, $ 20 for the view, $30 for the larger room size, and $15 because the online service level and expected personal service is more convenient/better. Astute observers have realised this adds to $280, not the $250 I’m actually paying. What this means is that l would be prepared to pay $280 for this package, so I feel it is good value at $250, compared with the $230 at the hotel down the road.

‘Cost’ and ‘value’ are different too!

But we don’t actually do this calculation explicitly when we make the decision. We just say ‘That’s better value’, or ‘I like that one better’, or ‘It’s worth it’. And, in fact, we find it very difficult to decide how much of the value actually belongs to each bit of the total package. Try working out why you fly Qantas or Virgin or Jetstar or Tiger to a particular place to see what I mean. Their prices are very different for the same outcome, but the experiences vary quite a lot.

So what we often rely on is cost, not value. One costs $230, one $250. To some people this difference is substantial. To others it is nothing. Because they ascribe different total value to the same package. They receive different benefits.

And organisations think that, because it ‘costs’ them a particular amount to make a product or provide a service, that is the ‘value’ it is worth. Wrong. ‘Cost’ (to the producer) is not ‘value’ (to the buyer).   And money spent by the buyer (‘This cost $250’) is not the same as the value received by the buyer (in this example $280).

Using value, not cost, to make decisions

This is important to understand, because this is how all our decisions are actually made, or should be made. That is, what value do I get from this decision, compared with the cost to me?

Normally, we see this as the economic value and the economic cost – that is the monetary amounts paid or received. But, actually, we get a lot of social value, or incur social cost in making decisions.

For instance, if I choose the more expensive tomatoes, I do this because I want to buy Australian, not imported tomatoes. I think the taste and cooking performance of the tomatoes will be the same (actually the imported ones might even taste better…), but I feel better – receive social value – from buying local. I choose the more expensive hotel because I value convenience and I’d rather be close to where else I need to go, rather than take a cheaper option and take longer to get there.

‘Value’ in activities: social benefits and social costs

When I was a basketball referee, I volunteered to do the job rather than be paid. Few people understood this. But for me the social value was the real value and the economic value was low. The social value for me was the joy of being on the court, being part of the game, contributing significantly to the quality of the game by making good decisions (hopefully!), helping kids enjoy themselves, allowing the basketball association to keep the money they would have paid me for more worthwhile uses and the psychic enjoyment when parents came up to me after the game to thank me for doing a good job. That time of the week was actually one of the most enjoyable, one of the most valuable parts of my week.

On the other hand, sometimes I worked interstate or overseas and was away from my family. Even though the financial reward (economic value) was usually quite high, the social costs – being away from the family, loneliness, missing family and social events – were quite high. That’s why many people don’t like to travel a lot on business, despite the apparent attractiveness of the places where they may be working.

So how do I make better decisions?

This is difficult to understand isn’t it? How can I make it work?

Try to understand – in life – what actually gives you ‘value’ and what the elements of that value are. (For instance, in an earlier article on hubbardtalk.com, I’ve argued that friends give more ‘value’ than family do, so spend more time with friends.)

As a buyer, think about the ‘value’ you get from what you decide to do or buy. Compare it to the costs involved, including the social costs, not just the economic costs. Then make your decision on a more informed basis.

If you are a seller/producer/provider of goods or services – a company, an organisation, an individual – think about what ‘value’ the buyer expects to get, or what value you are trying to offer the buyer when you make your offer. It could be the quality of your offer. It could be the convenience. It could be the speed of response. It could be the cheapness. It could be the uniqueness. It could be the experience, not the product or service itself. Marketers call this the ‘value proposition’.

I guarantee this way of thinking gives you or your organisation a better understanding of what you should provide (as opposed to what you actually provide). And I guarantee that, if you can sort out what you, as a buyer, really value – not what you think you do or are told you should – you will make better decisions.

But it is very difficult to do. And that’s why most people don’t make good decisions. And that’s why there’s a Nobel Prize waiting for the person who can work out how to calculate ‘value’ for buyers, so that sellers produce something that better matches that desired value. Then everybody will be happier!

What do you think about this? I’d be pleased to get your feedback.