Making Money

I recently interviewed a candidate who, when presented with the opportunity to pose some questions of his own, asked me how the company made money. This initially seemed like an idiotic question (since it immediately followed “why is the bathroom door locked?”), but in hindsight perhaps there’s a subtlety here that I didn’t appreciate in my rush to get the next candidate in the door.

While anyone with a knack for self-preservation ought to know a company’s basic business model before walking into a job interview, there’s a deeper question which is worth asking, both by existing staff and by potential new employees: “what exactly are our customers paying for?”


Honey, whaddya do for money?
Honey, whaddya do for money?
Where you get your kicks?

AC/DC

For most companies, this would seem an easy question: customers pay for a specific tangible thing or for the execution of specific tangible tasks. Of course, the math is rarely this simple. If it was, a pair of jeans from Barneys New York wouldn’t bloody cost $350. What companies charge their customers incorporates a whole range of intangibles, including, at the furthest edge of the spectrum, the privilege of simply being able to buy.

Between these two extremes — the tangible product or service at one end, the intangible equity of what the market will bear at the other — lies a wilderness of opportunity. Stray too close to one end of the barrens and you find yourself commoditized into a corner and struggling to shave pennies off your price; that’s the infamous Walmart crevasse. Stray to the other extreme and suddenly you exist at the whimsy of the luxury goods economy. The ideal path is a crooked median between the two, but it’s a difficult road and easy to meander uncertainly through conflicting revenue models and variable pricing tiers.

Just as big companies gravitate toward bloated product lifecycles and runaway costs, small companies seem to drift to the opposite extreme, undercutting each other in a spiraling frenzy of overcommoditization. Like Alex Guinness in The Bridge on the River Kwai, they follow the wrong course for the right reason: their customers want lower prices, and they want to compare apples to apples. Overly cost-competitive companies often suffer a sort of Stockholm Syndrome, increasingly lowering their margins in response to competitive threats real and imagined.

You’ll know you work for one of these companies if you hear things like this:

If we don’t slash our rates, they’ll go somewhere else.

We need to be leaner. Can we reduce quality control?

Let’s take the chance that we’ll find efficiencies as we go.

We just got outbid by two kids working out of a garage. How can we beat them next time?

The problem here is value. Without addressing customer perception of value, a young company has little chance of pulling out of the pricing spiral. To break the cycle requires that you figure out exactly what you’re charging for:

Do you charge for the time you spend thinking about a problem, or just the time you spend fixing it? When a valued potential customer pushes back on price, do you lower your rates or do you offer a one-time goodwill discount? When you lose in a bidding war, do you focus on how to reduce your price next time or do you wish your lost client well and tell them to call when they want it done right? How much of your price is directly attributable to something you can see or hear or touch?

Every company, every product or service, will have its own level of market tolerance for intangibility, but a good rule of thumb is to maintain at least a 1:2 ratio of intangible vs. tangible value: a third of the cost should represent work for which the customer will see no tangible value. In some industries, such as software development, this ratio should be closer to 2:3: a third planning, a third testing, and in the middle the actual development of the tangible product.

Many companies balk at this point, not because they don’t see value in charging for brains over brawn, but because they fear appearing at a competitive disadvantage. They’re like the people you see playing the slots at any casino: blowing big money in small increments because it somehow feels safer than risking less money in larger increments on games of some marginal strategy.

In business, as in a casino, you always compete against the house. No matter how intimate a bidding war you choose to fight, your ultimate competitor isn’t the company down the block charging a nickel less per unit; it’s the marketplace which will keep its knee on your throat until you struggle to your feet and claim the valuation you need to thrive.



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