Innovation Blog

The REAL Margin:  Customer Value Margin

By Shlomo Maital

  Innovators are taught to think about profit margins, even before they launch their businesses.  They are led to believe that to survive, they must make a profit and satisfy their shareholders.  The key is ‘margin’, can you make ‘margin’?,  operating margin (operating profit/revenue) or net margin (net profit/revenue).

   I believe this is wrong. In the next edition of our book Innovation Management, we will try to change this way of thinking.  The most important stakeholder for you, the innovator, is your customers, not your shareholders. If you satisfy them, you will also satisfy your shareholders.  And there is a way to measure customer value.  It is called ‘customer value margin’, and it is defined as the difference between the maximum your customer would pay for your product or service, and the price they actually pay.  As a rule of thumb, your customer value margin should be as large as your net margin.  MBA students insist this is dumb, that it is leaving ‘money on the table’.  I believe it is wise, the way to long-term sustainable profit.  And it is consistent with what CEO’s used to believe, that pleasing their customers came before pleasing their shareholders.

    Can you measure ‘customer value margin’?  You can.  Pick a typical customer.  By empathy, or direct questioning, find out the maximum they would pay for your product. Of course this varies across customers.  But it is powerfully influenced by differential value – the price of the closest substitute.  If you have no close substitutes, then you are generating strong customer margin. This is what you must shoot for.  Customer value margin is equal to V, the most the customer would pay, minus P, the price they actually pay.  Profit margin is equal to P, price, minus C, unit cost.  Total social value is the sum of customer value margin and profit margin, or V – C.  This is how innovation creates social value and divides it fairly between those who fund the innovation and those who buy it and benefit from it.  The bigger V-C, the bigger the social value. [See Figure]

    If you think in terms of customer value margin, primarily, you cannot go wrong.  In doing so, you are making meaning, not just money.  Innovators once thought that way.  They should do so once again.

   #……………………#…………………………..#

V                                P                                            C

.cust.marg…..   ………..prof marg…….

……  total social margin…………………