Saturday, December 22, 2007

Creating Value Vs. Making Money

I distinctly separate the notions of creating value and making money. Generally you need to provide some value to the customer if you’re going to make money, but you can build substantial value without making any money.

Let me provide a few examples of endeavors that created incredible value but made relatively little money: the Interstate Freeway system, the Internet, Netscape Communications Corporation, NASA, and Xerox Parc in the 70’s. There are plenty of initiatives that make gobs of money, but don’t create any lasting value: bottled water, handbag manufacturing, municipal services, dry cleaners, and Google ads.

As engineers, we are primarily engaged in the creation of value. Making money is often a secondary but necessary evil.

The question then becomes – how do you measure the value you’re creating independently of the money you’re making? One way is to simply ask yourself how much would the engineered assets be worth sold as a company? You can also quantify the value of the Intellectual Property as measured in patents, trademarks, and copyrights. You can also look at the net sum of money that everyone using that valuable engineered good is making.

Part of the point of this is that the engineering innovation isn’t always directly monetized. Google could have developed its search engine technology and sold it as packaged software, or attempted to charge people for every click. Instead, Google stumbled on text-based advertising as it looked to monetize the value it created through traffic. The core search algorithm helped acquire customers and page views that lead to monetization through advertising.

Value creation and money making do not necessarily go hand-in-hand. To have a successful business you need to manage both. Think of value as potential-energy and money-making as kinetic energy. If you aren’t increasing the potential energy of your business, you’re growth options are limited. If you aren’t turning potential energy into kinetic energy then you’re failing to convert your value into cash flow. Those companies who create value but don’t make money are generally bought for multiples far less than the full potential. Those companies who generate money, but no additional value tend to stop growing. The best companies create an engine that generates more value and more money hand-in-hand.

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