Whatever you’re selling, to anyone anywhere, the price you will get is always about what your customer perceives your value to be, not what your value actually is.
This is hard enough for most people to get. It is almost impossibly hard for two types of people:
- Engineers: Yes, I am an engineer too. Engineers look at the world rationally. They solve problems with math, science and algorithms. They are trained to think in terms of trade-offs and problems with a defined set of solutions. And so they think everyone else does as well. If they want to sell a hammer, and can prove, yes, actually prove, that the hammer will save each customer $50 of lost time or effort or band-aids per year, then they are 100% convinced that the hammer should sell for, say, $40. But if the customers view this new hammer as nice to have, that old hammer is good enough unless the new one isn’t too expensive, well, then they won’t pay more than $25 for it, no matter how many algorithms or spreadsheets prove they should think otherwise. The converse is also true. If the hammer saves them $50, yet a talented designer combined with a first-class marketer can make it a status symbol (hammer as status symbol? maybe for “Bob the Builder”), then customers will pay $100 for this hammer, and engineers will usually stare slack-jawed at these idiot customers.
- MBAs: Yes, yes, I am one of those, too. MBAs love those spreadsheets, in many ways they are the engineers of spreadsheets. We were taught in business school, as was just about every other MBA, that a company’s value is just the net present value of its discounted cash flows (DCF). If a company is somewhat risky, but not too much, so it should have a discount of 10%, and it is a going concern with $100MM in free cash flow (i.e. net profit), ignoring taxes for the sake of simplicity (which just about every CFO, CEO, Chairman, and investor, well, I guess, everyone wishes they could!), then the company should have a valuation of $1BN ($100MM / 10%), end story. But they don’t. Two similar companies will have dramatically different valuations, one worth $500MM, the next worth $2BN. For that matter, the same company, will have two different valuations, even if its fundamental numbers don’t change!
All of this is true, because, as Ben Horowitz points out on his blog (and Horowitz is almost always worth reading), markets are not logical, they are emotional. This is true for markets of the whole world, a single niche, or one individual customer (many of which, after all, make up a market). It is true today, tomorrow, in one year, in a thousand, and was true back when King David ruled much of the known world; it is true for capital markets, software sales and hammers. Horowitz shows how the valuations of IT companies on the capital markets whipsawed dramatically from 21 times their profits up to 73 and then back down to 15.5, and will do so again.
Whether you are selling your shares to private investors or public markets, hammers to Bob the Builder wannabes or smartphones to the masses, understand that the value they place on your product is all about their perceived value, and never about what it is actually worth. Get to know the customers, understand them, and market correctly to them if you really want to get the maximum value. If you don’t know how to, never neglect finding and hiring the people who can.