I spent the last week working from the family farm in Southern Idaho. As a teenager, one of my jobs was to change hand lines. Hand lines are sprinkler systems for fields that have to be moved by hand, pipe section by pipe section. It’s tedious and labor intensive work.
In the past twenty years, my dad has replaced all of the hand lines with automated pivots. Pivots are computer operated pipes on wheels that pivot in circles around a connection to a source of water.
For the first half of the upgrades to pivots, my dad used a local supplier operated by a guy named Jack. For the other half, he used someone else over an hour away. Why?
At some point in the years long upgrades of all his fields, my dad noticed that Jack started to price gouge his customers. Now he only uses Jack’s business when he absolutely has to.
There’s a conceptual model in business about value creation and capture. The model says that when a business sells a product it creates value above the cost to supply the product. For the sake of argument, let’s say it costs a $100 to provide a product and it’s worth $150, creating $50 of value in excess. The business captures some of that in profit, but not all of it. The part it doesn’t capture is excess value that goes to the customer. So if you charge $125, you take $25 in profit and the customer takes $25 in surplus value.
When the customer is capturing a lot of value, they feel like it’s a “steal.” When you’re capturing most of the value, it feels like they’re being “gouged” or “bled.”
The fastest way to improve profit or capital to grow is to increase prices. But at some threshold, there’s a consequence to this where you begin to destroy goodwill.
“When Jack tries to retire, no buyer is going to acquire his business,” my dad said of the local supplier. “He has destroyed his reputation trying to cash out.”