Not Knowing This Value Equation Almost Cost Me Everything as a CEO
A vacuum cleaner, value exchange, and business profit
Many come to business, dreaming of gaining a lot. But they should be dreaming of giving a lot.
I didn’t know that when I was promoted to CEO in 2004. I asked the shareholders: “What do you expect from the business?” They shrugged, grinned, and said: “More profit.”
So, I saw the company I led as a vacuum cleaner—designed to collect as much ‘magic dust’ from the market as possible.
And that worked—for some time. We were growing by 30% every year. Clients loved us—or at least, I thought they did.
But in 2006, our competitor launched a groundbreaking product. I’ll spare you the technical details—ours required skilled workers and high commissions; theirs was a sleek, plug-and-play solution: cheaper and easier to use.
I saw the backs of my departing clients— no farewell, no blown kiss.
My shareholders wanted to show me the door. I managed to fix my mistake and realized one important thing along the way: those who think too much on profit and too little on customer value always lose in the end.
This is the second article in a series of eight that explores the habits that distinguish deep strategic thinkers. Read the first one here. Find a present at the end of the post.
Value exchange
What do you do every moment you interact with other people? You exchange value with them.
Imagine a stock exchange where brokers buy and sell assets. Our world is a kind of stock exchange, too—where people and organizations trade value.
When you work, you’re exchanging your skills, knowledge, and experience for money—and maybe a promotion, if you’re lucky.
When you tell a joke to a friend, you're trading a story for a bit of closeness — for connection.
When you buy a birthday present for your spouse, you’re exchanging your love and care for their affection and warmth.
When you run a business, you’re exchanging the value it creates for customers for the value it captures from them.
Our world is a vast marketplace of value where everyone trades what they have for what they want. Some exchanges involve money, but many don’t.
All these interactions have one thing in common: you must first create and offer value. Your success depends on your ability to create value for others.
Where does profit come from?
A CEO chasing profit is like a movie director chasing an Oscar. Profit doesn't stem from big ambitions but from the volume of value you offer to others.
Every business, big or small, must solve the following tasks:
Create value for customers.
Capture value from them in the form of money.
Some businesses capture value from other stakeholders. For example, TV and radio may be free for users, but they capture value from advertisers.
Create value for employees, suppliers, subcontractors, and other stakeholders.
Capture value from them in return.
Let me show you how this value exchange actually works in practice:
A business creates value for customers and captures value from them. But Captured Customer Value is almost always less than Created Customer Value, as competition drives prices down.
The difference between Captured Customer Value and Created Customer Value is Untapped Value.
A business incurs costs to produce a product — that’s the Total Cost. But it sells the product for more than it costs to make. The difference is the Added Value. The greater the Created Customer Value, the greater the Added Value.
For example, Apple’s gross margin on the iPhone 16 Pro Max is 59.5%, Samsung’s Mobile eXperience (MX) division operates at a profit margin of 11.6%, while Xiaomi’s smartphone margins are in the low single digits.
When a business creates strong value for customers, it can also gain additional benefits through Transferred Friction — the tangible and intangible costs customers absorb, which improve the company’s profits.
Luxury brands like Louis Vuitton, the iPhone, or Ferrari charge eyebrow-raising prices. That premium is a form of Transferred Friction.
Costco places its stores outside city centers and sells in bulk. The inconvenience for customers is Transferred Friction — and it helps lower operating costs, increasing profit.
Southwest Airlines in the US and Ryanair in Europe operate from remote, less expensive airports. It's less convenient for passengers, but they accept it in exchange for lower fares.
By paying suppliers, employees, and partners, a company creates value for them—this is Created Outbound Value, and it’s part of the Total Cost.
But the company also captures value from them — and in many cases, the Captured Inbound Value exceeds the Created Outbound Value. For example, retailers often push for the best possible prices from suppliers and rarely offer premium salaries to staff.
That difference creates Additional Inbound Value — and it’s another source of profit.
And finally, every business generates Waste. It’s losses from inefficiencies, failed products, and poor strategic choices—because their top managers (unlike you) aren’t subscribed to my newsletter. (Just kidding — but not really.)
The value equation is the same for all businesses, but they tweak its different elements to maximize profit.
The fifth chapter of my audiobook is already available as a podcast – and this chapter is free! Learn more here.
Value Equation
Profit = [Created Customer Value – Untapped Value] + [Added Value + Transferred Friction + Additional Inbound Value] – [Waste + Created Outbound Value]
Companies follow different strategies to grow profits:
They minimize Untapped Value.
That means closing the gap between Created and Captured Customer Value — often by building their own uncontested markets. They don’t have competition that could drive the prices down.
They increase Created Customer Value in their current markets
— to widen the gap between what customers get and what it costs to deliver. Classic example? Premium products.
They increase Transferred Friction
— shifting more cost or effort onto the customer. IKEA is a master of this.
They fight Waste.
Better efficiency = lower costs. Some companies turn that into profit. Others — into lower prices. Toyota does both: its operating margin is 9.9%, while the industry average is 7.5%.
They grow Additional Inbound Value
— the gap between Captured Inbound and Created Outbound Value. They squeeze every last drop out of their suppliers and employees.
Some combine several of these strategies
— and create entire business models around them.
In 2004 and 2005, I used strategies 4 and 5, but the company that beat me used strategy #2. While I was chasing profits and optimizing costs, they were developing a product that delivered much more customer value than anything else in the market.
Back in 2006, I managed to retain most of our key clients by offering them a huge discount and promising that we'd provide them with a better solution soon. In the end, it actually turned out for the best. The competitor’s product inspired my team, and we launched an even better one in 2007. We were almost too late but caught the last train.
We often instinctively focus more on the cost side — the last part of the value equation — because it delivers faster results. Business leaders must be frugal, but unless you’re a discounter, you have to increase customer value every single day.
Strategies 3, 4, and 5 have their natural constraints. Many companies thrive on them, but you can’t cut costs and pass them on to your customers forever.
Strategies 1 and 2 have unlimited potential. You can increase customer value or create your own markets as long as you wish. Want to create your own market? Check out this or this.
A present for you
A year ago, I published my book Red and Yellow Strategies: Flip Your Strategic Thinking and Overcome Short-termism. To celebrate the anniversary, I’m offering a special price — all through June.
🎧 Get the audiobook at a special price here.
📘 Get the ebook at a special price here.
⭐️ Upgrade to a paid subscription and get the book for free — plus full access to the archive, all podcast episodes of the book, and every members-only post on Substack.
And of course, you can still grab the book at full price in your favorite bookstore.
My best strategy quips of the week
When some clients ask me for help with strategy, what they really want is an IKEA cabinet — with step-by-step assembly instructions.
When I hear “Your call is very important to us…” while waiting on hold for twenty minutes, my brain quietly finishes the sentence: “…but some calls are more important than yours.”
In a family, someone who thinks they know what everyone else needs is called a tyrant.
In politics, they’re called a dictator.
In Silicon Valley, someone who thinks they know better than consumers what they need is called an entrepreneur.
Download more Strategy Quips here.
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Read also: Stop Competing on Features – Start Winning With Feelings
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I used to think doing more meant earning more. Turns out, doing what actually matters is what moves the needle. Profit follows value, not the other way around.
Hi Svyatoslav, thank you very much for this interesting read and for reminding us of the importance of focusing on customer value!