“You’re building a great product — but a product isn’t a company.”

Have you ever heard this after delivering your startup pitch? What does it mean?

As an angel investor, I know I’ve given this feedback more than once after listening to pitches for cool products — but products that didn’t have a chance in hell of supporting a company.

The reality is that a product is just one of the components of a successful business. Also needed is a large enough market of potential buyers. Don’t forget cost-effective, reliable production. And, of course, throw in a capable team to move everything forward.

The key concept in a business’s eventual success, though, is how it will generate value for customers and for itself — a.k.a. its value driver.

Businesses operate via a series of transactions and processes, each one building on the previous to eventually deliver a product to a customer.

For instance, each step in agriculture, from planting a seed, growing a vegetable, harvesting, distributing, and selling, add value for the customer and businesses involved. In other words, there is no value in growing a vegetable if nobody ever ships it to where it to the marketplace.

Value drivers are one component of a business model, which is a nebulous term representing how all the transactions, processes, and parties involved in a business interact. As Joan Magretta of Harvard Business School writes in her Harvard Business Review article, “A good business model remains essential to every successful organization, whether it’s a new venture or an established player.”

And, every successful business model has a solid value driver as its foundation.

Professors Raphael Amit and Christoph Zott, in a 2001 study, researched 59 publicly-traded companies in order to understand how online businesses create value more effectively than traditional companies. The data collected in their grounded theory research led the authors to describe four value drivers that leverage the connectivity and efficiency of the internet.

Value Drivers Underlie Business Models

In their smashingly successful book Business Model Generation Alexander Ostewalder and Yves Pigneur describe value drivers (they term them value propositions) as mechanisms that create value for customers through a mix of elements catering to customers’ needs.

Amit and Zott, after researching 59 companies, write that value driver is a more encompassing concept. In essence, it is a mechanism by which a business generates value for all its stakeholders. That includes customers, employees, shareholders, vendors, and even society.

Ultimately, though, value drivers describe the mechanism by which a customer benefits and a business profits.

Couple value drivers to production, markets, teams, etc. and it all describes an overall business model.

A straightforward example of value creation can be found in a restaurant. When it serves a meal, it charges a premium above the net cost it incurs for the food and labor. In fact, a customer likely could prepare a comparable meal for much less than the restaurant charges. Why does a customer pay the premium, then? Simple. They place a value on the quality and/or convenience of the prepared meal. In exchange, the restaurant extracts a portion of the created value as profit.

Look to the Internet for Endless Value Innovation

Amit and Zott explain in their research that the internet opens many new possibilities in business and, specifically, helps businesses generate value by

facilitating community building,

breaking down traditional boundaries between businesses,

providing businesses nearly limitless reach, and

enabling a richness of depth and detail in relationships with customers.

They write that value is created, ultimately, through transactions. And discovering new ways to transact (money, goods, information, or relationships) is a hallmark of online businesses.

These new transaction methods can provide value through innovation (novelty), ease or savings (efficiency), related products or ecosystems (complementarities), and/or loyalty (lock-in).

Let’s take a deeper look at each of these four value drivers.

Four Ways Your Business Can Create Value

Efficiency

Amit and Zott write that the essence of online value creation is transaction efficiency.

Improved information can also reduce customers’ search and bargaining costs.

When the cost of a transaction decreases, more value is left over for the participants.

For instance, when eBay, the online marketplace, initially launched its business by creating a new way to sell used items online, it experienced tremendous success. Why? Because it massively streamlined the cost of finding buyers for garage-sale-quality merchandise.

eBay improved the information available for buyers and sellers.

On the other hand, Stripe, the website payments company, follows a long line of businesses whose value driver comes from easing the chore of building or maintaining a website.

In their case, Stripe makes it trivially easy for any small business to add credit card processing to a site, eliminating the time and expense of custom solutions.

Novelty

The unique characteristics of virtual markets . . . make the possibilities of innovation seem endless.

Innovation has long been a source of new value drivers. Amit and Zott explain that virtual markets lack geographic or physical barriers and provide efficient communications and connections.

This combination provides endless, explosive possibilities for business model innovation.

The authors particularly mention the possibility of innovating through

transactions (e.g. around the clock purchasing, subscriptions),

connecting previously unconnected parties (e.g. dating, social media, crowdsourcing),

removing inefficiencies (e.g. two-hour grocery deliveries, ridesharing),

capturing previously undiscovered customer needs (e.g. razors by mail, ridesharing), and

creating brand new markets that never existed before (e.g. streaming video, meal preparation kits).

Lock-in

The value-creating potential of an e-business is enhanced by the extent to which customers are motivated to engage in repeat transactions.

Amit and Zott write that lock-in prevents customers and strategic partners from leaving easily. Lock-in introduces switching costs for customers.

Lock-in can come in many forms, including loyalty programs, effective user experiences, trustful relationships, and community or network engagement.

For instance, are you a member of Amazon Prime?

The online shopping behemoth’s membership program charges an annual fee in exchange for free shipping and free movie streaming. If you are a member, you likely always visit Amazon first when shopping online.

You’ve happily been locked-in to their shopping ecosystem.

Complementarities

Complementarities are present whenever having a bundle of goods together provides more value than the total value of having each of the goods separately.

With complementarities, the whole is greater than the parts.

As Amit and Zott explain, complementary products increase the overall value of all the products when they are used together.

The classic example is a music player and song files — they are most valuable when used together. And each is essentially worthless without the other.

Other examples of complementarities include after-sales service (e.g. free scheduled maintenance on a newly purchased car) or product bundles (e.g. purchasing car rentals and hotel nights while booking an airline ticket).

As usual, Amazon is at the forefront of leveraging value drivers.

For instance, think about how you can now order groceries through AmazonFresh. Then, two hours later they are sitting on your front step. The value for the customer comes from combining online ordering with rapid delivery.

Remember, a Great Product Doesn’t Equal a Successful Company

There is an endless number of possible value creation mechanisms a business can build into their business model. We’ve looked at four particularly well-suited for online businesses.

But whether through novelty, lock-in, complementarities, or efficiency — or a combination of these or others — the most important takeaway is a great product is not a company.

A successful company must devise a way of generating enough value to satisfy a customer’s needs while also generating a profit for itself.

How does your business generate value?

Can you borrow from the ideas presented here? For instance, can your product or service eliminate a costly or time-consuming process for customers?

AmazonFresh does by delivering groceries in two hours.

Or, can you better lock in your customers so they benefit more by staying within your product ecosystem?

Figure out your value drivers and start building a successful company.

Originally published at www.founderscholar.com on March 10, 2018.