Commentary: The Value of Middlemen

Lead Author: Dr. Jeff Howe

Publish date: 03.01.2005

 

Adding Value & Getting Your Coconuts

 

There has been a lot of talk about the importance of “adding value” in business and “value-added” processes. People have begun to discuss the practice of sustainable management and certification as value-added activities, and numerous studies have been undertaken to identify exactly what this value is worth to the customer. These “willingness to pay” research projects have asked customers subtle questions like “how much more would you pay for this stick if I told you it came from a forest that is sustainably managed?” Naturally, being concerned citizens, many respondents say things like, “oh how lovely, surely I'd pay 10 or 20, or maybe even 30% more.” Unfortunately, when you ask them to fork over the dough, they foolishly respond – “well, I really didn't want a stick anyway!” So are consumers simply liars and thieves? Do they just not care enough about the environment to pay one thin dime more? Or, is it really not that simple.

 

Getting a customer to buy a product is a complicated business. First, you must make them aware of your product; then you must get them interested in your product; then they must have the ability or financial means to purchase your product; then you must motivate them to act; and finally, they must make the purchase. This chain of events must all occur with the right product at the right place at the right time. It seems like a miracle that it ever occurs. Luckily, in America we have a vast system of middlemen whose role it is to make transactions occur. Truly, middlemen are the basis of our economy.

 

Middlemen

 

What is a middleman? Imagine you are on a desert island, living in a grass hut and sustaining yourself on bananas and coconuts. If you want a banana, you pick it - simple enough and no middleman needed. But, the coconuts are a bit higher up and more of a challenge. Suppose you get tired of falling out of trees trying to pick coconuts. Luckily, along comes a monkey who offers to get those coconuts for you in exchange for a few bananas. You agree, and everyone lives happily ever after. Behold, the middleman (or in this case, the middle monkey) is born.

 

What does the middleman provide that is of value (the value-added component)? The obvious answer in the desert island scenario is the coconut (product), but you could have had that anyway. The other obvious answer is that the monkey saves you time (reduces labor), and if he can pick coconuts more quickly than you, you might say he increases efficiencies. Of course, if your alternative is simply lying on the beach for another 15 minutes the added value from efficiencies might be pretty small. Perhaps what the monkey really provides you is safety, by reducing your risk of being injured by falling. Maybe as a result you even live longer due to better nutrition and because the middleman can still provide you coconuts beyond the age when you can climb trees. So now what is the value of the monkey's service? What is the value-added by the function the monkey has provided? Perhaps it is immeasurable!

 

Value Added

 

Value added is any function fulfilled by a product or service that a customer will pay for. This function can be as simple as comfort, as is often the measurement of a good mattress, convenience as evidenced by the plethora of vending machines readily available, pleasure as provided by a wide range of materials from candy to music, and finally to functions as basic as those served by food, clothing, and shelter. The key to receiving this value is to correctly identify exactly which of the functions the customer perceives your product or service to provide. Please note the word “perceives,” because it really doesn't matter what the purveyor believes the product to do, but rather what the customer perceives the product to do.

 

Market Transactions

 

What about the common thought that middlemen are unnecessary complications in a market? Some argue that middlemen are simply there to make a buck in between the person that does the “real” work of making the product and the person with the “real” need as a customer. To address this charge, Figure 1 illustrates the transactions necessary in an economy with producers operating separately from users but without middlemen.

 

In this situation even with only six basic needs and six users the number of transactions is quite complex (and totals thirty-six). As you increase the number of users, the situation becomes unwieldy. Transaction costs such as sales calls, shipping, invoicing, and packaging multiple very quickly.

 

On the other hand, Figure 2 demonstrates the potential impact of a middleman. In this case, the number of transactions is reduced from thirty-six to twelve. In theory, 2/3rds of the transaction costs are eliminated.

 

Over the centuries a wide variety of middleman have arisen. The key to their economic survival is their ability to increase the efficiency of the system in some manner and to identify and satisfy the perceived wants and needs of their customers.

 

The challenge that arises with environmentally friendly products is in clearly defining what the customer perceives as a want or need, and the extent to which a value can be put on that perception. Research has found that customer's willingness to pay a premium is based on concerns of health, safety, and convenience. Customers will also pay a “premium” for products that are perceived as unique and innovative solutions to common problems. Paid programming on TV is full of examples of this latter approach.

 

Perceived Value

 

Understanding the perceived value the customer places on a product or attribute suggests an intimate knowledge of the customers themselves. In the same manner that the monkey was providing safety and long-life, instead of just coconuts, environmental messages must address real interests or concerns. And as we've stated in previous commentaries, different segments of the marketplace are interested in different messages, and some messages appeal to a wider audience than others.

 

So, why is it so difficult to develop an environmental message that resonates with consumers? Certainly it is in part a result of the fact that green products have such a wide range of perceived benefits, many of these being emotionally based and thus individual. Additionally, middlemen have often misinterpreted the needs of green consumers and offered benefits that consumers didn't value. Interestingly, new more direct channels are being created to address consumer needs. The Internet offers a real threat to certain middlemen by creating the ability for businesses well up the channel to efficiently reach retailers and/or even consumers directly. In many ways the Internet is the ultimate middleman!

 

The Bottom Line

 

The gist of the story is that many wood products companies that serve the role of middlemen are very efficient, but need to increase their knowledge of environmental attributes that are important to their customers. Lumbermen in particular have to remember that consumers are generally looking for shelves, fascia, or doghouse walls, and not boards. And the real path to adding value that consumers will pay for is not going to come from taking an existing product, e.g. boards, and announcing that it comes from a well-managed forest and then asking for a premium of some kind. I, ah, don't need a stick – remember?

 

The real added value comes in offering cut-to-size boards ready for assembly into a doghouse, AND there are no chemicals added so doggy will be safe, AND it comes from sustainably managed forests so the earth will be safe (heck, maybe you should attach a direct Internet connection in one of the boards so the doggy can email its psychiatrist!). Now the $10 worth of boards may be worth $15, or $20, or $??

 

We must remember what it is the customer is paying for. Is it coconuts, or a long and healthy life? Is it a two-by-four, or a safe and healthy playground set? Once it is understood what the customer wants, then and only then can products and messages be crafted that address defined and real needs. In the absence of the development of this understanding between crafter and consumer – price rules and the benefits of middlemen are lost.

 

Dr. Jeff Howe