The political gaffe du jour is President Obama’s “You didn’t build that” statement last month in Roanoke. Whether you believe this is a secret insight into Obama’s evil plan or just one more statement intentionally taken out of context, it does contain a vital, often-overlooked truth about our increasingly connected society. Innovators make money because they have good ideas, but without the infrastructure, economic tools and cultural standards of the society they live in, these innovations would never succeed and they wouldn’t make any money.
As business people and wannabe innovators, however, let’s take a minute to examine this issue from the other side–that is, from the consumer’s side. What share of the value of an innovator’s creation is actually captured not as profit for the innovator but as convenience or some other benefit for the consumer? There is an economic term for this value. It’s called “buyer’s surplus,” and according to the Financial Times Lexicon, buyer’s surplus can be defined as “the amount of money someone is willing to pay for something, minus the amount they actually paid for it.”
It turns out that when an innovation is successful, the innovator only gets to keep a tiny fraction of the total economic value created by the innovation, because competition from other players forces prices down. Academic studies have shown that the vast majority of value created by whatever new device or service an entrepreneur actually brings to market goes to consumers rather than to the entrepreneur, in the form of “buyer’s surplus.”
But you don’t need an economic study to quantify this. You can do it with a simple thought experiment and a few back-of-the-envelope calculations. Imagine for a minute that Google has a worldwide monopoly on Internet searches, because they have no competition. As a result, they can charge people whatever they want to charge, meaning they’d be able to increase their profit by however much consumers would actually be willing to pay for the searches they currently do for free.
Now, how many times did you yourself use Google (or any other search engine) yesterday, and the day before, and the day before? (And don’t forget those searches you did on your iPhone!) To understand how much value these searches created for you, ask yourself what you would have been willing to pay, if you’d had to, to accomplish those various searches? Obviously some of your searches were more important (and economically valuable to you) than others. You might have been willing to pay a few dollars for that business-oriented search to get information on a company you were scheduled to meet with, but only a few pennies for that Red Sox score or the news update on Justin Bieber.
As an extremely conservative estimate, however, let’s intentionally err on the downside and say that on average a typical consumer would be willing to pay just 10¢ per search, and that she would do 1/3 fewer searches as a result. Worldwide, this would still mean about 100 billion searches a month, earning another $10 billion in profit per month for Google, about ten times its current profit (which it would still earn, mostly from advertising). Too bad for Sergei Brin and Larry Page that they couldn’t capture this value, too–they could have become trillionaires instead of just billionaires.
So the next time you’re planning an innovation, think carefully about what’s really at stake in your success. It’s not all about you. You’re creating value for me, too. And I thank you for it!
[Image: Flickr user Daniel Kulinski]