In business, creating value is essential, but it’s not enough. A company’s long-term success hinges on its ability to not only create value but also capture it. This often-overlooked concept, known as Value Capture, is the cornerstone of a business’s profitability and sustainability.
Big businesses aren’t always great, and great businesses don’t have to be big. The true measure of success lies in a company’s ability to turn transactions into lasting profits, not just revenue. Value Capture is critical, yet few understand its full impact. Leaders like Warren Buffett, Peter Thiel, and Bill Gurley have all highlighted its importance, though it’s often discussed in varied terms.
At its core, Value Capture is a business’s ability to keep a portion of the value it creates rather than allowing it to leak away to competitors or customers. In this article, we’ll dive into the nuances of Value Capture and why it’s the most important idea that doesn’t get enough attention.
In this post, we'll explore:
- Creating Value Is Not Enough
- Not All Revenue Is Created Equal
- Fade Rate: How Long Can You Capture Value?
- The Red Queen Race: An Unwinnable Struggle
- The Dangers of Undercapitalizing Value Capture
Creating Value Is Not Enough
Peter Thiel, in Zero to One, emphasizes that creating value without capturing it is a path to mediocrity. He explains that a business creates X dollars in value but captures Y% of that value, and crucially, these variables are independent. Large businesses can fail to capture value even with significant revenue streams, while smaller companies with high margins can thrive by capturing a greater percentage of their value.
Consider the airline industry, which creates billions in value but captures almost none of it, compared to Google, which captures a significant portion of the value it creates. Despite their vastly different sizes, Google is much more effective at retaining the profits generated by its operations.
Not All Revenue Is Created Equal
Understanding that not all revenue is created equal is fundamental to Value Capture. Bill Gurley, in his post "All Revenue Is Not Created Equal," highlights the concept of Revenue Quality. High-quality revenue is sticky, repeatable, and defensible, driven by factors such as pricing power, switching costs, and customer loyalty.
For example, subscription models with low customer churn have high revenue quality because they retain customers longer and can raise prices with minimal pushback. Conversely, businesses with high churn or low switching costs have weaker pricing power, making it difficult to capture value effectively. The ability to lock in customers—through technical or contractual means—allows businesses to retain more of the value they create.
Fade Rate: How Long Can You Capture Value?
Michael Mauboussin’s concept of the Fade Rate describes the inevitable decline in a business’s competitive advantage. A slow erosion due to competition allows a company to capture value over time, while sudden obsolescence can lead to a rapid loss of value capture opportunities.
The competitive landscape is always shifting, and businesses must constantly reinvest in their competitive advantage to slow the fade rate. This is where companies often falter, either underinvesting in their core offerings or failing to innovate fast enough, leading to a gradual loss of their ability to capture value.
The Red Queen Race: An Unwinnable Struggle
In today’s hyper-competitive business world, companies face what’s known as the Red Queen Effect, a term borrowed from evolutionary biology. Just like in nature, where species must constantly evolve to survive, businesses must continually run faster just to maintain their position. It’s a never-ending arms race with competitors, where standing still means falling behind.
In business, this manifests as constant pressure to improve, innovate, and outpace competitors, but without capturing value, these efforts become unsustainable. For example, Red Hat, a company built on an open-source model, struggles with limited pricing power and reinvestment capabilities. This forces the company into a perpetual race without sufficient resources to reinvest in product development or maintain a competitive edge.
Pricing Power: The Ultimate Test of Value Capture
One of the clearest indicators of a company’s ability to capture value is its pricing power. As Warren Buffett famously said, “The single most important decision in evaluating a business is pricing power.” If a business can raise prices without losing customers, it has strong value capture. Conversely, if even a small price increase drives customers away, the business likely lacks the competitive advantage to sustain long-term profitability.
Buffett and Munger understood this well, particularly in their investment decisions. Companies like Disney and Coca-Cola, which have been able to raise prices without sacrificing demand, demonstrate how pricing power directly ties into value capture.
The Dangers of Undercapitalizing Value Capture
Most businesses focus heavily on value creation, often at the expense of value capture. It’s easy to be swept up in developing innovative products or services, but without the ability to retain value, much of the effort is wasted. Nespresso is a prime example of a company that excelled at both, turning a commodity (coffee) into a high-margin product through effective packaging and marketing strategies.
In The Social Network, Mark Zuckerberg is portrayed as building Facebook without fully understanding how it would eventually be monetized. While Facebook ultimately became one of the most valuable companies in the world, this kind of success without a clear business model is extremely rare. It's tempting to believe that simply creating something valuable will naturally lead to profit, but this is an exception, not the rule. Too many companies fall into the trap of assuming that creating value guarantees capturing it, but as research shows, that's seldom the case. Maximizing value capture requires intentional effort, strategic planning, and a focus on sustainability from the start.
Final Say
Businesses can’t afford to overlook the importance of value capture. While creating value is the first step, capturing it ensures long-term sustainability and profitability. Understanding how factors like pricing power, revenue quality, fade rate, and the Red Queen Effect play into a company’s ability to capture value can make the difference between surviving and thriving in today’s competitive landscape.
At Portfolio, we help businesses not only create value but ensure they capture it—building stronger foundations for growth, sustainability, and competitive advantage.