How Austrian Economics Helps Entrepreneurs Understand The Mind Of The Customer
On the Mises Institute’s Economics For Entrepreneurs podcast, Dr. Per Bylund has stated more than once that entrepreneurs who can develop an understanding of both the laws of economics and the mind of the customer can thereby create a competitive advantage and a successful business.
The laws of economics he refers to are the principles of Austrian economics, including customer sovereignty, subjective value, and dynamic flexibility in resource allocation. Our podcast has covered these and many more from the entrepreneurial perspective. We pursue a value-dominant logic: that the role of the entrepreneur is to facilitate valued customer experiences; that value is in the mind of the customer; and that the tools of value facilitation for the entrepreneur are empathic diagnosis and imaginative innovation.
In other words, entrepreneurs need to understand the mind of the customer. Does this mean that we are crossing over some demarcation line between economics and psychology? Not at all. Economics seeks to explain why economic actors behave in the ways we observe them behaving. What motivates them? What incentives are at work? How do they make choices? The answers to these questions can form the building blocks of entrepreneurial success.
The analytical tools for the construction of an understanding of the mind of the customer are all freely available from the Austrian economics canon. In a new e-book, Understanding The Mind Of The Customer, a publication of the Mises Institute’s Mises For Business project, we offer an ordered presentation of some of the most important of these tools for entrepreneurs.
The Means-Ends Ladder
People select the means that they judge will best help them achieve their self-selected ends. It’s helpful for entrepreneurs to visualize the means-ends progression as a ladder or a pyramid. At the top are the ultimate ends that people pursue. Those ends are always values that they hold dear — values such as “a life of comfort” or “family security”. They are not material. People buy material things because they make a judgment about how those things will contribute to a feeling or an experience they value.
Just below the highest values on the means-ends ladder for consumers are the emotional benefits experience as a result of consuming an offering from an entrepreneur. These benefits are feelings, and it is through feelings that consumers experience economic value. For a consumer of a cola beverage, the emotional benefit might be feeling refreshed or energized or even joyful. If the beverage is consumed in a group setting, there might be a feeling of bonding or shared fun. Feeling better is a benefit that consumers seek from all their economic transactions. Feeling better is a means towards the achievement of higher values.
Supporting the emotional benefits, in the sense of occurring before them on the means-end ladder, are functional benefits. To continue with the cola beverage analogy, these might be good taste, and a distinctively enjoyable carbonated mouthfeel. The beverage container might be particularly convenient, and it may cool quickly in a refrigerator. The functional benefits are the means for the consumer to experience the associated emotional benefits.
The functional benefits result from features and attributes of the product or service itself. The consumer experiences these via sense perception, and they enable — are the means to — the experience of the higher-level benefits.
The base of the means-end ladder is the assortment of contact points at which the entrepreneur can make the consumer aware of the offering that will eventually escalate them through all these rungs of the means-end ladder. Contact points might include a retail store, or online advertising, or a coupon in the mail or word of mouth recommendation.
The means-end ladder is a business tool built on Austrian causal-realist logic. Stripping away the academic terminology, we can provide entrepreneurs with a useful tool with which to analyze the mind of the consumer when they contemplate, choose, consume and experience an economic good.
The Subjective Value Cycle
Subjective value is an important subject in economics. It’s even more important in entrepreneurship, where it is fundamental to what entrepreneurs do. It’s the critical factor in entrepreneurial success. Business schools talk about “creating value” and “value added” as if value creation were an objective process. But it’s not. And businesses can fail if they misunderstand subjective value, because they can easily produce something for which there is no market.
Value lies entirely in the mind of the consumer or customer. Therefore, the task of the entrepreneur is to try to understand consumers’ feelings and preferences, and to design a value experience — an experience in which the consumer will achieve desired ends by utilizing means made available by the entrepreneur. Ends are individually selected, and the entrepreneur can not forecast the ends for which a value proposition might be utilized. Value is uncertain.
Utilizing empathic diagnosis to give dimension to (some) customers’ ends, the entrepreneur designs a potential consumer experience — a good or service that is unique — for validation. Using economic calculation and resource assembly, the entrepreneur advances the design to the marketplace at a cost that he or she believes will yield a profit because the value it represents to the customer is greater than the price the consumer will pay, which is, in turn, higher than the production cost.
If the consumer does, indeed, experience value, the entrepreneur is encouraged to produce more and spread the word to additional consumers of the opportunity to experience value. Advertising and marketing are fundamental to the value formation system. More consumers experience the value, and spread the word even further. Some make suggestions about further improvements to the experience, which the entrepreneur can attempt to incorporate in future iterations. The process continues endlessly and the entrepreneur and the consumer practice continuous dynamism.
The subjective value cycle is a system of value formation. Our free e-book provides a map of the system for entrepreneurs to follow.
Values As A Basis for Brand-Building
People adopt values as ends in themselves, and as a signpost for prioritizing their preferences and choices. Entrepreneurs who fully understand and embrace consumers’ system of values can create strong brands — forms of advantaged intellectual property — and build strong relationships of loyalty and preference for their offerings.
What are the values that consumers hold so dear? Milton Rokeach was an American sociologist who wrote The Nature Of Human Values, reporting on his extensive research. There are 18 values that are classified as the “highest” that people strive for — they define people’s lives. They include Freedom, Family Security, A Sense Of Achievement, Wisdom, Pleasure, and 13 more.
In addition, Rokeach also identified 18 instrumental values: guides to their behavior when they are pursuing their ends, and a signpost for prioritizing their preferences and choices.
Entrepreneurs who can identify the values that guide customers’ choices can be more accurate in designing and communicating the ways that their offerings fit into people’s lives. When consumers recognize their own values embedded in brands and branded communications, a strong bond is created.
Empathy For Entrepreneurs
Empathy is the most important skill in entrepreneurship, and it is critical to achieving the uniqueness that characterizes successful entrepreneurial offerings. Uniqueness is a characteristic of customer perception, and empathy helps entrepreneurs to define and understand others’ perception.
Empathy is a human action: the action of understanding and even experiencing the feelings, thoughts and experience of another. Entrepreneurs employ it to understand subjective needs, dissatisfaction and unease among target customers — with a view to meeting the need, resolving the dissatisfaction and ending the unease. Entrepreneurs begin the value design process with an empathic diagnosis.
The new e-book provides a detailed description of the use of an empathic diagnosis tool called a Contextual In-Depth Interview. Understanding consumer feelings in the consumer’s own context is the key to diagnostic accuracy. Processing the results from the diagnosis will help the entrepreneur to improve consumer experience functionally, cognitively and emotionally. Consumers can be confident of a future feeling of betterment because of the empathy
the entrepreneur has exercised in developing an understanding of them, their dissatisfactions and their unique individual preferences. The entrepreneurial system is best for everyone because it’s based on empathy.
The Customer’s Opportunity Cost
Entrepreneurs are not in competition with other entrepreneurs. Rather, they compete with the customer’s opportunity cost. Opportunity cost is what the customer gives up in order to purchase your offering. Is that a direct substitute? An indirect substitute? Or a different use of the same dollars? (“Does she buy the dress or buy the handbag?”) Or, quite possibly, non-purchase or savings. Understanding the customer’s opportunity cost is an important part of making a sale.
Successful entrepreneurs train themselves to see opportunity costs in the way the consumer sees them. To do so, entrepreneurs can employ an opportunity cost calculator. It solves an equation: consumer value = the value of what the entrepreneur is offering minus
the customer’s perceived opportunity cost of acquiring it. The consumer’s cost is not only in dollars (and their alternative uses for these dollars) but also in the time and effort and convenience and fun of making the transaction.
The entrepreneur applies the discipline of the opportunity cost calculator for every potential consumer transaction.
Customer Journey Mapping
There is a technique to compress all of this Austrian entrepreneurship thinking into a single analytical tool: the customer journey map. This technique decomposes a customer’s purchase and usage of a service into a series of stages, and asks the question, “What is the customer doing, thinking, experiencing and feeling at each stage?”
This technique is a sound application of Austrian economics. It starts with human action — what is the observed behavior? Then, it asks about motivation (why did they act?). Finally, it examines the consequences of the action — customer experience — and tries to probe the emotional benefit, defined as feeling.
Customer journey mapping enables the kind of negative feedback that is most useful in the service improvement process. Does the customer’s experience fall short? When? At what stage? Why? Under what circumstances? All of these negative feedback hooks can be pointed towards opportunities to improve, further enabling the dynamic entrepreneurial system of betterment.
A Valuable Bundle of Tools and Techniques
Our Understanding The Mind Of The Customer e-book describes these six techniques, with accompanying tools, either in the text or via e-links. You can preview one chapter , and, if you would like to receive more, we’ll send it via e-mail to a valid address.