There is no such thing as Intrinsic Value, only Perceived Value
A note here on perceived value. I remember when I was young, I would often wonder. Who decides what things cost? Who decides what a packet of cereal costs versus a car, a house, an plane ride and so forth.
I thought that there must be some sort of formula to work out what the intrinsic value of things were.
With my various journeys in real estate and business over the last couple of years, I’ve learnt that there is no formula for intrinsic value. Then I came to learn that perhaps there is no such thing as intrinsic value at all.
Let’s unwrap that.
The Case for Capitalism
Under Capitalism, the theory for value and pricing is subject to two main factors. Supply and Demand. Two factors, which are determined by an endless array of other variables.
An important cog in the ideology of capitalism is that of competition. If Mrs Jones is the only baker in town, she can charge $100, $200, maybe a $1000 for a loaf of bread if the villagers oblige. However, if Mr. Sikes enters the town and sees Mrs Jones charging $100, he can fill a gap in the market and sell loaves for $50.
But then Mrs. Rachel comes to town and starts offering $10 for a loaf of bread. Mr. Sikes and Mrs. Jones now have two choices — they can slash their prices as well to compete, or try to vary their product sufficiently such that it is worth more than $10 to the market.
The result? Supposedly, competitive prices for bread.
Under capitalism, if a product or service can be offered at a more competitive rate, then in theory an entrepreneur will be incentivised to take advantage of this opportunity.
In an ideal capitalist world, competition keeps goods and services affordable, and once there is too much competition in baking, entrepreneurs will look for another avenue to create value. Thus the cycle of competition spins on and on.
A Helping Hand
We don’t have really live in a free market scenario.
For an entrepreneur and their teams to fill a need, it must be financially rewarding or at least financially stable for them.
This is why governments often fill the gaps that private enterprises will not. How much control and regulation over industry a government has changes from country to country. Not only governments, but the central banks of nations will regulate market forces.
For example, if there are issues in the housing market, these regulators will look to steer the ship as housing is something that is very important to the whole economy.
So what’s meant to happen?
Businesses should only thrive if they can create competitive value. They should then reinvest in the means of their production to employ more people. Governments help to regulate competition, important industries to prevent monopolisation, and fill gaps that shouldn’t or won’t be the scope of the private sector (businesses basically).
Think of our society like one big experiment — for it to function ideally, it relies on several hypotheses or assumptions.
We know that some of these are violated. For example, businesses don’t always reinvest in scale to create more jobs. Often they focus on extracting more work out of their existing employment base. The 8 hour work day becomes 14 with no extra pay or overtime.
In regards to value being determined by market pressures, this I believe is violated as well, depending on how you look at it.
The issue is that value can be manipulated aggressively. For this reason I do not think there is such a thing as ‘intrinsic value’ at all, only ‘perceived value’. The value of something to us or its price are not naturally determined by a simple supply and demand equation. Marketers, consumers, governments, enterprises and other bodies play a major role in twisting, hiding or overstating perception of value.
Let’s explain this.
Pricing
A short while ago, my grandmother wanted to downsize to a house closer to her church. As a widow, she needed a smaller space to maintain and likely live in for the remainder of her life.
She doesn’t travel or spend on many items apart from food and other basic living expenses.
A house came up for sale across the road from her Church, and she wanted to buy it at auction. I did some research for her and found out that the ‘intrinsic’ or ‘real’ value of the house was probably around $1.1–1.2 million. I stressed that she shouldn’t spend more than this.
I’m a big advocate for being conservative and wise in property transactions. Normally it’s hard to borrow money or resell without taking a loss if you don’t appraise the value of a property correctly. My grandmother wouldn’t need to resell and didn’t need to borrow money. So these factors that normally constrain most bidding didn’t really apply.
So she was determined to spend up to $1.5 million to buy the house. I baulked quite naturally! This is everything I go against I thought.
But anyone who knows my grandmother knows how stubborn she is!
She ended up bidding against someone with a much bigger budget- the church itself!
She very quickly bid above the $1.5 initial budget, and after stiff competition was stoked to get the house for $1.75 million!
We were all gobsmacked. But, she was delighted, and we were happy for her. On paper, she’d been ripped off massively (compared to the ‘intrinsic value’), by more than half a million dollars. But in her eyes, she’d pay any price to achieve that result. Her life revolves around the Church, and visiting her sister.
So what is more valuable than a low maintenance home across the road from the Church?
Property Example: Comparables
Now if you understand property, an important tool we often use to determine value would be comparable sales. That is, sale prices of other similar properties within the same area and at around the same time.
So someone reading about this auction result in the paper, or the next door neighbour would see this value, and it would shape their understanding of prices in the area. They don’t necessarily see my grandmother’s story behind it, or the fact that she was bid up so high by the Church.
When the neighbour decided to sell, do you think they were going to be happy with $1–1.1 million for their house?
Next door sold for $1.75 million!
Now if my grandmother had decided to move to Queensland, there wouldn’t have been such an obstinate bidder against the Church and the property may have sold for $1.4 million.
In that case, the slightly poorer property next door might be happy with $1.1 million.
It’s more subjective than you realise
Now we get to our point about value. Value and price are a lot more subjective than you realise. Real estate is one of the most important domains of value.
I want you to imagine a 4 bedroom house that has a garden and pool. The pool is a sickly yellow colour because it hasn’t been cleaned in 5 years. The garden is overgrown and poorly maintained. The house is filthy, belongings strewn everywhere, beds crooked, and underwear hangs from lights.
If you take the same house and clean the pool, have the garden cleared and do a thorough clean and tidy up inside, you would get a very different reaction at an inspection. You can’t imagine that prospects walking through to see a neat and tidy house with a bright blue pool and clean garden, will offer the same for the house that is in a dirty condition.
What has changed between these two conditions? Has any value changed? We haven’t done any painting or added any new features to the house. There have been no renovations or refurbishments. Everything we’ve discussed could probably be done by a purchaser in a single day after buying the home.
Yet what would be the difference seen in offers? $100,000? $200,000? $500,000?
It is hard to argue that the value of the property has really changed. Yet the price it would achieve has changed just because of presentation.
So value can be easily manipulated. There is a much more devastating example of this next:
Collatoralised Debt Obligations (CDO’s)
What is a ‘CDO’?
A collateralized debt obligation (CDO) is a structured financial product that pools together cash flow-generating assets and repackages this asset pool into discrete tranches that can be sold to investors.
You might watch The Big Short a hundred times and still not understand the technical details of CDO’s and what havoc they wreaked in contributing to the 2008 Global Financial Crisis.
In short, this financial product equated to a pile of s%&t wrapped in tinsel and sold as gold to people looking to gain a financial return.
People make consumer decisions based on an unfounded trust, and rely on social proof. We rely on these factors to make a decision… especially when we don’t understand something.
For example, it is easy to understand the difference between Mrs. Jones’ and Mr. Sikes’ bread loaves. If the bread is burnt, we will know it is rubbish. But if one day Mr. Sikes decides to sell you a loaf that looks great on the outside but actually has sawdust, instead of dough inside, you might not know till you get home and cut it open.
Mr. Sikes can do this a couple of times and then move to a new market as one strategy to cope with competition. Instead of dropping his price to compete, he can keep the same price, make the product look as though it is the same, but increase his margins with dishonest tactics.
What do we do when we don’t understand something we want to buy, like an investment product? Because this is so convoluted, we rely on branding and social proof heuristics.
Maybe your friends are buying the CDO, or it is endorsed by a prominent businessman. If there is strong demand, the price might go up. This alone might be taken as social proof. Everyone is buying it. Surely people wouldn’t buy it if there was something wrong with it.
Well, you’d be surprised.
Because consumerism is so rampant these days, we are making more and more purchasing decisions. There is no time to gather a deep understanding of every product and service. We often look for some combination of the lowest price, a trusted brand, and social proof. Or in some cases, this equation is flipped.
Think about luxury goods and dining for example. Luxury clothing, sunglasses and watches will often have a massive markup. The same is true for high-end dining, where food portions are actually a lot smaller. These transactions are not matters of convenience, but of indulgence. If the price is too low, consumers will perceive that they are not luxury goods and potentially consume them less. Or the producers will need to generate a lot more product to achieve the same margin.
If a real estate agent puts up 7 “For Sale” Signboards on a busy street, all the passers by will take notice. They will think that this agent is incredibly prominent, and must be talented. What if the agent merely has 7 friends on the street who are happy to put the signboard up for social proof?
Homeowners don’t necessarily have the time or energy to audit the legitimacy of these sales. But the marketing is done on them and it would be very convincing.
Does a bank spending $40 million dollars on naming rights for a sporting stadium increase its service capabilities by doing so? Does it enable it to offer better savings rates?
What it definitely achieves however is branding. It feeds into a rule of thumb that consumers use. This must be a big, reputable bank as they are able to spend $X Million on naming rights for a stadium.
In summary, it is easy for people to sell us on complete and utter horses%&t. No one can understand everything. We all use heuristics and rules of thumb in purchasing decisions.
Blue Pill or Red Pill?
So if you view things the way I do, let’s look at the ramifications. Depending on your perspective, you might feel like you’ve been infinitely ripped off over the course of your life.
In one manner of speaking, our entire economic system and modern society is built on the foundations of nothing but perceived value and hype. If you look at a spreadsheet of sales values over a 12 month period you will see a list of numbers. They look scientific in this way.
But remember that the bricks of each of these values is a story like my grandmother’s. Emotion, random situational factors and chance. What drives up property or share prices, what fuels sales ultimately comes down to human behaviour. And human behaviour is wildly erratic.
The Controversial CDO’s of the 2000’s are not extinct. They are really rebranded and sold in another name today. But if I were aware of this, I could still buy CDO 2.0’s and later sell at a profit before the gig is up. Because if others perceive value in CDO 2.0’s and are buying them, the demand will drive the price up.
Great investors possess this understanding of how value and price really work. That above all else, value exists where it is perceived to be.
We all know that Varys from Game of Thrones is no fool. Click for a chilling 24 seconds.
Power resides where men believe it resides. It’s a trick. A shadow on the wall. And a very small man can cast a very large shadow.
We might amend this for our purposes here.
Value resides where men (and women) believe it resides. It’s a trick. A shadow on the wall.
Talk about the fact that our whole economy is built on perceived value. The different qualities between perceived and actual value are what make the flaws in capitalism. This is because perceived value can be
Honest vs. Dishonest Marketing
I fed “marketing” into Google to see what definition it spits out:
MARKETING: the action or business of promoting and selling products or services, including market research and advertising
When we look at modern consumerism with a critical lens, we can very easily see the cynical side. We see transactions for products and services with very little or no value happening quite often. There are even whole sections of governments and corporations with jobs that serve very little or no value.
Does this mean that all marketing and sales are essentially feeding some artifical bubble?
I’ve thought this way previously, and it’s made me reflect negatively on my work and my business at times. But I love Seth Godin’s perspective on this issue, which helped change my own ideas around what the role of marketing can be.
It is from Paula Braun’s review of Godin’s book This is Marketing.
For everyone who has the courage to make a difference, ‘This is Marketing’ helps demystify how people make decisions so that you can help create an experience for them that is both exceptional and worthwhile. Decide what impact you want to make, be open to what’s possible, and do it with intention.
Let’s go back to one of our earlier examples. Does a luxury brand or high-end restaurant want to dupe its customers into paying more than they reasonably should for food or fashion? Or, is its goal to actually create an experience for its customers, through its branding and marketing?
Think about Bentley, Rolls Royce, Chanel, Louis Vuiton… these luxury brands create products of aspiration. They are very much aspired to as markers of a lifestyle or a reward for hard work. They are not just objects. They have the potential to create an experience. Marketing and branding play a very important role in creating this experience.
Think about the role that great customer service and a hotel experience contributes to someone’s memory of their holiday. Memories are the measure of a good life. If manipulation creates this experience, then there is a benefit to the consumer. So long as the cost of this manipulation is negligible.
After all, the perception is the experience. If you don’t believe how powerful perception is, check out the McGurk effect which positively blew my mind the first time I heard it in a university lecture.
At Sydney Listings we use terms like “Finding New People We Can Help” instead of “Marketing” and “Sales” from time to time. I find that this gives us the right mindset to focus on helping people rather than misleading them as to our service.
To me this is the difference between honest and dishonest marketing. Even if all value is perceived, and customers are highly impressionable to marketing, it doesn’t mean that deception needs to be the dominant currency. But many will exploit this opportunity for selfish gain. Honest marketing uses these ideas to make things better. To create great experiences, or to inform people about great products or services that exist.
As an entrepreneur I can assure you, that there is no greater pain than struggling to reach enough people to tell them how great the thing you have created for them is.
Marketing is not bad. Sales are not bad. They are tools, and they are amplifiers for the purpose they are deployed to serve. It is up to individuals, whether acting alone or in groups, to determine if they want to use marketing honestly or dishonestly.
This is CDOs vs. finding new people one can help. Making loaves filled with sawdust versus trying to create a fantastic new pastry in response to competition.
Thanks for Reading!
