Relative Value v. Absolute Value
I have been reading a book called Predictably Irrational by Dan Ariely which has raised some thoughts I’ve had for awhile about why human nature tends to define value on a relative basis rather than on an absolute basis. The first time I started thinking about this was when I would ask friends to pick which scenario they’d prefer:
- You make $80,000 in a world where everyone else makes $50,000.
- You make $90,000 in a world where everyone else makes $150,000.
Most people I asked that question to, after thinking about it, preferred scenario #1 despite making more absolute money in scenario #2. It shows that in this instance, they value relative wealth over absolute wealth. It’s clearly an imperfect example because it’s too theoretical, but it does start to uncover the issue at hand. Let’s take a more practical example – imagine you had to rate the “value” of the fish and chips on the following two menus:
- Fish and Chips: $15, Grilled Chicken: $7
- Grilled Chicken: $29, Fish and Chips: $15
My guess is if you conducted a study, the fish and chips on the second menu would be rated as a better value than the fish and chips on the first menu – despite the same absolute price. While not using this example, Predictably Irrational does leverage compelling studies that show that a highly effective technique to sell a given product at a given price is to put another product at a higher price right next to it. Again, this plays to our sense of relative value. Another example - imagine you had to rate the attractiveness of the second person in each scenario:
Somehow I think the results would show a higher rating for the middle picture in the second scenario than the first. In fact, Predictably Irrational talks (semi-seriously) about how if you’re going to a bar – the best advice they have to optimize your personal attractiveness is to make sure your wingman is slightly less attractive than you. OK, one more example, and then I will in fact relate this to the venture world and technology. This one is from the book – imagine you had to select in both cases whether you would make the drive:
- Drive 10 minutes to save $5 on a $15 pen.
- Drive 10 minutes to save $5 on a $500 suit.
Despite the same absolute economic savings and same cost (driving 10 minutes), a substantially higher percentage of people would make the drive in scenario 1 rather than scenario 2, because of its higher relative value. You get the drift.
OK, this dynamic does in fact play out in the venture world more often than one might expect. I’ve seen it in many different instances, but most classically during an acquisition process. Consider how supportive you would be of taking the deal in the following two scenarios:
- You have a $20M revenue software company. An acquirer comes along and offers you $20M and says you are worth 1x revenues. Then through your shrewd negotiating and creation of a bidding war, you’re able to walk up the price offered by that acquirer up to $100M. You have increased their offer by 5 times!
- You have a $20M revenue software company. An acquirer comes along and deems the company strategic and offers you $200M. But, then through the diligence process they uncover some issues and decide your company is “only” worth $100M – an insulting 50% less than their original offer.
In my experience, despite the same absolute value at the end, boards would more likely be celebrating in scenario 1 and angrily walking away in scenario 2. Why? Again, it’s all about the relative value against the starting bid.
While I’m not trying to make relative value seem irrational (because I don’t think it is) – it’s worthwhile to recognize how human nature can sometimes inappropriately define value exclusively on a relative basis to the neglect of all other reasoning. Perhaps we need to learn how to put aside our need to compare, and just be happy with what we’ve got. In an orthogonal way, this reminds me of a quote I heard years ago, “Being rich is not about how much you have (or how much more you have), but it’s about how content you are with what you have.”