Raising Capital: Mysteries of Revealed Preferences, Part Nine

In our last article, we discussed competition and different types of substitute products. This week we’ll cover Revealed Preferences (RPs), and how they show up in your business and in your life in general.

What are Revealed Preferences?

RP theory was developed around 1940 by economist Paul Samuelson to analyze choices made by people in their purchase decisions. We use a simplified definition to help size the market, determine actual customer behaviors, and to figure out whether we can justify an investment in a client company.

For our purposes, we define RPs as follows: What a customer will actually do versus what they say they will do. RPs get to the underlying truth behind the decisions that people make—when a person’s words and actions are in agreement.

Understanding Revealed Preferences

Let’s say that your company just developed a great tasting new chocolate candy bar. You set up statistically valid focus groups and conduct trials to determine how likely it is that customers will purchase your new candy bar.

At the end of the testing, statistically significant results show that you have a winner: 80% of potential candy bar customers will buy your product over other candy bars. You then use these data to develop your sales forecast, financial reports, cash flow, capital needs, and ROI.

But wait! Those focus group customers told you truthfully and in good faith that they would buy your new candy bar . . . but will they? When they get to the store, here are some things that might influence their actual purchase decision:

They have a 30-year history with their favorite candy bar.
During your product trials, the customer may have wanted to “please you” unknowingly, telling you that they liked your candy bar and that they would buy it. But you’re not in the store now with them now.
There are many more choices on the shelves than you had in your focus group trials.
They don’t have advertising history nor social interactions with their friends related to your candy bar that would help influence their decision to buy your bar.
In the middle of their busy day they aren’t as focused on deciding which candy bar to buy—they want a candy bar that they know will satisfy them.

Missing the RPs is a common mistake. It’s also a common miss in management and in our personal lives. Ever had an employee tell you that they really liked doing something and then failed to do it, repeatedly? Had a friend tell you that they loved your homemade smoked olives, but the jar you made them last year is still sitting in their refrigerator?

Key point. Revealed Preferences: Pay attention to what people do, not what they say that they are going to do.

Bottom Line

Don't miss the RPs! Figure out how you can test customer affinity for your product accurately. Then forecast product sales, cash flow, investment requirements, and ROI, to justify the business and strategy to investors.

Next week we’ll dive deeper into RPs to help prevent you from making big mistakes in market sizing and forecasting.

Until then!

All the best,