Competing on cost or competing on value

A decision on how to satisfice or optimize

Suppose you want to buy a widget. You don’t want to spend more than $100 on a widget. You go out to a store and you see a widget for $80, a widget for $99, and a widget for $120. What should you do?

In general, you really have two frameworks within which to answer this question. In the first framework, you should be the cheapest item, which means you should buy the $80 widget and move on. In the second framework, you should buy the “best value” widget, which means you need more information about the different features of the three widgets.

In procurement parlance, the first framework is called “lowest-price, technically acceptable” or “LPTA.” The second framework is called “best value procurement.” You might imagine that there are plenty of situations where it’s advantageous to use LPTA, and you might imagine situations where choosing based on price alone would be disastrous.

In decision-theory parlance, you might describe the first framework as satisficing and the second framework as optimizing. There are numerous examples that describe – both objectively and normatively – when satisficing is a superior decision strategy over optimization.

Critically, though, there’s a strand of economics research that argues that satisficing is just a form of an optimization problem. When you’re satisficing, you’re actually engaged in a form of optimization under specific constraints. In other words, the difference between satificing and optimization as a strategy is only a question about certainty of which constraints should be applied at the beginning of the exercise. If you know your hard constraints, then all of the remaining factors are effectively equivalent. Knowing your hard constraints, therefore, can simplify an optimization problem into a satisficing problem.

What’s important to realize, then, is that the simple question of “what thing to buy” ultimately requires a second, much harder, consideration: “what do I really value in the transaction”? And the harder question of “what do I really value” can, in principle, be reduced to “what am I unwilling to negotiate on” if you know your hard constraints.

To me, then, the first lesson here is that organizations should not talk about about price and cost without the context of value. You need to understand your goals in order to reason meaningfully about price. The second lesson is that organizations should also seek opportunities to clarify their hard constraints around value. If it’s possible to know what your hard constraints are, then you can simplify the decisions and move on without spending energy on a harder optimization problem.

It’s worth considering, in your own work, where you spend time optimizing when you should be satisficing, and vice versa. Today, ask yourself, how might I manage my energy to focus on defining the right problem at the outset?