Value and Money 2: Potential Value

In a previous article, I made the case that “value” comes from the transformation of resources. But that is not the complete source of value. There are actually two sources of value:
1) transformation over time, or “past” value, and
2) potential transformation in the future. We won't call this “future value” because that term is already taken (you can calculate the future value of $100 earning 10% interest, compounded annually, using the formula Fv=Pv*(1 + r)^n → 100*(1+0.1)^n, where n is the number of years.) So, instead of calling this future value, let's call this, “potential.”

This “potential” value is where opportunity exists. It is easy to calculate past value, or how much transformation and resources have gone into something. But it is difficult to calculate how much that something will be worth in the future (i.e. with additional transformation).

Potential value is a measure of the probability of transforming something with value into something with different value.

Let's return to our Smidget Widget example. Bob buys consumables and transforms them into widgets. He knows that if he sells widgets in bulk, people will buy them and he will make a profit. You suspect that widgets can be sold individually in a certain location for a mark-up. If you are right, then those widgets have more value to you than to Bob because you have spotted a potential opportunity.

In this case, you are putting forth additional transformation to the widget: you are taking bulk widgets, transforming the bulk widgets into individual widgets, and targeting a specific market. So, those widgets have potential value to you, and the price you are willing to pay for Bob's widgets is based on a calculation of how likely it is that you will capitalize on that potential.

Now that we understand that all value comes from transformation put into it and potential transformation in the future, it becomes clear that the source of all business opportunity is actually a form of arbitrage – taking advantage of value differentials in the marketplace.

Opportunistically yours,
Aaron