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Session 3 HO

This document discusses concepts related to determining the economic value (EVC) of a product or offering to customers. It defines key terms like reference value, positive differentiation value, and negative differentiation value that contribute to the EVC. It also discusses the importance of understanding value from both the product and customer perspective, focusing on customer needs, wants, pains, and alternative options. The document uses a case study of the drug Angiomax to illustrate how to determine objective value to patients, what hospitals are willing to pay, and strategies for marketing a new product. It also covers concepts like value pricing frameworks, consumer biases, prospect theory, and how to address negative differential values to facilitate adoption of new products.

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Chakri Munagala
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138 views12 pages

Session 3 HO

This document discusses concepts related to determining the economic value (EVC) of a product or offering to customers. It defines key terms like reference value, positive differentiation value, and negative differentiation value that contribute to the EVC. It also discusses the importance of understanding value from both the product and customer perspective, focusing on customer needs, wants, pains, and alternative options. The document uses a case study of the drug Angiomax to illustrate how to determine objective value to patients, what hospitals are willing to pay, and strategies for marketing a new product. It also covers concepts like value pricing frameworks, consumer biases, prospect theory, and how to address negative differential values to facilitate adoption of new products.

Uploaded by

Chakri Munagala
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Form Value to WTP

INDIAN SCHOOL OF BUSINESS


MANISH GANGWAR

Economic Value
EVC tells the economic value of the offering to the fully informed customer.

Negative
Differentiation
Value
Positive
Differentiation
Value

Differentiation Value is the value to


the customer (both positive and
negative) of any differences between the
firms offering and the reference
offering.

EVC
Reference
Value

Reference Value is the cost to the


customer of the competing offering that
the customer views as the best
alternative to the firms offering [they
are already incurring this cost]

EVC = Cost they already incur (and will save) + Net benefit from switching
EVC = Reference Value + Pos. Differentiation Value Neg. Differentiation Value

Understanding Value

Product Perspective

Customer Perspective

Features
Relevant Benefits
Experiences

Needs (rational )
Wants (emotional)
Pains (risk)

Alternative ways
to complete the same job

Everyone Talks Value


...but few actually walk the talk

Features

Product Focus
What do we offer?

Benefits

Application Focus
Why should the
customer care?

Cost
Reductions

Revenue
Increases

Customer Focus
What is that worth?

$ Value

Medicines Company

Context and Costs


 Angiomax is a blood-thinning drug, an alternative to generic Heparin,

which causes much less complications during the angioplasty surgery.


Heparin is priced at $2 per dose.
 Determine the Price to charge for Angiomax




Value of Angiomax to Various Patient Segments


Other Objective Assessments
Valuation by the Hospitals

 Strategy to Market Angiomax





Understand the buying process of Hospitals


Price and Promotion mix for Angiomax

 Industry practice: Ratio of price to cost of goods sold is 10.








Variable cost per dose of Angiomax = $40 (P.9)


Acquisition costs = $2 million(P.9)
Development costs = $28 million (P.9)
Marketing costs = $3 million (P.11)
Total fixed costs = $33 million

Objective Value of Angiomax


Reduction in complications

3.5%

5.3%

13.6%

Cost of complications

$8000

$8000

$8000

Savings from Angiomax

$280

$428

$1088

Number of doses

1.45

1.45

1.45

Objective value of 1 dose of Angiomax

$193

$295

$750

Number of patients

644000

322000

64400

Approximate revenue potential (Million)


assuming selling only one dose per patient
Approximate Gross Profit (Million)
Fixed cost
Breakeven volume (#doses)

Other objective criteria for Angiomax over Heparin: Predictability; Speed; No Immune reaction.

Optional: Sizing the Customer


Demand for Angiomax
Constant Elasticity Curve
Thus, Elasticity = -1.70
(for hospitals, not consumers)

700000

Size of the market

600000

y = 5E+09x-1.701

500000
400000
300000
200000
100000
0
0

200

400
Price per dose

600

800

How Much Hospitals are Willing to


Pay for Angiomax?
 This depends on the choice of target market (patient type by risk).


For example, if the very high-risk patients are the target, a price of $700 per dose may be
possible because of compelling value proposition, more focused selling effort, higher
margins, and low production volume.

Similar arguments can be made for other patient types.

 Another factor is the subjective value of Angiomax as placed by the hospitals. Here

the variables are:




Low price of Heparin,

Doctors satisfaction with Heparin,

Cost containment within the hospitals,

Disbelief in clinical data, and

Belief about own ability (for doctors with above average ability, Angiomax is of less value).

Strategy to Market Angiomax


 Need to understand the complexity of the selling task
 Several entities are involved: Doctors, pharmacists, and

administrators


Focus efforts on doctors (cardiologists) first and then pharmacists.

Recognize the cascading impact of one Angiomax adoption by a cardiologist.

Recognize the difficulty with pharmacists (due to budget limitation).

Recognize that the way to influence administrators is through the doctors.

 Identify a suitable price once the target and promotion strategy is

decided upon.


Need to use experienced sales force.

Recognize that the adoption process will be slow.

Value Pricing Framework


Use Value
Economic Value
Maximum Price

Fully Informed consumers


Objective economic Value

Pricing Zone
Penetration or Skimming

Reference Price

Minimum Price
Relevant Cost

Value Pricing Framework


Use Value
Economic Value
Unrealized Surplus
Maximum WTP

Perceived Value

Realized C. Surplus

Pricing Zone

Reference Price

Relevant Cost

Fully Informed consumers


Objective Value
Marketing Efforts to tap
into Unrealized Surplus

Willingness to Pay

Height vs. Circumference

Which Bet will You Choose?

A: A chance of winning $4000 with probability 0.2


B: A chance of winning $3000 with probability 0.25

Consumer Biases
Reference / Anchoring / Order Effects
Heuristic / Availability / Substitute
Optimism / Overconfidence
Loss Aversion / Sunk Cost
Framing / Fairness

Prospect Theory
Daniel Kahenman and Amos Tverskey
100

Perceived Value

Small Gains
Overvalued

50

Akerlof vs. Kahenman

Gains
Risk Averse

Status Quo

Risk Seeking

Small Losses Strongly


Overvalued

-50

Losses

1. Gains and losses from


Reference point
2. Losses loom larger than gains
3. Marginal diminishing utility
4. Possibility and certainty effects

-100
-100

-50

50

100

Objective Value
Toward a positive theory of consumer choice by Richard Thaler

Framing Effects Gain vs. Loss


 Multiple Gains x > 0 and y > 0



v(x) + v(y) > v(x + y)


Segregation is preferred

 Multiple Losses -x and y where





x and y still positive

v(-x) + v(-y) < v(-(x + y))


Integration is preferred

 Mixed Gain x > y





v(x) + v(-y) < v(x y)


Integration is preferred - cancellation

 Mixed Loss x < y





v(x) + v(-y) > v(x y)


Segregation is preferred silver lining

Mixed Gain or Losses


Value Function v()
v(x) = x if x > 0
v(x) = -(-x) if x < 0
(with a typical = 0.88 and = 2.25)

Prospect Theory
(Kahneman and Tversky 1979)
(1) outcomes are valued as gains or losses relative to a current reference point instead
of final levels of wealth;
(2) the disutility of a loss is greater than the utility of an equivalent gain (referred to as
loss aversion);
(3) decision makers are risk averse over gains but risk seeking over losses;
(4) the value of an outcome is weighted not by the probability of its occurrence, p, but
rather by a weight of the probability, w(p), where w(p) > p for p near 0 and w(p)< p
for p near 1 (i.e., small probabilities are overweighed and large probabilities are
underweighted, which is referred to as the possibility effect and the certainty effect,
respectively; and
(5) there is an editing phase in which outcomes and their probabilities may be
simplified before applying the evaluation phase

Final Price Setting


Economic
Utility

Total Utility

Transaction
Utility

Actively manage price expectations


Establish credible
Manage product

reference prices

Relative incentives
(Weber-Fechner law)

price trends

Encourage favorable

Context & cues

comparison

Product differentiation

(Reference price)

to avoid unfavorable comparison

Actively mange perception of goods sold


Include

and communicate fixed costs

Bundling to
Focus

avoid direct cost comparison

of consumer value

10

Fairness
(Cost of goods sold )

Fairness & Framing

First Chicago setting


the $3-per-visit fee for
customers who use tellers
more than four times a
month
"If nobody changed their behavior,
80 percent of my customers would
never see the $3 charge," said Jerry
Jurgensen. "For the other 20
percent, I want one of three things
to happen: I need for them to
change their behavior; I need for
them to be willing to pay more, or I
need for them to find another
bank."

Perceived Value / WTP

Adjusted negative
Differentiation
Value

Small negative
Differentiation are over
valued

Adjusted positive
Differentiation
Value
Perceived
value

Small Positive
Differentiation are under
valued

Reference
Value

11

Negative Deferential Value

Why Consumers Dont Buy


Find niche and
move to right

Slow Adoption,
need good
communication

Or drop

Segment and
move to right

Premium
Pricing and
communication

Or fight on price

New tooth brush


Segway
Electric vehicle
Dvork keyboard
Online grocery

Positive Differential Value

New Product Marketing Strategy




Seek out un-endowed

Make it behavioral compatible

Find Believers

10 times improvement

Eliminate old

Brace for long time adoption

12

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