Value Creation

The source of pricing advantage

Lesson 2

Pricing for Value

Jishnu Changkakoti

1
• Your mother wants to buy a floor mat for the bath-room.
• A normal mat costs Rs.100.
• The salesman shows her 2 types of mats, both with value-
added benefits
• Both are priced at only Rs. 110
• Which one will she buy?

2
 Moral of the story
• Simply adding performance features into a product will not
justify charging a price premium

• These features need to translate into actual value to the

consumer

• competitively superior, economic and psychological value

• Therefore the value is likely to be different among different

customers

3
The role of value in pricing
• Value - the total savings, monetary gains or satisfaction that the customer receives from using
the product/service offering

• Also known as “Use Value”

• The difference between the use value and the market price(exchange value) of a product is
known as the “consumer surplus”

• You are the only one among your batchmates appearing for a special entrance exam. The
exam is a week away, and you have not been able to buy an essential text book as it is not
available anywhere.

• Finally you find someone who has a used copy of that book. She is willing to sell it to you for
Rs. 500. The MRP of the book is Rs.400.

• Will you buy the book?

• If this book is really critical, maybe you value it at double the MRP = Rs. 800 = your “Use
Value”

• Therefore, your Consumer Surplus = Use Value - Exchange Value

= Rs. 800 - Rs. 500 = Rs. 300

4
The role of value in pricing
• Pricing is concerned with “economic value”( or
exchange value) - what the customer is willing to
pay for the product

• Economic value is driven by:

• the alternatives the customer has for the

product

• the degree of differentiation in the product

vs. the alternatives available

5
 Economic Value
Economic value = Reference value + Differentiation value
• Reference value - price of the “next best competitive alternative(NBCA)” to your
product for the customer

• Differentiation value - the additional value the customer is willing to pay for the
differentiation offered by the seller to the best alternative

• Monetary

• Psychological
Negative
differentiation value
Positive
differentiation
value

Total
Economic
Reference value Value

6
 Economic value
• It is the maximum price that a “smart shopper” would pay

• Smart shopper - is fully informed about the market & is seeking the
best value

• But all buyers are not smart shoppers

• If buyer is uninformed, then perceived value < economic value

• Job of the sales & marketing team to ensure that all important
features & benefits are explained to the buyer

• Toyota Prius website initially allowed visitors to easily calculate

the savings they could get in terms of fuel consumption etc. by
choosing a Prius vs. other cars

7
 Reference price
• Price of the NBCA

• Sometimes NBCA may not be another product, but

another method used by the customer to achieve
the same objectives

• Face pack- NBCA will probably be home-made

packs with multani mitti etc.

• Sometimes it needs analysis of data to arrive at an

idea of the reference price
8
Assessing reference price

9
 The importance of communicating
economic value
• The perceived value of the product by the customer may sometimes fall far short
of the actual economic value

• The underlines the need of marketing to communicate the economic value of the
product

• For example, if you are trying to convince advertisers to advertise on the HT

website instead of the TOI website, & if the number of visitors to TOI is 20%
higher than to HT, what parameters could you use to communicate the economic
value of HT?

• Good communication & positioning can sometimes also get the perceived value
of the product to be significantly higher than the economic value

• The higher price you would pay for Levi's vs. Big Bazar jeans, a Swiss branded
watch vs. a digital watch

• Using an iPhone vs. any other smart phone

• Builders advertising that they use Jaquar bathroom fittings

10
Economic Value Estimation
(EVE)

11
 Economic Value Estimation(EVE) Process

Study customer Estimate

Quantify value drivers
economics differentiation value

• Study customer economics - understand the main value drivers &

develop hypotheses of which are the most important to the product
offering

• Quantify value drivers - determine the monetary worth of these value

drivers

• Estimate differentiation value - use value driver algorithms,

knowledge of customer economics, competitive information and
differential performance data to do so

12
Study customer economics
• Identify the reference value of the product for the customer - the price charged by the next best
competitive alternative( NBCA)

• Identity the value drivers - customer needs upon which our product can have an impact

• Businesses tend to have objective value drivers like productivity improvement, durability etc.

• These value drivers are mostly dependent on the customers’ business models and strategies

• Individuals have their own value drivers:

• Since I travel a lot, I need a laptop that is lightweight & has good battery life

• I want to reduce my electricity consumption

• List out all the potential value drivers of your offering and see which of these are most relevant to
the customer. These can be of 3 types:

1. Cost drivers - the customer saves money, time or effort if they use your offering vs the NBCA

2. Revenue drivers - help the customer increase their revenues & profits e.g. Intel Inside e.g.
helping increase the speed/efficiency of their processes etc.

3. Psychological value drivers - e.g. “Nobody got fired for specifying IBM”, hotel has Bose
sound system or Jaquar bathroom fittings

13
 Quantify value drivers
• Gather the data required to assign a monetary value to each value driver

• Best way to do it is via depth interviews with customers

• probe the economics of the customer’s business & your products prospective role in it

• Use the interviews to devise value driver algorithms - formulas and calculations to estimate the
differentiated monetary worth of each unit of product performance

• e.g. using time taken to complete a task and how much time is saved using your product to
estimate manpower/energy cost savings

• approximations of value rather than statistical precision

• Dyna Test Example (page 47):

• The company GenetiCorp markets a DNA analysis test named Dyna-Test

• The reference price is of the main competitor EnSyn at $30

• Depth interviews with customers indicated that using Dyna-Test saved 16 hours of processing
labour time vs. Ensyn

• Taking the average lab personnel wage of $24/hour, the labour savings by using Dyna-Test
turned out to be $384
14
Estimate differentiation value
1. Calculate the reference value - the price for the quantity of
competitive product the customer would buy to substitute
for your product

2. Calculate value of each value driver using the algorithms

devised

• Make sure negative differentiation values are also created

- e.g. extra cost of using your product, inferior
performance on some specific attribute etc.

3. Calculate total economic value = reference value +

differentiation value

15
Dyna-Test EVE for industrial buyers
Sample size labour savings = $38

Sample size opportunity

costs = $468

QC labour savings = $48

Yield labour savings Total economic

= $384 Total positive differentiation value = $2528/kit
value = $2498/kit

Yield opportunity costs

= $1560

Total reference
Reference: Ensyn $30
value = $30/kit
16
What did Dyna-Test do with this analysis?
They successfully increased the price of the kit by 2 - 4
times the original price

17
 Value-based market segmentation
• It is important to price differently to different customer segments because
charging the entire market the same price results in under-pricing some market
segments and over-charging others

• However, there are certain issue with standard segmentation methods like
demographics/firmograhics, or even need-based segmentation

1. Poor correlation of segmentation criteria to different buyers’ motivations to pay

higher or lower prices e.g. yellow pages

2. Priority given to the customer’s needs, but miss identifying those needs that
have maximum impact on the seller’s costs & constraints to serve those
needs

3. Do not estimate the monetary value of satisfying high-priority customer needs

- pasteuriser example

4. The depth interviews needed for value-based segmentation uncover a lot of

“whys”, which reveal opportunities for pricing & benefit communication, as
well as for new products & services - IH-John Deere example
18
 International Harvester example
• International Harvester markets tractors to farmers

• Its main competitor is John Deere

• Despite significant quality improvements by IH, farmers consistently rated JD

higher in quality

• Depth interviews revealed that IH breakdowns were not more than JD ones

• The difference was that JD had an extensive service network, and also gave
farmers loaner tractors to use while repair work was being done - less than 1 day
down time

• IH tractor users were facing downtimes of 2 days or more

• Value segmentation would have revealed that JD was actually serving a segment
of customers who wanted a full service solution

• Given the relatively weaker service network, should IH be targeting the same
segment, or should they be looking at farmers where the downtime aspect is not
so important as other factors?
19
 The value-based segmentation process
1. Determine basic segmentation criteria

2. Identify discriminating value drivers

• purchase motivators that vary between segments, but are uniform within segments

• large farmers - down time and response time vs. small farmers - probably cost
more important

3. Determine your company’s operations advantages & constraints

• which value drivers can you deliver more efficiently & at lower cost than others

• which drivers are constrained by your resources and operations

4. Create primary and secondary segments

5. Create detailed segment descriptions

6. Develop metrics and fences

20
Thank you

21
 Segmentation in catalog printing industry

Catalog market

Primary Customer
Printer controlled
Segments controlled
scheduling
scheduling

Unique Cost Low touch,

Brand Focus Consistency
equipment conscious low price
Segment segment
segment segment segment

Secondary Segments
22
TOI classified rates

23
Detailed segment descriptions

24