Value Creation

THE ROLE OF PRICING

Lesson 2
Pricing for Value
Elkana Ezekiel

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HOW
MUCH
WOULD
YOU
PAY FOR
HOW
MUCH
WOULD
YOU
PAY FOR
 What can we learn from this?
 Under different circumstances the same product can be priced differently

 In each of the circumstances the worth or perceived value changes

 The final price paid will be driven by multiple factors including the urgency and criticality of the
need, the availability of substitutes, the ability of the seller to ensure timely availability, etc.

 In some cases e.g. life saving drugs, the “value” of the life saved is more based on emotion
than $$

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 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”

Example: The MRP of a can of Coke is Rs. 35. On a very hot Delhi day, when there are no other
refreshments in sight, the use value of a Coke for you may be Rs.50. A vendor comes by carrying cans of
coke. Will you pay him Rs. 50 to buy a can?

◦ If you know other vendors will come along who will sell at MRP, then you probably won’t pay Rs.50

◦ Let’s say you buy it at Rs. 40

◦ Then, your Consumer Surplus = Use Value - Exchange Value = Rs.10

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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

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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
Negative
differentiation value
◦ Psychological Positive
differentiation value

Total
Economic
Reference value Value

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Total Economic Value
Air Conditioners 3 Star Rated 1.5 Tons 5 Star Rated 1.5 Tons
 TEV is the Price Point of
Indifference between the two
MRP 50,000/- To Be Fixed options
Avg. electricity units 1700 1000  If Price set at TEV then
consumed per year customer gets no economic
advantage over the 3 Star
Price per unit 5 5  The challenge is for the firm to
Total Electricity Rs 8500/- 5000/- profitably share additional
Useful Life in years 5 5 value with the customer
 Customer Education can
Lifetime Elec cost 42,500/- 25,000/-
increase the perception of value
Total Savings 17,500/- derived
Total Economic Value
50,000+17,500=
67,500/-
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 could be misrepresented

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

 Toyota Prius website allows visitors to easily calculate the savings they could get in
terms of fuel consumption etc. by choosing a Prius vs. other cars

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Reference price
Price of the NBCA

Usually defined as the main competitor – gain share from OR lose

share to

Sometimes NBCA may not be another product, but another method

used by the customer to achieve the same objectives

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0
EXAMPLES
EXAMPLES
UNDERSTANDING THE TRADE
OFFS

 Evaluating “savings” may be challenging

 Typically value will be generated along non-financial dimensions e.g.
convenience, hassle free, easy to use, quick solution, etc.
 These compete with positives like nature knows best, natural
ingredients are safe, I like to pamper myself, etc.
Economic Value Estimation
(EVE)

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Economic Value Estimation(EVE) Process

Study customer Estimate differentiation

Quantify value drivers
economics value

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 Study customer economics
1. Identify the reference value of the product for the 3. Assess relevance of value drivers to customer.
customer - The price charged by the next best
competitive alternative 3 types of drivers:

1. COST - The customer saves money, time or

effort if they use your offering vs. the NBCA
2. Identify the value drivers - Customer needs upon
which our product can have an impact: health, 2. REVENUE - Help the customer increase their
time, prestige, etc. revenues & profits e.g. Intel Inside

◦ Businesses tend to have objective value drivers 3. PSYCHOLOGICAL – “Nobody got fired for
e.g. productivity, energy savings, headcount specifying IBM”; Hotel has Bose sound system
or Jaquar bathroom fittings
control, etc.
◦ These value drivers are driven by the customers’
business models and strategies

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ICE CREAM SUPPLY CHAIN
Retailer
Distributor
Warehous
Retailer
e
Distributor
Factory
National
Consumer
retail chain
 Economic Value Estimation(EVE) Process – Ice
cream cold chain vendor

Study customer Estimate differentiation

Quantify value drivers
economics value

Cold chain costs

Spoiled goods

Out of stock

Brand reputation

Regulator – FSSAI
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 Quantify value drivers
Gather data required to assign a monetary value to Dyna Test Example (Chapter 2)
each value driver
◦ The company GenetiCorp markets a
Easiest depth interviews with customers DNA analysis test named Dyna-Test
◦ probe the economics of the customer’s business & ◦ The reference price is of the main
your products prospective role in it competitor EnSyn at $30
Use findings to devise value driver algorithms – ◦ Depth interviews with customers
formulas to estimate the differentiated monetary worth indicated that using Dyna-Test saved 16
of each unit of product performance hours of processing labour time vs.
e.g. using time taken to complete a task and how much Ensyn
time is saved using your product to estimate ◦ Taking the average lab personnel wage
manpower/energy cost savings
of $24/hour, the labour savings by using
◦ Approximations of value rather than statistical Dyna-Test turned out to be $384
precision
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 Economic Value Estimation(EVE) Process – Ice
cream cold chain vendor

Study customer Estimate differentiation

Quantify value drivers
economics value

Cold chain costs Price per Ton Km

Spoiled goods 100% write off

Out of stock Lost sale & profit

Brand reputation Incalculable

Regulator – FSSAI Legal costs

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 Estimate differentiation value
1. Calculate the reference value - the price for the competitor brand

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

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 Economic Value Estimation(EVE) Process – Ice
cream cold chain vendor

Study customer Estimate differentiation

Quantify value drivers
economics value

Cold chain costs Price per Ton Km Compare absolute prices

Spoiled goods 100% write off Capacity / Number of trucks

Out of stock Lost sale & profit Estimate breakdown probabilities

Brand reputation Incalculable Quality of network information

Regulator – FSSAI Legal costs Risk weighted cost per ton

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Usefulness of EVE beyond pricing

 Identification of key value drivers for each customer segment can used to
plan new products and offerings – e.g. Business Class vs. Leisure Travel

 Customized solutions – e.g. Modular furniture

 Product improvements – e.g. Frost free refrigerators

 Formulate distribution channel strategies – e.g. HP

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 Value-based market segmentation
Flat price for all customers is an exclusionary business strategy

Segmenting for special price strategy has some limitations:

1. Poor Correlation of segmentation criteria to different buyers’ motivations to pay – Door delivery to
remote manufacturing locations Vs. Size of factory criteria

2. Customer segments may not reflect sellers higher cost to serve – Scale vs. Assortment range

3. May not reflect the monetary value of satisfying high-priority customer needs e.g. Delicate wash cycle
for expensive clothes

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 e.g. water
efficient detergents; hybrid cars

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 International Harvester Vs. John Deere

 Despite significant quality improvements farmers consistently rated JD higher in quality to IH

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

 JD scoring on superior customer service – Minimum down time <= 1 day

 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?

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Value based segmentation approach
1. Define segments based on standard and value driven criteria

2. Narrow down the key discriminating value drivers

3. Evaluate seller firm’s competitive advantage

4. Target Primary segments for maximum business

5. Use Metrics and Fences to mop up Secondary segments

Thank you

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