Value Creation

THE SOURCE OF PRICING ADVANTAGE

NO.
Lesson 2
Pricing for Value
Elkana Ezekiel

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• 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?

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 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

If it had been a 19 year old college student who was buying the floor mat,
would he have chosen the bloody footprint one?

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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 (may not always be quantifiable)

◦ 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 (comparable products or practices)
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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 Negative

Positive differentiation value
customer is willing to pay for the differentiation differentiation
offered by the seller to the best alternative value
Total
◦ Monetary Economic
Reference
value
Value
◦ Psychological
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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 / Facial Care Kit - NBCA will probably be home-made packs with
multani mitti or a facial in a salon, etc.

◦ Carbonated soft drink brands like Coke redefining competition to “all” liquid
thirst quenching options not just other cola brands

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 Economic value
Total Economic Value 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 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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 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 e.g.
industrial buyers may pay more for tighter control limits or urgent door delivery

Estimate differentiation value - use value driver algorithms, knowledge of customer

economics, competitive information and differential performance data

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 Communicating economic value
The perceived value of the product may fall far short of the actual economic value

This underlines the need for marketing to communicate the economic value

For example, While trying to convince advertisers to advertise on HT website instead of TOI
website & if the number of visitors to TOI is 20% higher than HT, what parameters could you
use to communicate the economic value of HT?

Good communication & positioning can sometimes increase the perceived value of the product
to be significantly higher than its economic value

◦ The higher price you would charge 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

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ATLANTIC
COMPUTER
 ATLANTIC COMPUTER
1. What are the real business & pricing challenges facing the company for the
Atlantic Bundle(Tron – Pesa)?

2. What price could Atlantic set with the following pricing approaches
1. Cost plus pricing
2. Competition based
3. Value in use pricing

3. What approach would you recommend and why? What are the financial
implications of each?
THANK YOU
Economic Value Estimation
(EVE)

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

2. Identity the value drivers - Customer needs upon which our product can have an impact: health, time, etc.

◦ 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

3. 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; 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
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 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 findings to devise value driver algorithms – formulas 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 consumers 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

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 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

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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
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 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

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

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 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?

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 The value-based segmentation process
1. Determine basic segmentation criteria – demographics and criteria that distinguish between value derived

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: To ascertain where you have competitive advantage

◦ 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 (measures of value delivered) and fences (policies & rules of eligibility for special prices)

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Thank you

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 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
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TOI classified rates

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Detailed segment descriptions

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