1. Value-based pricing requires estimating the economic value a product brings customers above alternatives. This economic value to the customer (EVC) equals the reference value of substitutes plus the differentiation value of unique product attributes.
2. For a new product with lower manufacturing and lifetime operating costs, the maximum price a customer would pay to be indifferent is the original product's price plus lifetime cost savings. The minimum price maintains the original profit percentage or dollar amount.
3. When pricing within the range of $115,000-$150,000, different prices determine how the $35,000 total value creation is split between customer savings and company profits.
2. Value :
Overall satisfaction derived out of using a product or Service offering. Also called
Use Value (Utility gained from the product). ( Few ppl opt for it so not a Pricing
baseline for marketers)
Consumer surplus :
Difference between Use Value & Market Price
Economic Value:
Value-based pricing requires the estimation of the economic value of a
good/ services.
The goal of EVC (economic value to the customer) is to quantify the
additional value a product brings to customers above what they already
receive from their present suppliers
4. • The Reference Value is the price of the closest perceived
substitute. This is extremely important - understand what alternatives
and substitutes the customer sees in the market.
• The Differentiation Value is the value of your product's attributes
that exceed the reference value. These attributes includes features
and functionality, time to market, size, cost, licensing, support etc.
You also need to ensure that the customer is fully informed of all of
the differentiation you provide.
EVC = Reference Value + Differentiation Value
7. CURRENT PRODUCT
Mfg. Costs $ 100,000
Selling Price $ 125,000
Customer life time operating costs $ 75,000
Company has developed an improved product
NEW PRODUCT ( Same Life time, same performance)
Mfg. Costs $ 90,000
Selling Price ????
Customer life time operating costs $ 50,000
8. TOTAL Value Creation = ??
Manufacturing cost decreased by : 100,000 – 90,000 = $ 10,000
Life time cost decreased by : 75,000-50,000 = $ 25,000
Total Value Creation : 10,000+25,000 = $ 35,000
How to incorporate this value creation in pricing?
How to price the product now ?
Who will capture this value? Company or Customer?
Work out the Minimum and Maximum Price that can be charged for this
Product.
9. Maximum Price ( From customer perspective)
For old product, Customer is paying $ 125,000
Life time operating cost $ 75,000
Total cost incurred = $ 200,000
Maximum cost for new product: where customer would be indifferent for using
new product or old product.
Total cost of using A = Total cost of using B
Price of A + life time cost incurred on A = Price of B + Life time cost incurred on B
125,000 + 75,000 = PB+50,000
PB = 150,000
At Price of $150,000,
Sellers’s profit gain would be = 150,000 – 90,000
= 60,000
Profit gain from initial product = 125,000 – 100,000
= 25,000
Profit Value Creation = 60,000 – 25,000
= 35,000
All Value creation is captured by seller, Buyer has no incentive to buy new product/ Buyer
is indifferent .
10. Minimum Price ( From seller’s perspective)
Either maintain the same $ value in Profit i.e. $ 25,000 ( 125,000 – 100,000)
OR maintain the same % margin i.e. 20% ( 25,000/125,000).
To maintain the same $ Value:
Price would be ?
Profit = Selling price – Mfg. Cost
25,000 = S.P – 90,000
S.P = 25,000 + 90,000
S.P = 115,000
To maintain the same % margin i.e. 20% :
Price would be ?
%Margin = Profit / Selling price
% Margin = (S.P – Mfg. Cost)/ Selling Price
0.2= (S.P-90,000)/S.P
0.2 S.P = S.P – 90,000
S.P-0.2 S.P = 90,000
0.8S.P = 90,000
S.P = 90,000/0.8
S.P = 112,500
Customer gain would be : 10,000 (in price) + 25,000 (life time
costs savings) = $ 35,000
Whole Value creation is captured by customer
Customer gain would be : 12,500 (in price) + 25,000 (life time
costs savings) = $ 37,500
More than 100% Value creation is captured by customer. But
how????
Value gain to company would be:
Profit = 112,500 – 90,000 = $22,500
Profit in previous product = 125,000 – 100,000 = $25,000
Net loss in value = 22,500 – 25,000
= $ -2,500
MINIMUM PRICE RANGE $112,500 – 115,000
11. Tentative Price Range
$ 150,000 – 115,000
What if new product is priced at current market price i.e. $125,000 ?
Seller’s profit would be : 125,000 – 90,000 = 35,000
Value gain would be : 35,000 – 25,000 = 10,000
Customer’s Value gain would be : 75,000 –50,000 = 25,000
Total Value gain : 10,000 + 25,000 = 35,000 ( Shared between buyer and seller)
What if new product is priced at $135,000 ?
Seller’s profit would be : 135,000 – 90,000 = 45,000
Seller’s Value gain would be : 45,000 – 25,000 = 20,000
Customer’s Value gain would be = 15,000
BUTTTTTT how??
Total Value gain : 20,000 + 15,000 = 35,000
Price difference = 125,000 – 135,000
=-10,000 (negative value gain for customer)
Life time costs : 75,000 – 50,000 = $25,000
NET Value gain for customer : 25,000 –
10,000 = 15,000
