Setting Value, not Price
Value pricing" is too often misused as a synonym for low price or bundled
price. The real essence of value revolves around the tradeoff between the
benefits a customer receives from a product and the price he or she pays
for it.
The management of this tradeoff between benefits and price has long been
recognized as a critical marketing mix component. Marketers implicitly
address it when they talk about positioning their product vis-à-vis
competitors' offerings and setting the right price premium over, or
To illuminate the nature and magnitude of this missed value-management
opportunity, value needs to be defined properly. Customers do not buy
solely on low price. They buy according to customer value, that is, the
difference between the benefits a company gives customers and the price it
charges. More precisely, customer value equals customer-perceived
benefits minus customer-perceived price. So, the higher the perceived
benefit and/or the lower the price of a product, the higher the customer
value and the greater the likelihood that customers will choose that
product. (We will return to this later.)discount under, them. Marketers
frequently along the two dimensions of value management, however. First,
they fail to invest adequately to determine what the "static" positioning for
their products on a price/benefit basis against competitors should be.
Second, even when this is well understood, they ignore the "dynamic"
effect of their price/benefit positioning—the reactions triggered among
competitors and customers, and the effect on total industry profitability and
on the transfer of surplus between suppliers and customers.
In classic marketing and segmentation theory, a segment is defined as a
group of customers with identical needs and buying behavior. In theory, all
customers constituting a precisely defined segment would be equally
receptive to all products positioned anywhere along the VEL. Therefore, all
products positioned on the VEL should have the same market share. In
practice, this is clearly not the case. There are two ways to resolve the
conflict:
Define each segment so narrowly that it contains only one customer.
Define a segment (and the products positioned in it) so that it contains all
the realistic and feasible alternatives customers consider for a given
purchase, and accept that there will be some differences in buying
decisions.
We will take the second approach, as it makes the concepts in this article
easier to apply in the messy "real" world, without compromising the quality
of the answer.
The value map explores the way customer value and the price/benefit tradeoff work in real
markets for a given segment (Exhibit 1). The horizontal axis quantifies benefits as perceived
by the customer; the vertical axis shows perceived price. Each dot represents a competitor's
product or service. Higher-priced, higher-benefit competitors are toward the upper right;
lower-priced, lower-benefit competitors are at the lower left.
If market shares hold constant (and if you have the right measurement of
perceived benefits and perceived prices), then competitors will align in a
straight diagonal line called the value equivalence line (VEL). At any desired
price or benefit level, there is a clear and logical choice for customers on
the VEL. So competitors aligned on the VEL say in such a market that "you
get what you pay for." The clarity of that choice almost defines a market in
which shares are stable. (Note that while market shares might be stable for
competitors along the VEL, their shares might not be equal. Again, more on
this later.)
If, however, market shares are changing, then share gainers will be
positioned below the VEL in what is called a "value-advantaged" position.
Competitor A in Exhibit 2 is value-advantaged and should logically be
gaining market share. If a customer is searching for a product in the benefit
range of A and B, then he or she would be more likely to choose A, since A
provides the same level of benefits as B but at a lower price. Likewise, if a
customer were searching for a product in the price range of A and C, he or
she would probably choose A over C, since A provides greater benefits than
C but at the same price. So A, positioned below the VEL that B and C reside
on, offers more customer value than B or C, and therefore more customers
prefer it.
The opposite is true for competitor E, which finds itself in a value-
disadvantaged position above the VEL. Competitor E will be a share loser if
the value map has been constructed properly.
While the marketing concepts that underpin the value map are basic,
advanced market research techniques (conjoint analysis, discrete choice
analysis, and multi-staged conjoint analysis, for example) allow an accurate
quantification of the perceived benefit dimension and its tradeoff against
price. These advances make the effective application of value maps easier
than ever for marketers. That said, examples abound of costly positioning
errors that could have been avoided through the use of this tool.
Exhibit 3
Illustrative case: Alpha Computer Company
The Alpha Computer Company's experience illustrates the value map's
power, even when applied in a simple, static fashion. Alpha Computer
supplied minicomputers for use primarily as servers in network
applications. Alpha prided itself on its engineering skills and ability to
deliver high levels of technological performance at reasonable cost. In an
attempt to diagnose unexpectedly poor market acceptance of its new line
of minicomputers, Alpha created a value map that reflected its perception
of the price/benefit positioning of competitors Ace Computer and Keycomp,
and itself (Exhibit 3).
Alpha believed customers chose minicomputers on the basis of two
technological attributes: processor speed in MIPS (millions of instructions
per second), and secondary access speed, that is, how quickly the computer
accessed data from an external storage device such as a hard disk drive. Ace
Computer was the premium competitor: it had the highest processor speed
and secondary access speed, but also the highest price. Keycomp not only
had slower processor speed and secondary access speed than Alpha but
was also priced 10 to 15 percent higher. So, Alpha thought that Keycomp
was value-disadvantaged and that Alpha itself was value-advantaged.
If Alpha's perception of the value map in Exhibit 3 were correct, then Alpha
should have been gaining market share and Keycomp losing it. The opposite
was occurring, however, and Alpha's managers were baffled. They thought
their product was superior to Keycomp's at a lower price, and they could
not understand why it was not a huge success.
Alpha's problem was a common one. It did not understand the customer-
perceived attributes that really drove customer choice of minicomputers.
Alpha's marketing department commissioned research to try to confirm its
hypothesis that processor speed and secondary access speed were indeed
the most important features. Sixty buyers were questioned about their
criteria for selecting a network minicomputer supplier.
Much to Alpha's surprise, processor speed and secondary access speed
ranked only fourth and sixth on their list. Software and hardware
compatibility, perceived reliability, and quality of vendor technical support
ranked above raw processor speed. Even quality of user documents (the
manual that accompanies the hardware) ranked above secondary access
speed.
As it turned out, processor speed was indeed important, but most
customers had a minimum processor speed requirement that all
competitors easily exceeded. However, the nature of most network
applications made secondary access not that important. In fact, Alpha was
understood by customers to be slightly better than Keycomp on processor
speed and secondary access speed, but these features just did not matter
that much to them.
The research also showed that Keycomp was highly rated on compatibility,
reliability, vendor support, and user documents. Alpha, on the other hand,
fell short on these. Its operating system software and hardware plug
configuration created compatibility problems for many customers. Some
remembered reliability problems with an earlier generation of Alpha's
minicomputer that tainted their perception of its new product. Alpha's
technical support was considered difficult to get hold of and its user
documents were seen as the weakest in the industry.
Exhibit 4
Exhibit 4 shows how the value map was redrawn to reflect customers'
perceptions of benefits and performance rather than Alpha's. It showed
that Keycomp performed so well on the attributes most important to
customers that, despite its higher price, it was value-advantaged and
therefore justifiably gaining market share. Conversely, Alpha performed so
poorly on attributes most essential to customers that, despite its low price,
it was still value-disadvantaged and predictably losing share.
The insights from this properly constructed value map prescribed a clear
course for Alpha. It mounted a crash program to correct the important
attributes on which customers had rated it so poorly. A minor rewrite of
operating system software and a simple redesign of the hardware plug
configuration fixed the compatibility issue. The company then mounted an
aggressive market information campaign to demonstrate the improved
reliability of its latest model. Additional service representatives and toll-free
access lines were put in place to enhance technical support, and user
documents were redrafted.
Exhibit 5
The results are shown in Exhibit 5. In only six months, Alpha increased
customer-perceived benefits so much that it was able to increase its price
by 8 percent and still gain its fair market share. The price and volume
increase more than doubled Alpha's operating profits.
The Alpha Computer case illustrates several important points about value
management:
• The key to success often resides in gaining a clear understanding of the
real attributes driving customer choice and their relative importance.
• "Softer," nontechnical attributes (perceived reliability, quality of vendor
support, ease of doing business) are often as important as or more
important than precisely measurable technical features.
• Trusting internal perceptions of which attributes drive customer choice
can be a fatal mistake; rely on customers for this critical information.
The case also shows the opportunities value maps offer value-
disadvantaged companies to understand their markets better. Another case,
that of car maker Mazda's experience with its Miata sports model,
demonstrates the kind of opportunity that a value-advantaged company
can easily forgo if it does not fully appreciate its position (see sidebar, "US
economy sports car market, 1990").
Exhibit 6
Introduced to the US market in 1990 at a manufacturer's suggested retail
price of $13,800, the Mazda Miata was a retro-sports roadster that
captured the imaginations of ageing baby boomer car buffs who originally
fell in love with the classic British roadsters of the 1960s and 1970s made by
MG and Triumph. As much fun as its British predecessors but better built
and more reliable, the Miata was an instant hit in the United States.
Mazda underestimated the appeal and the high perceived benefits of the
simple but unique Miata. The price was disproportionately low for the
perceived benefit. Mazda dealers, however, recognized this price/benefit
imbalance and claimed the surplus for themselves in the form of $2,000–
3,000 "market price adjustments" that they added to the suggested retail
price (and which customers gladly paid).
In discussing the stability associated with a position on the VEL, and the
effects of competitive moves away from it, we have implicitly assumed that
all positions along the line are equally attractive. This is not the case. Even
for a well-defined segment, customers are not spread evenly along the line;
if they were, every competitor on the VEL could be expected to have the
same market share. Sometimes this can be explained by historical reasons;
mostly, however, it is due to the distribution of customers along the VEL
(Exhibit 6).
History plays an important role: how long a competitor has held its position
with customers often explains large market share differences among
companies with otherwise the same value proposition. This phenomenon,
also called "order of entry," can be seen in its extreme form in deregulated
utilities. A new competitor offering similar or even slightly better value than
an incumbent telephone or electricity company will not provoke the
significant changes in consumer purchasing that might be expected.
A more important and probably more common explanation of market share
differences among competitors on the VEL is the distribution of customers
along this line. Typically they are not distributed evenly, but clustered.
There are several reasons for this. Sometimes consumers are not equally
aware of the true nature and availability of competing products. Companies
might use different channels to reach consumers, or their salesforces might
not adequately communicate benefits to customers. If so, a gap can exist
between customers' perceptions of a product's benefits and the benefits
that it actually delivers.
Even in a perfect world, consumers would be unevenly distributed along the
VEL because they do not necessarily view benefits and prices in a linear
way. There are benefit-bracketed customers who explicitly want minimum
or maximum benefit levels and find positions on either side unacceptable.
Market research shows that break-points exist for some products and
services at which a small increase in the benefits offered will lead to a large
increase in the value a customer perceives. Some buyers of automotive
components, for example, will not accept delivery reliability below a
minimum level. Some computer buyers, on the other hand, do not value
additional memory beyond a certain level because existing memory more
than satisfies their needs.
A second group is price-capped customers who are unwilling to spend more
than a fixed amount for a particular product or service. The price of the
average home PC has held at about $2,000 for several years, even though
performance has improved sharply. This could indicate that there are price-
capped customers at around this level who are unwilling to spend more
even if they could get more features. Only customers who fall into neither
category, benefit-bracketed or price-capped, are actually willing to consider
the full range of tradeoffs along the VEL.
Understanding volume distribution along the VEL is therefore crucial to
making an intelligent decision about product position. In many cases,
however, it is poorly understood, leading to wrong decisions. Typical
mistakes are:
Positioning an apparently competitive product at a low-volume part of the
VEL and not getting the expected volume gains. A maker of metal-coating
machinery positioned a new product technically half way between two
competing products, hoping to pull in customers not entirely satisfied with
these. What it had not realized was that there was no significant volume
between the two extremes, because each answered a specific speed
requirement of downstream customers. Failing to understand that there
was no demand for a medium-speed machine, even one that was
competitive on technical specification and price, forced the manufacturer to
take a multimillion-dollar writeoff.
Positioning a product too high or too low on the VEL, thereby inadvertently
excluding a large portion of price-capped or benefit-bracketed customers.
The drastic fall in demand for one company's supercomputers is an example
of this.
Even though the company's ever more powerful machines remained on the
VEL, there was no longer a customer imperative for all that processing
power to be concentrated in one machine, as more broadly distributed
processing had become preferred by most users.
Dynamic value management
Alpha Computer and Mazda Miata illustrate the pitfalls of failing to
understand the "static" value positioning of a product or service. But getting
a product to the right position on a static value map is only part of
managing value effectively. Unfortunately, neither competitors' positions on
a value map nor customers' perception of products and suppliers are frozen
in time. Value maps are not static but dynamic, constantly changing in
important and often predictable ways.
Any change in product positioning by one competitor, be it cutting price or
improving features, will lead others to move, either to preempt shifts in
market share or to react to them. We apply the term "dynamic value
management" to the discipline of managing price/benefit positioning not
just in a static fashion, but with explicit and thoughtful consideration of
likely changes in competitive value positions and customer value
perception. Companies that master this discipline can reap huge rewards
and avoid equally huge pitfalls.
Exhibit 7
Changing your position in a dynamic world
Marketing managers have two basic options for improving their products'
position, regardless of whether they are in a proactive or reactive situation.
They can reposition their product along the VEL, or move off it. These
different moves engender very different outcomes—different competitor
and customer reactions and different prices, volumes, profits, and risks.
Repositioning along the VEL
Repositioning a product along the VEL, usually a less aggressive move,
requires a company to understand where customer clusters are on it, and
how other competitors are positioned in relation to them. The decision of
whether and how far to move should include the following steps:
Understanding and weighing the risks and opportunities. Repositioning a
product is likely to lose some customers who preferred the old positioning.
Equally, it will gain customers who prefer the new positioning. Failure to
understand this tradeoff could lead a company to surrender a good
customer franchise in exchange for a reduced, and probably more
competitive, new franchise.
Being smart about choosing the right attributes to vary. Customers do not
consider all product attributes to be equally important; there is therefore
more "bang for the buck" in changing some attributes rather than others.
The knack is to select the features that will attract new customers without
losing old ones, that have the greatest impact on customers, and that the
company can provide cost-effectively.
Knowing what price change is appropriate for a given attribute change. If
the aim is to stay on the VEL, any change in benefits must be accompanied
by a price change. Not increasing the price enough will force competitors to
match the new positioning, leading to an unwanted industry price decline
(as with MTE); raising the price too high will lead to a volume loss. Market
research tools such as conjoint analysis can determine the magnitude of
change required.
Choosing those changes least likely to provoke undesirable competitive
reactions. If the repositioning is successful, or looks as if it will be,
competitors will react. The likeliest, and least desirable, reaction is a price
cut, which often leads to price cuts across the industry and lower profits for
all. One manufacturer of medical supplies always reacted to competitors'
price cuts by improving benefits. Every time a competitor dropped its price,
the supplier countered with an improved version of its product at the same
price, but on the new VEL. In this way it gained a distinctive market
position, offering increasingly superior benefits over competitors that chose
to move only along the price dimension.
Choosing the new position along the VEL. There are two options: either to
move to a new position within the extremes defined by current
competitors, or to move to a new position beyond the current extremes.
There are differences in risk and potential competitive moves between the
two:
The success of a new positioning within current competitive extremes
depends on locating the right customer concentration and standing out
from competitors. As this approach seldom expands a market, competitors
will probably react to their declining sales.
Moving to a new position along the VEL outside the existing extremes can
expand a market. While the upside opportunities can be greater (and the
threat of retaliation lower), success depends on a thorough understanding
of the size and needs of the latent demand that the new product or service
is designed to meet.
Moving off the VEL
A move off the VEL into value-advantaged territory might seem attractive
on the surface. As the experiences of many companies show, however, such
a move requires an even better understanding of the dynamics, risks, and
opportunities than do moves along the VEL.
What is different about moves off the VEL? A repositioning along the VEL is
likely to threaten only one or two neighboring competitors currently on the
line. Moving below the VEL often threatens all competitors, because such
moves usually define new and lowered VELs that force them to reconsider
their own positions. Only rarely does the VEL move upward; to do so would
require customers to accept the actual value reduction and most suppliers
to move in the same direction.
Exhibit 9
When a product is repositioned below the VEL, its "horizon" of potential
customers grows (Exhibit 9). Take, for example, an electric drill whose
power was increased
but which was sold for the same price. The new product appeals not only to
customers who initially bought it, but also to those who had previously paid
more for a drill with the higher power rating.
Just moving off the VEL to expand the horizon of customers does not
guarantee success, however. Market research must first establish that the
expanded horizon does indeed include new concentrations of customers,
not just empty space.
Likely competitive reactions to moves off the VEL
In today's highly competitive markets, rivals seldom passively accept
volume or market share losses. They usually react by trying to improve their
products by selectively adjusting attributes, or by dropping price. How they
will react is a function of a number of parameters, including:
The type of change that set the whole process in motion. The typical
reaction to a competitor's move is to try to counter along a similar axis. If
the salesforce reports massive price cuts by a competitor, they will want to
reciprocate. If a competitor introduces a new service, the salesforce will
want to offer something similar. A first mover's repositioning along the
benefits axis tends to damage profits less than price reductions would. It is
also easier to retract benefits that are rejected by the market or are
uneconomic to provide, than to try to raise prices after a round of
reductions.
Competitors' strategic mindset. The degree of volume and profit pressure a
competitor is under and its understanding of the economics of price
changes (for example, how price and volume trade off against profit) will
drive the type of reaction it makes.
Even in commodity-like industries, there are examples of manufacturers
successfully improving their products and services rather than cutting
prices. In a US specialty chemical segment, for example, the two leading
companies have about 40 percent of the market. They and their customers
recognize that there are no real technical differences between the two
suppliers' products. So when one competitor increases its support services,
the other improves its services too. While the industry is competitive, and
the level of service high and rising, prices have also risen and profits have
remained strong. In the past five years, neither leader has reacted to a
competitor by reducing its price—a move that would surely have made the
industry less profitable.Every Consumer has a unique way of measuring
value against cost
Higher Cost items and low cost items depending upon there value driven
WHO
What diiferentiate
