click for presentation: Value Maps Intro
Value Map Overview
In some product categories, value can be expressed as monetized costs and benefits, and calibrated in purely economic terms. The underlying concept is Economic Value to the Customer (EVC). In essence, rational buyers add up the anticipated benefits, relate them to the associated costs, and buy the product if it offers enough benefits for justify the price (absolute EVC), and the most favorable economics relative to other spending options (relative EVC).
When all costs and benefits can be monetized, and buyers are economically rational - a pricing analysis is conceptually straightforward.
More typically, though, firms make pricing decisions in a context where the economic value of a product's benefits is more implicit than explicit, or where economic value may be enhanced or diminished by non-economic factors.
That is, buyers make decisions by weighing a multitude of factors that are important to them. Their decision may be a composite of both economic and non-economic factors that can be either objective or subjective.
In this more general case, the starting point for a pricing decision is to calibrate the implied worth of the delivered benefits and match them against the product's price in a competitive space.
An analytical technique for framing the price-benefits relationship is called Value Mapping.
In essence, a Value Map relates the aggregate perceived benefits delivered by a set of comparable products (on the horizontal axis) against their prices (on the vertical axis).
The more benefits that a product is perceived to deliver, the further to the right it appears on the value map. For example, product C (below) delivers more benefits than product B (B2 > B1); and product B delivers the same level of benefits as product A (B1).
Similarly, the higher a product's price, the higher it appears on the map. For example, product C is higher priced than product A (P2 > P1), and is equally priced with product B (P2).
Even in this simple hypothetical illustration, some logical inferences can be drawn with respect to the value delivered by the products. Product A delivers more value than product B (same benefits at a lower price).
Similarly, product C delivers more value than product B (more benefits at the same price). In other words, Product B is in an unequivocally disadvantaged value position.
But, the relative value of products A and C is less obvious. Product C delivers more benefits, but it has a higher price. So which offers greater value?
A more relevant and appropriate question is whether A or C or both offer value that is considered "fair" by potential customers. For example, product A may be a "stripped down" model that is priced just right for economy-oriented buyers and C may be a "step up" model that is suited for performance-oriented customers.
It seems reasonable to assume that customers have, at least implicitly if not explicitly, a relationship in mind that balances products' benefits with their prices.
For a given set of known product offerings, at specific points in time, customers are likely to internalize, a perspective as what constitutes a fair value.
This relationship can be conceptualized as a fair value line with each point on the line representing a specific combination of benefits and price that is considered a fair value by the market.
The important nuances and dynamics of the value map can be illustrated with a hypothetical new product introduction.
Assume that a company currently has a product in the market that offers a level of benefits B1 and is priced at P1. The product is on the fair value line and has a stable market share position.
Further assume that the company has a redesigned product that offers the same level of benefits (B1) and has lower manufacturing costs. The company has a minimum profit target for the product, so the relevant price range for the new product is from P1 (the old product's price - a "fair" price for B1 of benefits) and P2 (the price that just meets the company's profit objectives).
If the new product is priced at P1, market share should remain the same (since the product is on the fair value line), and profits should increase (since product costs are lower). In essence, the product is being priced at the ceiling, and all value that has been created is being retained as profits.
What if the company were to introduce the product at price P2? Assume that P2 is the "floor" price that enables the company to maintain the old product's profitability rates, and passes along the new product's cost savings to customers.
In essence, the product is being priced at the floor, and all value that has been created is being ceded to customers.
What is likely to happen in the market short and long-run?
At price P2, the new product exceeds the market's value expectations. The additional value is evident from two perspectives.
First, the product offers more benefits (B1 versus B2) than the market expects at price P2.
Second, the product offers the same level of benefits (B1) at a lower price than the market expects (P2 versus P1).
From either perspective, the new product is now unequivocally advantaged with respect to value delivered in the marketplace.
Since it offers more benefits for the price (or a lower price for the same level of benefits), the new product has created a value surplus that, at this price (P2), is ceded to the customer.
Keep in mind that the company could have priced the product at P1 and it would have been considered a fair value in the market.
All products in a comparable position (below the fair value line) are in an advantaged value surplus position.
Similarly, products above the value line are in a disadvantaged value shortfall position. That is, they offer less value than the market collectively expects. Accordingly, they are in very unstable positions and likely to lose share to higher value products.
So, what are the market dynamics when a product is introduced to the market with a value surplus that is ceded to the customer?
Initially, the product can be expected to gain market share versus competitive products (or legacy models) since it does offer an unequivocally better value.
The extent of the share gain depends on the price sensitivity that customers have towards the product (i.e., how important price is in their purchase decisions). Gains are most likely for price-sensitive products such as easy to compare commodities that are used frequently and represent a large portion of the buyer's budget.
Significant gains are least likely when
(a) Products or prices are tough to compare (e.g. long-distance phone plans with different monthly fees, time variable usage rates, surcharges, and small print restrictions)
(b) The full cost isn't borne by the buyer (i.e. charged back to companies or insurers)
(c) The product represents a small part of the buyer's costs or budget
(d) Customers are formally or informally locked in to their current brands (e.g. high comfort factor, low risk tolerance, routinized procedures, financial or operational "tie ins" with complementary products, or incentive buying programs such as quantity discounts or loyalty programs).
But, any share gains may just be short-lived. Competitors positioned on the value line are confronted with a fundamental decision: do they allow the new product to take market share or do they respond with a more competitive product offering (pricing or product changes) that protects their market position.
If a competitor concludes that they are at a competitive cost disadvantage and a lower price would cut profit to an unacceptable level, they might ignore the new product and accept the volume consequences (lower share).
In the very short-run, competitors are most likely to rebalance the value relationship with lower prices or focused advertising that accentuates their products' benefits.
Longer-run, they may redesign their products to offer more (or different) benefits, or to reduce costs, enabling a lower, profitable price.
Either way, the market's value curve becomes recalibrated with customers expecting more benefits for the dollar than they were previously able to get.
Conceptually, the fair value line rotates clockwise, reflecting the market's new expectations and eliminating any value surplus.
Given the above value map dynamics, the pivotal question is where between the ceiling and the floor should the price be set?
In general, the answer depends on the company's strategy for the product. If there is a compelling rationale for gaining share, and if the company is the low cost producer, then a price closer to the floor may be appropriate.
If share gains are not strategically critical, or the company is cost disadvantaged, then pricing may be closer to the ceiling to maximize profit margins.
As a rule of thumb, a product that delivers a perceptible increase in benefits (say, greater than 20% increase in benefits), and is priced to split the value created 1/3 to the customer and 2/3's to the company, may provide the best of all worlds since:
(a) The product is well positioned against reference products
(b) The product's market value is enhanced
(c) Short-term profits (per unit) are increased
(d) The company has "wiggle room" to cut prices (and still stay above the price floor), recognizing the ratchet effect (easier to reduce than increase prices) and the likelihood of competitive responses.
click to view more detail on The Rule of 20 and 2/3s