Economic Value Estimation

The first step to marketing is determining how products and services create value for customers. Value can vary between customers.

Value
Value is the total savings, monetary gains, or satisfaction that a customer receives from using a product or service.

The difference between this value and what people actually pay is called “consumer surplus.”  People often won’t pay for the entire value of the product because they know that the price charged in the market is less.  The price charged in the market is called the economic value.

Reference Value is the price of the customer’s best alternative or substitute for a product or service.

Differentiation Value is the economic value placed on the difference between a product or service and its best substitute.  Remember that perceptions can be the cause of the differentiation value.  This often makes differentiation value hard to estimate since its difficult to measure the subjective value of unquantifiable benefits.

Total Economic Value
is the reference value plus the differentiation value.

Economic Value Estimation ®

Economic Value Estimation ® (EVE) is the process of measuring Total Economic Value. Graphically, the process looks like this:

(This picture was taken from http://mgmtblog.com).

The EVE for a product is not always what the consumer perceives the value to be. Some reasons are:

  • The consumer may not know about the differentiating features of the product and doesn’t want to spend the time to find out.
  • The brand image may convince the consumer that some product is worth more than the EVE.
  • The customer may not be too picky about getting the most for her money.

Therefore, EVE only provides a good estimation of the maximum amount that can be charged for a product, assuming that consumers recognize all of the value that the product provides. If a product is under priced compared to its EVE, a good solution is to maintain or slightly raise prices while engaging in an aggressive consumer education campaign.

EVE is not the same for each consumer. That’s why price segmentation is beneficial, if possible.

The relationship between prices and economic value delivered can differ depending on circumstances. For example, new products usually must be priced below economic value to encourage people to try them. The opposite may be true for existing products with existing customers since consumers may not be motivated to switch. Or, perhaps, consumers don’t even care too much about determining economic value. This attitude of indifference toward price leads to a price premium called a regulation premium.

Its important for a firm’s sales force to use EVE so that they and the are focused on value of each part of an offering rather than on “price.” When there is price resistance, EVE can be used to present the customer with a less expensive alternative with fewer features. EVE can also be used to price segment among groups of consumers who need different bundles of features.

There are no shortcuts for estimating EVE. The steps for estimating EVE are:

  1. Study Customer Economics – Study customers’ objectives and their “next best competitive alternative.” The next best competitive alternative’s price is the reference price.
  2. Quantify Value Drivers – Customer depth interviews are the best source of information. The most important piece of information to try to obtain is the value driver algorithms. What does the consumer’s economic model say about the kinds of things that drive value?Note that its critical to do a good approximation about what drives consumer value rather than trying to do a complex calculation yielding an exact, but meaningless, number.
  3. Estimate Differentiation Value – Estimate the impact of the product on the marketplace by estimating the monetary value that consumers give to it above and beyond the value they give to the reference product. Remember that this can be positive or negative since a particular product is seldom better in all respects.Needless to say, the sum of all of the differentiation attributes must be positive in order for a product to sell at a higher price than a competing product. When trying to determine differentiation value, be sure to use equivalent units when asking the consumers to compare a product with a reference product. For example, two units of a firm’s product may replace three units of the reference product. It is important for consumers to be aware of this when their attitudes are surveyed.Use the estimate of differentiation value and the quality value drivers to build the economic value model.

A common problem in marketing communications is documenting the economic value. For example, an advertiser might look at the total circulation of a publication and purchase advertising based on cost per customer reached. In reality, she should be looking at the cost of reaching the kinds of customers that she really wants to reach, how long they spend reading the publication, etc. To convince the advertiser to purchase advertising space, the publication may have to learn a significant amount about the advertiser’s business so that the price differential between its prices and those of other magazines can be justified.

Commodity products are essentially identical products that are offered by more than one manufacturer. A good example is a cheap portable radio. There is no differentiation between products. Since there is perfect competition in commodity markets, prices will be set very close to the actual economic value of the product.

Consumer Value Modeling (CVM)

CVM relies on customers’ subjective judgments about price and attribute based performance. CVM assumes that consumers look for products that give them the most benefit for the money and time invested in using it. It rates various product strengths or weaknesses according to the weight that the consumer puts on them. Then, CVM tries to create an average linear relationship between price and perceived value for the attributes.

Consumer Value Modeling emerged from the TQM movement. Companies tried to use it to measure and deliver superior quality at a competitive price. The problem is that people may be willing to pay for a particular attribute of a product or may be willing to pay for combinations of attributes. Each consumer is different.

The biggest problem with CVM is that it underestimates the value of significantly different products for people who are willing to pay premiums for combinations of attributes. On the other hand, it also overestimates the value of products that are similar to each other.

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