Everyone agrees that value is critical to business and that we should sell based on the value we provide and buy based on the value the purchase will create. But value can be a hard thing to communicate. And what do we mean when they say “value”?
Value tools such as LeveragePoint for Value Management are most relevant to businesses that are selling to other businesses, the B2B sector as we like to say. And for the B2B sector value means the economic value that a solution provides. There are other way to think about value of course, psychological and brand factors are often more important in consumer markets, but what businesses care about is the economic impact of the solutions they purchase.
Even when we narrow our discussion to economic value different approaches have been proposed. One popular take on this is Customer Value Mapping (CVM), the output of which is often referred to as value maps. This approach, which grew out of the Six Sigma and Total Quality Management (TQM) way of thinking, maps some measure of quality or performance (often a bundle of measures) to price. It leads to a chart like that of Figure 1: A Simple Value Map. What this implies is that there is a straightforward trade off between price and value, the more you pay the more value you get (the function does not need to be a straight line). This approach is popular with many consulting firms and is used by some large companies to make pricing decisions and strategic positioning moves. That is too bad as this approach is fundamentally wrong.
Why? LeveragePoint advisor and value model expert Tom Nagle gives a good explanation of this in his article with Gerald E. Smith of the Caroll School of Management at Boston College on “Pricing the Differential” in the May/June 2005 edition ofMarketing Management. The short version: Value Maps do not differentiate between different types of value and they do not take into account specific business models of actual customers. One cannot capture a high share of the value to the customer of benefits that are sold competitively in the market (benefits that the customer can get from several different sources), but you can capture a high share of the value of the benefits that make your offer unique.
Value mapping does not distinguish between competitively produced benefits and differentiated benefits. For example, imagine a new medical procedure that reduces the time a patient spends in the hospital by an average of ten days. How much more is it worth than the conventional procedure requiring longer hospital stays? That depends on the cost of hospitalization and who is bearing that cost, which will likely differ from patient to patient and hospital to hospital, and the health care plan concerned. The market will have already established a price for the standard procedure. The value of the new approach will depend on the differentiated benefits it provides. And most new procedures also have some new risks or costs as well as benefits; these will need to be deducted to get the actual differentiated value. Generalized approaches mapping performance or quality to price miss the point and lead both sellers and buyers to bad decisions. In general, value mapping tends to overstate the value of competitive value and to understate the contribution of differentiated value. Sellers tend to under price while buyers often pay for performance they can’t use to get other value on other dimensions that they need. The value mapping approach should be scrapped.
So how should companies think about value? As sketched in Figure 2: The Value Cascade, there is a cascade of value from Value in Use, to Value in Exchange (the Economic Value), to Perceived Value (Market Value), to Willingness to Pay (of a specific buyer). The price for any specific buyer will depend on the willingness to pay, which depends in turn on the cascade down from Value in Use. Smith and Nagle give a good explanation of this in a second article “A Question of Value” in the July/August 2005 issue of Marketing Management. A key point to note is the distinction between Commodity Value and Differentiated Value.
The commodity value is the value common to all solutions in a certain category – all cars will get you from A to B. The market sets the price for this component of the economic value, and in LeveragePoint for Value Management it is captured in the price of the Next Best Competitive Alternative. What matters is the positive differentiated value that you provide, which could be a car that accelerates from 0 to 60 in six seconds, less the negative differentiated value, your car can only get twelve miles to the gallon (or 5 kilometers to the liter – converted using Wolfram Alpha). When establishing the economic value of your offer, you start with the commodity value, as set by the market, you do not control this, add your positive differentiated value (which will vary from customer to customer) and then subtract your negative differentiated value. Sad but almost always true, any solution that provides extra value on some dimension almost always trades this off for a cost of some kind.
So, if you want to get serious about value and use it to set prices, you need to understand the differentiated economic value that you provide to specific customers. Value mapping won’t do that for you. You need to dig deeper, understand your customer’s business model and then use a tool like LeveragePoint for Value Management to model and then communicate this.
by Steven Forth