Continuing on the theme of pricing, one of the core concepts that product marketers and product managers instinctively understand, whether they acknowledge it or not, is the concept of economic value.

We are commonly concerned with creating value by prioritizing our development to focus on features of capabilities that increase the intrinsic value to our target segment(s).

Yet, how to quantify this value, and then identify how to capture it? It is probably best to go back to the basics, and to define some terms.

Reference Price

The first relevant term is the reference price. In a competitive market, this is the price at which a customer can reasonably purchase a product that is comparable. This is also called the next best competitive alternative price (or NBCA price). I like this as it has a direct analog to the concept of Whole Product. You can also call it the “table stakes“.

The beauty of this concept is that it is knowable. You can do competitive research, identify the competition, get prevalent pricing, and a list of attributes (or features) that provide a baseline of comparison.

Differential Value

Once you have established the reference price, or the NBCA, you can begin to identify what you add that customers will see value in. This is your differential value, or what you add on top of the table stakes that will cause a customer to choose to pay more for your offering or service.

Returning to the “Whole Product” concept, this is what makes up the “augmented product”. It can be features, or convenience, or a solid ecosystem of support, brand equity. You get the idea.

For a concrete example, let’s take the example of a peddler on a beach selling cold sodas to the sunbathers. While you could get up and walk to the snack shop and buy a cold soda, there is some value to paying more for the benefit of not having to get up and walk to the snack shop. This willingness to pay more, leads to the differentiated value. In this case, the convenience is worth the extra money. And if you don’t agree, you can get up and walk to the snack stand and pay less. Or walk further to a convenience store and pay still less, or drive to Costco and pay the least amount.

Sidebar: think about the bottled water market, and how you will pay significantly for something that is practically free at the tap, as long as you have a bottle to put it in…

In the above example we see two concepts, the differentiated value, and customer segmentation (by price). As marketers, we are familiar with segmenting our markets, and clearly, there are at least two segments at play here, one where the price sensitivity isn’t important, just getting a cold beverage, and one where price is the sole consideration, and will drive miles to get the lowest price possible.

In fact, effective pricing requires that we understand our customers, and have segmented our markets, as value is inextricably intertwined with the customer behaviors.

Note however, that differential value can both add and subtract value to what a customer perceives, especially in a market with multiple competitors, so you need to be honest in tallying your value propositions. I can attest that this is difficult to do, as a marketer, we like to think solely of the positives.

Once you have made these honest evaluations of the reference price and differentiated value(s), the determination is relatively simple.

The Economic Value

Diagram of the ValueBringing these concepts together, in one simple equation:

EV = RP + DV

Where:

EV = Economic value (ie the price you set)
RP = Reference Price (or the NCBA)
DV = Differentiated Value

Sounds simple, and conceptually it is, but its simplicity is deceiving, as the effort to get the true reference price is usually not as easy as calling your competitors up and asking for it (or downloading a pricelist from the internet), but I will save some tactics for a later post.

Summary

As one of the most important decisions you will have to make, with or without help, is to set the price for your product. Yet all too often, it is done without a strategic plan, or is influenced by groups with a vested interest in setting the price to align to their priorities (think of sales and how they want a lower price, or finance and higher margins).

Yet, by knowing your customer segments, your value propositions (and the true differentiated value), you can work to set an appropriate price, that meets the market needs, and delivers profitability to your offering.


Want to learn more? A great book is The Strategy and Tactics of Pricing by Nagle et. al. A dense read, but clearly articulates the process, and rationale behind pricing.

Like what you see? Subscribe Today

One comment

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s