Value-Based Strategy Resources: A Collection

Our partners at LeveragePoint have made available a number of articles that we have written with our colleagues over the years. These cover many aspects of value-based product development, pricing, marketing and sales. We will add new articles and white papers as they are written, and will expand this to cover emerging best-practices.

Value-Based Strategy Resources

• A Question of Value by Gerald Smith & Thomas Nagle
• Customer Value-Based Pricing Strategies by Andreas Hinterhuber
• Driving Growth with New Products: Common Pricing Traps to Avoid by John Hogan and Tom Lucke
• How to Manage an Aggressive Competitor by George Cressman, Jr. & Thomas Nagle
• How to Pull It Off – Raising Prices When Others Have Given Their Customer the Power to Set Prices by Thomas Nagle
• Managing Price Competition by Thomas Nagle
• Money-Back Guarantee…and Other Ways You Never Thought to Sell Your Drugs by Thomas Nagle.
• Pricing the Differential by Gerald Smith & Thomas Nagle
• Reaping What You Sow by George Cressman Jr.
• Stop Reacting to Buyers’ Price Expectations; Manage Them by Thomas Nagle, Joseph Zale and John Hogan
• Towards Value-Based Pricing – An Integrative Framework for Decision Making by Andreas Hinterhuber
• What is Strategic Pricing? by John Hogan and Thomas Nagle
• When You’ve Lost the Power to Set Prices by Cameron McClearn

Book Signing at PPS Spring Conference

There was an excellent turnout for Tom Nagle’s book signing at the recent Professional Pricing Society Spring Conference in Chicago. About a hundred conference attendees stood in line to purchase the book and chat briefly with Dr. Nagle after he delivered the conference’s opening keynote presentation, “Advantage Based Marketing for Profit, Not Just Sales”.

If You Know Your Value, What Determines the Price?

Value-based pricing does not assume that one can price fully to value.  How much differentiation value one can actually capture, even once it is quantified and communicated to buyers, depends on other factors.  Before one can set a viable market price, one must firm understand and manage those factors.

For example, how certain is the buyer that the savings will actually be realized?  This is always a big one for new pharmaceuticals, since drugs perform better in controlled trials than when real world patients take them less consistently and real world doctors prescribe them for less than ideal candidates.  When the pharma company is willing to price a new product much below its potential value at the time of launch but the payer is unwilling to take the risk, pharma companies are increasing offering guarantees.  In return for paying a higher price that more closely reflects the value, the payer gets a refund—or even more in the case of a recent osteoporosis drug—if the treatment fails.

There are also purely psychological factors that determine the amount of differentiation value that can be captured.  One of those is the importance of the end-benefit associated with the purchase.  You might happily pull out your coupon to offset part of the cost of a regular dinner with your husband or wife.  But would you use a coupon for a discount if the differ were to celebrate your first wedding anniversary?  Would you send a gift to a client, say an excellent bottle of wine, from a discount wine merchant or from one with a name that everyone knows charges full price?  For some reason, paying fully for the differentiation value seems right when then end-benefit (use value) of something is very high. 

Exhibit 6-4 on pages 132-33 of the Strategy and Tactics of Pricing, 5^th edition describes eight such factors that influence the amount of differentiation value that is can be captured in the price. 

• Size of expenditure: Buyers are more (or less) price sensitive when expenditures  are relatively large (or small).
• Shared costs: Buyers are less price sensitive when some or all the purchase price is paid by others.
• Switching costs: Buyers are less sensitive to the price of a product the greater the added cost (both monetary and non-monetary) of switching from their current supplier (if any)?
• Perceived risk: Buyers are less price sensitive when it is difficult to compare suppliers and the cost of not getting the expected benefits of a purchase are high.
• Importance of end-benefit: Buyers are less price sensitive when the product is a small part of the cost of a benefit with high economic or psychological importance.
• Price-quality perceptions: Buyers are less sensitive to a product’s price to the extent that price is a proxy for the likely quality of the purchase.
• Perceived fairness: Buyers are more sensitive to a product’s price when it is outside the range that they perceive as “fair or reasonable”.
• Price framing: Buyers are more sensitive when they perceive the price as a “loss” rather than as a forgone “gain”. They are more price sensitive when the price is paid separately than when it is part of a bundle.

Those factors that suppress a buyer’s wiliness to pay must either be reflected in the share of differentiation value that you attempt to charge for, or must be managed through communication that changes buyers’ perception of them.

LeveragePoint uses these pricing sensitivity factors in its new Price Setting Tool.  The value model (based on Economic Value Estimation™) that establishes the reference price of the next best competitive alternative and the differentiated value is imported into a pricing tool that walks the price setter through the pricing sensitivity analysis and factors in cost considerations.

“Pricing the Differential” & “A Question of Value” available on-line

LeveragePoint has recently made available two key articles by Gerald E. Smith and Tom Nagle on the Resources page of their website.

“Pricing the Differential” first published in Marketing Management, May/June 2005, published by the American Marketing Association.

Summary: Customer value mapping (CVM) and economic value modeling (EVM – often referred to as Economic Value Estimation or EVE) are held up as alternative means to setting price. But their use leads to very different pricing outcomes. In this first of a two-part series, the authors show that CVM results in a series of consistent pricing biases that lead firms to get paid less for the differential value they create, especially with the market introduction of new, highly differentiated products, features, or services.

 “A Question of Value” Marketing Management, July/August 2005, published by the American Marketing Association

Summary: In this second of a two-part series, the authors show how economic value modeling (EVM – often referred to as Economic Value Estimation or EVE) is superior to customer value mapping (CVM) for setting price. EVM properly distinguishes between the value of highly differentiated product benefits vs. generally commoditized benefits. It calculates the savings and gains that comprise the product’s actual economic value. The result is more robust and more accurate pricing that recognizes the true differentiation value of the product.

 These articles are referenced in Chapter 2 – Value Creation of The Strategy and Tactics of Pricing Fifth Edition. We hope that over time other classic pricing articles can be made available.

Stop Reacting to Buyer’s Price Expectations; Manage Them

Expectations drive behavior and nowhere more so than when setting prices. A customer’s decision to buy something at the offered price, or not, depends upon more than the tradeoff between benefits and price. It also depends on customers’ expectations, and their experience answering this question: how might our behavior influence the prices we have to pay? For example, a retail consumer may believe that a new fall fashion is well worth the price asked for it in September, but still not buy it if she expects that the store following its past behavior will have a 20 percent off sale within the next month. A policy of regular, predictable discounting has trained many retail consumers to wait for the sale price. As a result, sales at regular prices are less than they would otherwise be, increasing the amount of inventory that ultimately will be sold at the lower sale price. The same dynamic plays out –only more so—when businesses sell products and services to other businesses. Professional buyers have learned to hold their purchases until the last couple weeks of each quarter when sales managers are often willing to discount more deeply to achieve their quarterly goals. Sellers in these situations see the increasing portion of their sales made when prices are discounted as a sign that customers are becoming more price sensitive in their brand choice. In fact, they are only responding to incentives for how to get a better deal on what they were otherwise willing to buy at a higher price. Read more on Monitor Perspectives …

Tom Nagle “Why Apple Should Win the E-book Price War” on HBR

Dr.  Tom Nagle recently put up a post on the Harvard Business Review’s blog.

“A clash of the titans will erupt on Saturday when Apple releases its iPad: it will be Amazon, with most e-books costing $9.99, versus Apple, whose prices on some titles, rumor has it, will exceed Amazon’s standard e-book pricing. Let’s hope Apple wins the fight.

Why would I champion higher prices — particularly when it essentially costs nothing to ship an e-book?”

Read more at Harvard Business Review. “Why Apple Should Win the eBook Price War“

Linking Value to Price Realization

It is one thing to understand the value that one’s products and services deliver to a customer, but quite another to realize that value in the price.  The gap between the value and willingness to pay has long led marketing researchers (as well as scientists outside the field of marketing) to argue that the value of something is simply what someone will pay for it.  Consequently, they prescribe making “optimal” pricing decisions based upon measurement of the price-feature tradeoffs that people are willing to make, as revealed by conjoint (tradeoff) surveys.  This approach has been touted as “scientific”, while attempts to understand and manage the psychology behind those choices has been seen as highly suspect.

Despite my training in economics, I have long suspected that managing the psychology of the transaction was as central to profitable pricing as was managing the price level.  Even the first edition of The Strategy and Tactics of Pricing (1987), written while I was still a professor of economics and marketing, listed nine psychological factors that can affect the relationship between value and willingness-to-pay.  An example: If the emotion you feel about the end-benefit that you seek from a purchase is positive, the more you are inclined to spend even when there are cheaper alternatives.  Thus the success of the slogan “Michelin: Because so much is riding on your tires” campaign in raising the willingness to pay for its brand of tires.

I recently read a book that vindicated the belief that pricing strategy needs to involve both the analytical and the emotional.  That book, How We Decide by Jonah Lehrer is beautifully written, non-technical, and engaging book.  In it, he describes the emerging consensus among neuroscientists that analytical and emotional aspects of a decision are not, as economists and scientists have long believed, integrated to make a decision.  People make decisions either by relying on their emotions, or by relying on their analytical capabilities, or by breaking the decision into sequential parts.  This has profound implications for value-based marketing and pricing. 

At Monitor, where I work, we do a lot of work with pharma and life science companies.  One of our clients developed a product that, while it had little impact on clinical outcomes (leaving the hospital alive and healthy), had a huge impact on the pain and suffering that the patient would endure to get to that outcome.  Compounding the benefit, the patient was often a child who, along with his or her parents, was particularly traumatized by the existing procedure.  Now the problem, US hospitals are paid in most cases a fixed amount to treat a patient for each condition, regardless of how much or little they spend to do so. 

The economic case for the new procedure involves some positive, quantifiable benefits: quicker processing of the patient through the hospital; more goodwill with patients and relatives likely to return to a hospital where people seem more “caring”, better morale among nurses who seriously disliked having to hurt people.  So did the emotional case:  it’s not right to hurt people (especially children) when you don’t have to.  But some hospitals bought the new procedure and others did not.  Traditional research on willingness to pay for features and benefits (tradeoff analysis) could not predict the differences in choice. 

What did predict the difference was how the buying process was structured.  If the pharmacist brought the decision to the P&T committee (a group that decides whether to fund a new therapy in a hospital), the decision was framed in terms of whether the potential financial benefits from adopting the new therapy were large enough to justify paying the price.  In that case, there was much counter-arguing on the committee about how much reducing the discomfort of the procedure really would improve consumer preference for that hospital and how much improved job satisfaction by nurses would really reduce the cost of nurse turnover.  The tenor of the discussion was one of distrust of the numbers and anger that the price revealed a lack of appreciation on the seller’s part of the tenuous financial conditions under which most hospitals operate.  Expenditure on the new procedure was often rejected when the decision was defined as an analytical choice, and people subsequently connected their feelings to that choice. 

However, in hospitals where nurses and doctors had tried the new therapy during a trial period, the P&T committee review began with impassioned arguments about why adopting the new procedure was the right thing to do for patients and the clinical staff.  Nurses would cry when describing how they felt about hurting children who did not understand that the nurses were trying to help them.  After that, the committee set out to create a viable economic case for doing what everyone emotionally wanted to do.  Rather than arguing why the economic benefits might not materialize, they argued about what they could do to make them materialize.  Rather than seeing the company’s economic value story as full or tenuous sources of revenue, they saw it as full of useful ideas for how they might be able to afford the therapy.

This case was a particularly dramatic demonstration of the importance of understanding the decision process and what you can do to influence it.  Even given the same perceptions of the analytical numbers and the uncertainties surrounding them, the decision changed when the process changed.  That is why at Monitor we never create a marketing or pricing strategy without first attempting to understand the decision process and how best to influence it. 

In B-to-B markets, a key to influencing the buying process is often to identify the drivers of value to the customer, since that forces a change in the process on the part of purchasing.  Instead of the decision being framed in terms of how important the buyer is to the seller and what concessions that justifies, economic value reframes the discussion in terms of the value that the seller will lose if he/she does not buy your product.  That enables you to identify who in the buying organization may benefit personally (and thus be motivated emotionally) from purchase of your product or service.  You can then think about how to influence the buying process in a way that engages them early in framing the decision and in advocating for and committing to the realization of the value.

(c) Tom Nagle, Ph.D. 2010 All Rights reserved

Partner, Monitor Group