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High quality vs Low-Cost Bargain: The Current Dichotomy (XV). EVC finally illustrated.

Today is my last chance to finally explain through an example how to measure the economic value to the customer (EVC). How do customers value products and services?

As I mentioned to you last Friday, the real essence of measuring value or EVC is based on perception (economic and psychological). And it revolves around the trade-off between the quality or the list of benefits (attributes) that a customer receives from a product and the price that she or he pays for it. I also wish you to understand the theory of Value-Based Customer pricing, because whatever it takes, without this comprehension, the world will continue pushing for Cost-Based Pricing, creating reactions of cannibalization between competitors by reducing costs, destroying the total industry profitability. If we don´t change cost-based pricing towards value-based pricing, the global trade problem between Asia and the rest of the world will continue, and it will cause social inequality because the Middle-Class business owners and entrepreneurs will not be able to compete with Asian producers. As a result this social group will be injured.

Precisely, EVC equals: Client perceived benefits based on certain attributes of quality, which are not only economic but also psychological (minus) the customer perceived price. So we are speaking of a difference between a level of perception of benefits and the perceived price.

Value maps. The latter definition forces us to leave the graph of quality vs price that we have discussed on our last two posts (seen above), and go to a new graph in which the general abstraction of quality evolves to Value benefits (the horizontal X axis quantifies benefits as perceived by the customer). We also emigrate also from variable price to a perceived price (The vertical Y axis shows perceived price). And here we have a new graph, which is called a value map. In this graph, we have risen a step up: we are not talking about the client mood-meter anymore, but the principles of value pricing management for a company.

Value Based conceptual Framework. From Marketing Management 11th Edition, Kotler/Keller

Without explaining anything else at this specific moment, the last figure provides to us the following inferences:

  1. Customers do not buy solely at a low price. A big portion of people may buy because of the price, but not even all of them do it. Otherwise, why do you observe citizens earning less than 200 dollars per month, paying a Smartphone of 800 dollars or more?
  2. Clients buy because they see a value-added by getting a product or service, in which they win something (opportunistic or not)
  3. The higher the perceived benefit (attributes) and/or the lower the perceived price of a product, the higher the EVC or customer value.  And the greater the likelihood that customers will choose that product.

What is a value map? A value map explores the way perceived customer value (EVC) and the price/benefit trade-off work in the real-life markets for a given segment.

Static Value Management. In a static world, in which no competitor changes or tries to get the clients from other competitors, the market share is stable (assuming that for each competitor there is a constant market share for their respective segments of clients). In this ideal context, then there is a correct or right measurement of perceived benefits and perceived prices. And for this static value management ideal setting, competitors align in a straight diagonal line called the Value equivalence line or VEL.

This last figure only tells us that at any desired price or value benefit level, there is a clear and logical choice for customers on the diagonal VEL.  So these competitors aligned on the VEL are under the “you get what you pay for” rationale. However, real life is not static value management. A value map holds clusters of positions near or around the VEL, but not exactly on the diagonal. In reality, consumers by nature are not equally aware of the true nature and availability of competing products, particularly now that the huge internet marketplaces don´t leave you the prudent time to choose. In addition, companies use different channels to reach consumers, and with social media, we have such a wide range of information disparity that is constantly changing because of massive global competition. In consequence, there is a gap existing between customers’ perceptions of the product’s benefits (EVC Value) and the benefits that each product actually delivers. For example, let’s see the Internet providers example. Now that we all have experienced working from home (WFH), or studying from home (SFH); it is much more imperative than ever to be subscribed to an outstanding Internet provider that can supply a satisfactory WiFi Internet velocity and sufficient data to satisfy the basic needs required. A stable existing 24/7 connection is not enough anymore. In this competitive Internet services industry, the value map is not static but dynamic, constantly changing. Any change in the Internet service from one competitor, either by cutting prices or improving internet features, will lead the others to move in pricing or to react. And the value map changes. Continuously over time.

As a result, when market shares are changing in between companies of the same industry, then you have dynamic value management.

Dynamic Value Management. In a world in which market shares are constantly changing, then market share gainers are those positioned below and to the right of the diagonal VEL in what is called the “ Value advantaged” position. Market share gainers are located in the unharvested value zone. Meanwhile, any other competitor that is located in the “value-disadvantaged position” above and to the left of VEL, is called market shares losers, or in the area of missing opportunities.
There are several advanced market research techniques (conjoint analysis, discrete choice analyses and multi-staged conjoint analyses, and more) that allow accurate quantification of the perceived benefit dimension and its tradeoff against its perceived price. Since competitors are always evolving and changing attributes or prices,  the effective application of value maps is also our most treasured conceptual framework available when it comes to using the value-based approach in pricing.

An example of the concept of EVC in a dynamic value management world. Let’s suppose that there is a market leader in artisan jams (hand-made marmalade’s company living in a famous little village in France). This French company started to export its beautiful glass packaged marmalade to different AirBnB housing and pretty rural lodging/hotels in Central America before the pandemic. With the pandemic, and the acceptance of WFH by multinational corporations, several executives living in high transmission COVID19 dangerous zones like New York, Madrid, California or Miami, decided to move temporarily from those cities and relocate to Antigua Guatemala, Lake Atitlán, Coatepeque Lake, Placencia Beach/the Belize Barrier Reef area, Península de la Osa, Suchitoto Village, Guanacaste and Manuel Antonio National Park, Bocas del Toro, and Ojo de Agua Lagoon.

Central America doesn’t have local high-quality marmalades, and these WFH executives are demanding this imported unique french marmalade. Given the growing demand, the french producer decides that is time to invest in a mini processing jam plant. He has analyzed a supplier, the Italian Bertuzzi Compact Multi-functional Bench model Pomona 50, and the French jam producer believes this is the machine that fits better for his needs and wants. This Bertuzzi model represents a very efficient integrated machine in three sections for the preparation of jams, compote, sauces, etc. The machine will treat up to 50 liters of fruit pulp/puree for mixing/cooking/evaporation under vacuum at approx. 65°C; dosing in glass jars, PET bottle, or other suitable containers; and finally, it can pasteurize the closed glass jars and containers.

To illustrate my example, let´s suppose that this machine is the market leader in its industry size, and it is sold at a price of US$ 30,000. In purchasing this product, the french jam producer will also have to cover start-up costs of US$20,000 (installation, initial training of the personnel, improving the jam atelier infrastructure, etc.). Additionally, post-purchase costs over the life of the machine represent a present value of US$50,000 (labor, maintenance, power, and other operating costs during 10 years-the life cycle). So, the total life cycle cost of the machine is US$ 100,000 ($30,000 purchase price + $20,000 start-up cost + $50,000 post-purchase investments) . In other words, the purchase price or EVC is basically under 1/3 of the total cost of employing the equipment during the whole life cycle. See Market leader A in the graph below:

Nevertheless, the French jam manufacturer wants to compare other options. And a Chinese competitor offers a new proposal. Competitor B knows very well the concept of EVC, and instead of a price cut to barren Bertuzzi, decides a new strategy here. The Chinese Competitor B has new technology, that focuses on building a more effective machine that includes two new sections: one that pulps the fruit and a second that refines the fruit. Additionally, this option cuts the start-up costs in half and reduces the NPV post-purchase investments to $30,000. The company B EVC to the french client is $60,000. The French jam manufacturer should be willing to pay up to $ 60,000 for this machine. At this price, machine A Bertuzzi and machine B would have the same total life-cycle investment (Both cost $100,000). For option B, if the Chinese decide to sell below the EVC $60,000 price, it would be rational for the french buyer to switch to machine B. If the french marmalade artisan has the certainty that all the attributes from his Bertuzzi’s initial loved machine A will be covered by the Chinese equipment B (and on plus machine B has added two new sections-Pulping and refining). Let’s say that the Chinese supplier decides to set it at $45,000. At this level, the Chinese offer is in terms of economics much better than Bertuzzi, and the client would have a saving of $15,000 in total. Would the french decide to go for the Chinese option B?

Illustrative figure of the marmalades.

Let´s continue. The french jam producer wishes to explore a new third option. He receives a quote from a British equipment company that has been the equipment supplier to Wilkin & Sons Ltd in the UK.  The British option C differentiates from the last two machine manufacturers, because its´ new machine has more attributes in terms of automation, a distillery section, and quality control at every section of the machine, providing a certified superior quality for the final marmalade. In addition, the British machinery supplier has been serving the Tiptree jam-making competitor in Essex since 1899. The high quality of machine C would help the french jam producer to use this machine for other products such as curds and spreads for patisseries and bakeries, liquors, and also syrups. This possibility to diversify new product lines is extremely interesting for the French jam manufacturer. The benefits of machine C are not only the reputation of the Brit machine manufacturer, but it provides more finished products with superior quality. When studying this alternative the french jam producer learns that even though the EVC is $70,000, this machine offers a cost-saving of $10,000 over the market leader Bertuzzi in the post-purchase investment, and it offers $30,000 of extra contribution margin that comes from the enhanced new products output. In addition, with machine C, the French firm would be able to launch four new products for different segments: a higher-priced brand to the quality-oriented jam customers in Central America; a lower-priced brand to the cheap cost-oriented segment of the market in France; a new product line of liquor; and a new line of curds and spreads for cake producers and bakeries.

I hope with this example you can understand that the EVC is the way to go when it comes to offering value to clients. When we compare different competitors,  through the eyes of EVC, then we can comprehend why the maximum EVC, that the french should be willing to pay is $70,000, more than double the EVC of Bertuzzi.

This is it for today. In my next publication, we will continue with topic number 8. Product Mix Pricing, to set the final prices, in our developing pricing strategy.

Disclaimer: Illustrations in Watercolor are painted by Eleonora Escalante. Other types of illustrations or videos (which are not mine) are used for educational purposes ONLY.  Nevertheless, the majority of the pictures, images, or videos shown on this blog are not mine.  I do not own any of the lovely photos or images posted unless otherwise stated.

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