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Value and ROI

January 2003 Pricing

Customers demand value. Customers want to be sure that when they buy a product or service they can use it and, in its use, derive more value from the product or service than the cost of selecting it and purchasing it. At the core of this decision criteria is the value proposition. Managing the value proposition is the responsibility of Sales and Marketing engines.

Stephanie Stahl, the editor of Information Week, and have many other industry analysts, has noted the increased demand to demonstrate ROI, Return-On-Investment, in technology investments. The recent pressure on IT departments to quantify the ROI of their initiatives reflects the market demand for value. In the late 90’s, customers focused on the ability of a product or service to meet the strategic goals of a firm, capture new opportunities, avoid a Y2K issue, or maintain parity with competition. As the industry evolves in the 00’s, IT has begun to reflect more of a cost of doing business. It became an input into the business organization and the business’s relationship with markets and suppliers.

In an effort to demonstrate high ROI and maintain transaction volume, some software businesses have elected to highlight their lower prices. Lowering the price of the product or service always increases the value captured by the customer in making a purchase. Lower prices show up directly in the ROI calculations and lower the value required before the hurdle of ROI is met.

Competing on price is a devil’s bargain. It appears as a simple move of which the anticipated immediate outcome is larger market share and higher transaction volumes. These benefits, however, come at the expense of margins. The long run outcome of price competition is an impoverished industry with a diminishing value proposition.

The results of price competition are prices set at marginal costs. Unfortunately, the marginal cost of software products is nearly zero. At this price, there is insufficient revenue to sustain future product development and further sales and marketing efforts.

The alternative to price competition is value competition. Competing on value is trickier than competing on price, but the industry outcome is better for both suppliers and customers. Value competition relies upon understanding how the customer will derive value from consuming a product or service. To get this right, the sales and marketing team needs to understand the customer’s frame of reference.

The prospect’s frame of reference in a value competition is their most likely outcome if the prospect opts out of consuming a specific product or service. Often, the frame of reference is for the customer to do nothing and accept the status quo. In other situations, the frame of reference is direct product or service comparison. Adding to the difficulty of knowing the customer’s frame of reference is that different prospects will have different frames of reference.

The complexity of understanding the customer’s frame of reference can be greatly reduced by segmenting the market and targeting specific customer groups. Specific customer groups will derive a similar value from a product or service differently than other customer groups. Defining the value proposition with respect to a specific customer group’s frame of reference will enable ROI calculations to be routinely communicated.

Key to getting the full frame of reference correct, and consequently the resultant value proposition or ROI, is highlighting the hidden costs of not selecting a specific product or service. When competing against the status quo, sample hidden costs include the costs of customer turnover, machine downtime, excess inventory, or resource bottlenecks. If the prime competition is another vendor, the hidden costs might be those of system integration, incongruous upgrade paths, survival risk in the next round of competition, or missing features. Both of these lists can be extended.

It is also possible to shift the frame of reference for customers. Shifting the frame of reference is a subtle process of highlighting a value offering’s relative strengths and mitigating the value of its competitor’s strengths. This is a direct process of increasing the market’s requirement for your value offering’s features and demonstrating that a sufficient portion of the features of the competing frame-of-reference are subsumed within all industry player’s offerings.

For instance, the debate over best-of-breed applications versus integrated suite applications is a debate over the strengths of a full-featured, focused solution over the strengths of integrated-product and monolithic-platform. Both best-of-breed and integrated applications have their value. Each can use the alternative solution type as its frame of reference in formulating the value proposition.

In selling a best-of-breed application, the sales message concentrates on the depth of features and their resultant benefits, the industry knowledge and commitment of the firm, expected upgrade path, and ease of integration with other applications. Alternatively, in selling a module of an integrated application that meets a solution requirement, the sales message concentrates on meeting the required level of features, the cost savings of maintaining only a single platform, the strength of the firm across industries, and the immediacy of system integration throughout the integrated application. Both of these sales messages are valid and value of each selling proposition is positive.

As professionals engaged in the creation of revenue, our responsibility is to construct or influence the ROI metric used by customers so as to encourage the purchase. As such, we can either lower the price or communicate the true value proposition for specific target markets. Let’s select the latter and avoid the price war.



About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

Tim J. Smith, PhD
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