Managing Value: Getting Smarter
Value Selling and profitability
In the article titled Managing Value: Where the Problem Lies (link to http://www.wiglafjournal.com/pricing/2015/02/managing-value-where-the-problem-lies/), I analyzed the key issues with Value Selling and also explored how automated web-based Economic Value Models can act as a good starting point to solve the issues. Here I will further explain how proper value management can lead to a firm getting smarter in various aspects of product management in general.
When every opportunity is studied using Economic Value Models and priced totally based on the value delivered (and agreed upon with customer), we are heading towards a situation of easier wins leading to eventual revenue growth and market share increase. However let’s understand that even such an ideal world situation doesn’t guarantee profitability. Remember – while deriving value we are only considering the benefits that we are offering the customer. We are not considering our cost of manufacturing. This works both ways:
- A. The value might be much higher than the cost – leading to an extremely profitable business.
- B. The value might be much lesser than the cost – making business survival itself an expensive affair!
Value based selling is a powerful method to maximize profitability but even at maxima the profit may be negative.
In a Fix
Consider the following situation – The cost of manufacturing of an item is $10. It is positioned against a competing item that sells at $5. There is additional value of $3. Thus the total value of the item is $8. A customer will thus only agree to buy the item when the price is <$8. Can we convince the customer in such a case to pay $11 at least so that we can make profits? If you are the customer will you ever agree to such a request? The answer to both the questions is an emphatic “No”.
Thus when such a situation creeps in we have to go back to the drawing board to explore all options at hand.
Cost of-course is the first number that we need to question. Often there is significant room for movement in cost. However there are tougher times when cost is already optimal and yet it is higher than the value.
When movement on cost is not possible we need to start questioning the product definition. The competing product is priced at $5. This indicates that its cost of manufacturing is <$5, maybe $4.
Why does it cost us $6 more to make our product when the value-add is just $3?
This could be due to multiple reasons:
- We have loaded the product with features that the customer doesn’t care about: Every feature is not a benefit. To be a benefit a feature has to be useful. What are the features that the customer considers to be a benefit and agrees to pay for?
- Segmentation not done correctly: Are we offering everything to everybody irrespective of what they actually need? Is it possible to segment the product portfolio better? By switching off redundant features can we make the product profitable? Instead of 1 product, do we offer multiple product options?
Mining Out the Solution
In Managing Value: Where the Problem Lies I had mentioned that creating Economic Value Models for every opportunity is a great way to build up a value data-mine. This mine needs to be excavated well to answer the above questions. Lets imagine that for the above example product we have stored the value data for every opportunity and thus are in the position to tabulate in the following way:
What do we see?
- We had assumed that our competitor is A or B – both of them don’t have Additional feature 1& 2, and both sell at an average price of $7.
- We had assumed that all customers would pay $3 for each additional feature and thus the total value would be $7+$4+$4 = $15
- In reality A&B both sell in the range of $5-$5.20. There is in fact a more powerful competitor C that sells for $6-$6.10. “C” has additional feature 2 and thus is feature is no more additional against C. Moreover the value-add for additional feature 2 would be based on the pricing of competitor C.
- Not all customers need all the additional features.
So how can we segment based on the above intelligence?
However we don’t know yet whether launching all the 4 variants would works for us. What we know is the optimal segmentation and the real-value of each product in the portfolio.
The base product costs $10 to make and the new expected value is $10 (the price will be lesser) and thus it would be wise to discontinue/prune it right away!
Whether NV1, NV2 or NV3 would work depends on the cost of each. We have to further consider that the price would be at least 10% lower than the expected value. If by shutting of features we can lower cost significantly to actually project profits then that should be the road ahead.
However there are times when shutting off features don’t actually reduce the cost significantly (example – technology products). In such cases the task gets even more complicated leaving us with only 2 options –
- Should we consider adding a third additional feature that would not cost much but would be a good value adder?
- Should we actually consider discontinuing the business? If a business is not profitable walk-away is definitely an option and it’s definitely not embarrassing. Perhaps the most romantic example of walking away from a business happens to be Intel’s decision to walk away from memory business when the DRAM price war of 1980s had made the business a liability. In the words of Andy Grove: I looked out the window at the Ferris wheel of the Great America amusement park revolving in the distance, then I turned back to Gordon (Moore) and I asked, “If we got kicked out and the board brought in a new CEO, what do you think he would do?” Gordon answered without hesitation, “He would get us out of memories.” I stared at him, numb, then said, “Why shouldn’t you and I walk out the door, come back and do it ourselves?
The objective of this article is not to take a decision on anyone’s behalf. The target is to provide a total framework to decide on the future product strategy by using value as the starting point. Value Selling has helped firms to optimize profits. At the same time it has been criticized of being a roadblock to quick wins. In my opinion the most critical mistake made during the Value Selling process happens to be fixation to data-points. This can be overcome by constantly reviewing the value proposition using the data gathered from the field from Economic Value Models.
Once continuous assessment of value becomes a part of the culture all of a sudden it all begins to seem logical – the right product, the right price and the right value positioning.