Monetary Value to the Customer Analysis
© 2009 Scott Davis and Strategic Marketing Decisions. Any distribution or other commercial use of the contents of this article is prohibited unless written permission is obtained from Scott Davis and Strategic Marketing Decisions.
Overview and process
A Monetary Value to the Customer Analysis (MVCA) estimates the customer's value of a good or service by evaluating its financial implications for the purchaser. A product's "economic value" is the price of the most preferred alternative to your product (called the replacement or reference value) plus the value of features that differentiate the product from this most preferred alternative (called the differentiation value).
In general this approach is more appropriate for products that are sold to businesses or for household products having significant financial implications. It may also provide a useful sales tool when the buyer's are accountable for costs, and therefore will tend to be price sensitive. It may be possible to justify purchasing a more expensive product if doing so will result in demonstrable savings in the future.
The MVCA process involves several steps:
- Identify customer's segments that are likely to have different preferences, values or choice sets
- Different customer types will vary in their valuation of a product offering. There are many reasons for this variation. Some customer types will use a product more intensely and will place a greater value on products that are more cost efficient in use. When considering business customers, industry type, technology use and organizational structure can also influence the value of a product to a customer. A failure to conduct a MCVA on a segment by segment basis can lead to estimates of average values that don't reflect the dispersion of valuations in the marketplace may not reflect the value to any single segment.
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- For each segment determine the customer's choice set and most preferred alternative
- This process begins by determining the desired function of the product. Often times are many alternatives that can fill the desired role. One of the common alternatives is to continue to use current product. From the set of feasible alternatives, the most preferred option should be identified. For this product the purchase price and its lifetime cost of operation and, if relevant, revenue generation potential should be determined. The purchase price is the replacement or reference value. If the most preferred alternative is to make no purchase and continue to use the existing product, the replacement value can be viewed as being zero.
- Identify the factors that both positively and negatively differentiate your product from the reference or replacement product.
- There are a number of potential sources of differentiating benefits. These might include:
- Startup Costs - Often adopting a new product requires incurring some costs in the form of installation, setup, or training. These costs may also include real and psycholigical costs of establishing new vendor relationships.
- Input or Usage Costs - Products may differ in the costs incurred in operating them. Energy efficiency or the ability to use fewer or lower cost inputs can provide differentiating benefits. Increased operating speed can also lower input costs.
- Maintenance and Repair Costs - Reducing the freqeuncy of required maintenance can lower costs both directly, by reducing the amount of maintenance required, and indirectly by reducing costs associated with downtime. Similarly improving reliability lowers usage costs by reducing the likelihood and frequency of repairs.
- Performance Benefits - A product may allow a business customer to produce superior goods and services that will provide added value to the their customers. These differentail benefits can have monetary implications by allowing the customer to increase profitability through a combination of higher prices and/or increased volume.
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- Estimate differentiation value for each segment by determining the monetary value of the factors that differentiate the proposed product from the most preferred alternative.
- Once the sources of differentiation are determined, the importance of these features should be expressed in monetary terms. One required piece of data is an estimate of the change in each of required inputs over the expected life of the product relative to the requirements of the reference alternative. For each input the difference in the number of units is multiplied times the expected cost per unit to determine the differentiation value associated with the input. Similarly the setup costs can be estimated by determining the resources required to begin using the new product and multiplying times the cost of those resources. Estimating the value of performance-related benefits can be difficult to determine reliably without a thorough understanding of the customer's market. Often it is best to determine a range of values based on surveys that obtain the expectations of customers about what proportional impacts of providing products with certain capabilities can do to the bottom line. The differentiation value is determined by summing the values obtained from each of the differentiating factors.
- Determine the expected monetary value to the customer of the proposed product for each segment.
- The monetary value to the customer is given by the sum of the reference/replacement value and the differentiation value for each segment. This value will provide an estimate of the most a fully informed customer in the segment should be willing to pay for the product, excluding intangible factors, such as perceived risk, and factors that are not readily monetized, such as brand attitudes and aesthetics.
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- Examples:
(Note: these examples are for illustrative purposes only. A number of subtleties have been intentionally omitted to simplify the discussion)
- An improved machine part lasts longer and therefore needs to be replaced only half as often. The replacement or reference value would be two times the price of the existing part since only one new part will replace two of the old parts. The differentiation value would be the labor cost of replacing the part along with any costs associated with the machine's downtime since using the new part would save one replacement process each time it was used in place of the old part.
- A computer inventory management system uses a scanner system to record deliveries and withdrawals from inventories. It also computes usage rates that helps optimize the sizes and timing of orders as well as partially automating the order placement process. The reference value will depend on the current inventory management system. If another inventory management system is used, the reference value would be the costs of continuing to use the system (such as licensing and maintenance fees). If inventories are currently managed utilizing an internally developed system, the reverence value would be the cost of maintaining the current system, which could be negligible.
There may be both positive and negative components to the differentiation value. The value of the labor saved due to the increased automation of the inventory management process and reduced inventory holding and ordering costs resulting from improved inventory management practices would be positive sources of differentiation value. However, a new system may require may require increased computational capabilities as well as setup costs and training costs. These latter costs are a source of negative differentiation value. Further, these costs are fixed in nature requiring that the monetary value to the customer be computed over a specified period of operation.
These values are likely to vary across customers depending on factors such as inventory size, inventory usage rates and the current system. A MVCA can assist in the identification of the most attractive market segments and allow a pricing policy that can get the greatest possible profit from the target market segments.
Advantages
This procedure has several advantages:
- Provides a quantitative estimate of the amount a fully informed for the product features having primarily a financial impact.
- Makes it possible to identify features that are incorrectly valued by customers and, therefore, may assist in planning of communications.
- Provides a useful sales tool for demonstrating value to a prospective customer and providing a justification for paying a price premium.
Limitations
- This procedure also has several limitations:
- Some of the estimated financial benefits may be arbitrary or difficult to estimate.
- Does not account for features for which the value is not primarily financial in nature. If an MVCA is applied improperly, these non-economic features may be undervalued or even ignored.
