Tuesday, June 8, 2010

Clarity Please-Product Value for an Individual

Every marketing textbook I look at defines product value as the relationship between the consumer's perceived benefits in relation to the perceived costs of obtaining those benefits. The relationship is generally expressed as the following ratio:

Value = Benefits / Costs

I know we can measure costs, which might be transportation costs, storage costs, maintenance costs, delivery costs, etc. But someone, anyone, please give me an example of when a marketer has actually taken the time to list out and quantify the tangible AND intangible benefits..... I fear I'll be waiting a long time. Now let's say someone actually went through the trouble of quantifying these metrics, I would like to meet an executive who used the resulting ratio to make a decision. If the ratio was less than 1 (indicating costs were larger than benefits), who's to say the analyst didn't forget a benefit or two that might tip the scale???

Can we please dispose of this nonsense and move onto a metric that allows us to make decisions? Let me propose an alternative definition of product value, which has been tested in major automotive and heavy equipment companies and has shown to be rigorous and worthy to be included in the decision calculus. Rather than give a mathematical derivation (you can find this in a book), I'd like to get there using our intuition (let me know if I can make some improvements).

Let's start with the illustration below. Here we have a buyer with a sack of money and a seller holding a TV (both men and smiling) with a lady in the background who is clearly disappointed about something. If the seller's price was equal to the buyer's Individual's Customer Value (let's call this VI, where I stands for individual), then there wouldn't be a deal as this would meet the buyer's willingness-to-pay threshold. Conversely, the seller wouldn't sell the TV for a price that was equal to his cost (let's call this CS). Therefore we know that price needs to be somewhere between VI and CS. The closer that the price is to CS, the happier the buyer will be; and the closer the price is to VI, the happier the seller will be. Let's say the buyer and seller were honest and fair in their dealings, for them to share equally in the deal they would set price as follows:

Price = (VI + CS) / 2

Let's define "Net Value" as  (VI - CS), so the buyer and seller are both happy because they split net value 50/50.

The challenge with real markets is that every potential customer has a different VI so it's impossible to charge a single price to split the net value in each transaciton. It's also rare that the seller divulges his costs and/or the seller divulges his/her willingness-to-pay. In the next post I'll tell a story about a customer value metric for a market of individuals. Don't worry, I'll also talk about the angry lady in the background in a future post.

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