Thursday, June 10, 2010

Clarity Please-A Product Value Metric for Decision Making

In "Clarity Please-Customer Value for an Individual"  I defined the metric to measure a single consumer's willingness to pay, which I labeled VI. Nevertheless, because a market is composed of many consumers, this single estimate of value does us no good when it comes to make decisions involving the whole market. What we need is an overall metric of product value that summarizes the willingness-to-pay of the entire market of consumers. This overall metric is critical to modeling how the market will respond to alternative product and service offerings.

According to Harry E. Cook (an expert in the area of measuring customer value), there are three properties that an overall measure of value for an economic good must possess (Cook 1997):

  1. It must have the same units as price
  2. The net value of an economic good to the consumer decrease as price approaches value
  3. If a product change creates an increase in demand while holding price constant, value has been increased.
Let's say our TV manufacturer wants to determine an overall metric that sums up the willingness-to-pay of those consumers that actually purchased his TVs and he wants to call this metric VB (buyer's value).

Let's also say that the TV manufacturer was able to get a representative sample of the market to participate in a survey that was able to discern the VI of each respondent (idealistic I know, but work with me) and when he graphs out the results it looks like the maroon curve in the figure below. The demand curve between the green and the yellow dots represents the consumers who wouldn't take the TV unless you paid them (maybe its unfashionable to own a TV in their neighborhood!). The demand curve between the yellow and the red dots represent the consumers that believe the TV is a positive economic good (they'd pay for it). The red dot represent the market's reservation price (no one will buy the TV if it is priced larger than the red dot).

Now, for any given price we can draw a line that is tangent to the demand curve and this line will intersect the dollars axis. Let's call this intersection VB (labeled as such in the figure above). This my friends is our metric that provides the TV manufacturer with an overall metric for the willingness-to-pay for those consumers who would actually buy the product. Over the course of this blog we will talk about VB (total product value or just product value) and how business leaders can use it to drive innovation, drive revenue growth, drive profitability, and drive customer satisfaction.

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