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Lecture 6

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Economics (Arts)
ECON 208
Paul Dickinson

Eco Lecture Economic Value to the Customer (EVC) is based on the insight that a customer will buy a product only if its value to them outweighs the value of the closest alternative, or when Utilitya ≥ Utilityb. The utility of a product depends on its value to the customer minus its price. Valuea − Pricea ≥ Valueb−Priceb Rearranging gives: Pricea ≤ *V aluea −V alueb++Priceb Pricea ≤ Differentiation Valueab +Priceb Rewriting *V aluea −V alueb+ as the differentiation value between product a and b allows us to summarize product a’s price ceiling as Pricea ≤ DifferentiationV alueab +Priceb Therefore, to sell a product, a firm needs to price at or below its competitor’s price plus the value advantage its product has to the customer over the rival product. Atlantic Computer has developed software that allows their servers to host twice as much webspace as its rivals. How should they price this new software-server combination? • Relative to buying two servers from Atlantic’s competitor, by buying one doubly efficient server from Atlantic, a firm would save $4,000 in labor costs, $500 in electricity and $1,500 in software licenses. This suggests that the differentiation value relative to the closest competitive offering is $6,000. • The price of two servers from the competitor is $6,800. • This suggests that the EVC of a server with the software is $6,000 + $6,800= $12,800. Practical Implementation of EVC analysis in a firm • Identify what benefit your product provides – Make sure you define a benefit, not a feature. Skill here reaps large rewards. • Identify closest competitive offering and calculate its price – Be honest about who your closest competitor is – Be honest with yourself about the price that competitors sell their product for. – Get the units and time-horizon right. This is far easier to do when you have defined the product’s benefit properly. • Identify potential sources of differentiation value – Be specific, not vague. It is important that your firm’s value proposition does not sound like it was churned out by generic software. • Measure how much value these create – Have an independent lab do measurable testing. – Often current customers are willing to take partin benchmarking stud­ ies, as they view it as free consulting. •
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