Rafi Mohammed

Reader Question: Rafi, Can You Please Elaborate on the Value Decoder?

Posted on January 4th, 2007 (0 Comments)

I recently received a note from Jim, a reader interested in how to present a product’s value and whether the Value Decoder works for his product. Great question Jim, I receive a lot of e-mails about the Value Decoder and it is a key concept that I discuss in my blogs (yesterday’s blog focused on TiVo’s need to use the Value Decoder, tomorrow’s blog will highlight Abbott Laboratory’s mastery of the concept).

First off, let me be clear – the Value Decoder is the right process to price any product or service. As I mentioned in a previous blog, you can have confidence in the Value Decoder as it is simply a managerially friendly adaptation of the cornerstone of microeconomics, the demand curve.

The crucial Value Decoder steps involve identifying close substitutes and characteristics of these competitors. The key to value is how your product measures up to close substitutes. Here’s an example that illustrates the rationale underlying the Value Decoder. Suppose the city of Malibu, California passes an ordinance that requires all beach lemonade stands to be located in a 25 yard by 25 yard “refreshment zone.” Suppose there are four lemonade stands that all sell the same lemonade drink. Since nothing differentiates these products (i.e., no product offers a higher value), the Value Decoder advocates that all stands charge the same price. If one sets a higher price, no one will purchase. Conversely, if another sets a lower price, everyone will purchase from that stand. Where pricing gets interesting is when companies start differentiating to add value. Value can be added by using real lemons, mountain purified water, or adding a thirst quenching additive. My point is that adding value, relative to competitors, will allow you to increase your prices. Just make sure that customers value these new features. While a thirst quenching additive may sound nifty, if it has a bitter aftertaste, customers may not value (hence not be willing to pay for) this additional feature.

Once you’ve added value, the next question is how do you equate value with price? There are three primary methods: (1) Market research (a costly yet data driven method), (2) Expert judgment (often a good “first cut” is to seek opinions from people on your front line on how much customers will pay for a new feature), and (3) Ask your customers (“so you want mountain purified instead of tap water, how much are you willing to pay for that?”).

Sellers often tell me of customers that demand extra value and then refuse to pay for it. That’s just crazy – unless, of course, your competitors are throwing in the extra value for free. Often times, and I’m guilty of this myself, companies will demand more value and not agree to a price increase as a starting point in their negotiations. Don’t be thwarted by these negotiation tactics, you are entitled to profit from the value you create.

When presenting the value of your product, clearly highlight how your product’s value differs from your competitors’: “our product uses real lemons (which we estimate is worth a 15 cent premium) and mountain purified water (which we estimate is worth a 10 cent premium).” In fact, I know of companies that have actually shown customers the print out derived in the Value Decoder section of this web site to justify their value.

So go ahead, spend some time working through the value decoder section of this web site (a more detailed description of the Value Decoder is in The Art of Pricing). My bet is that this exercise will make you more confident in articulating and justifying the value of your product.

Thanks Jim for the question!

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