1

INDIAN SCHOOL OF BUSINESS

MANISH GANGWAR

Form Value to WTP

Economic Value

Differentiation Value is the value to the customer (both positive and negative) of any differences between the firm’s offering and the reference offering.

Reference Value is the cost to the customer of the competing offering that the customer views as the best alternative to the firm’s offering [they are already incurring this cost]

ReferenceValue

PositiveDifferentiation

Value

NegativeDifferentiation

Value

EVC

EVC = Cost they already incur (and will save) + Net benefit from switchingEVC = Reference Value + Pos. Differentiation Value – Neg. Differentiation Value

EVC tells the economic value of the offering to the fully informed customer.

2

Understanding Value

Product PerspectiveFeatures

Relevant Benefits

Experiences

Customer PerspectiveNeeds (rational )

Wants (emotional)

Pains (risk)

Alternative ways to complete the same job

Everyone Talks Value…

Product Focus

“What do we offer?”

Application Focus

“Why should the

customer care?”

Customer Focus

“What is that worth?”

...but few actually walk the talk

Features

$ Value

Benefits

RevenueIncreases

CostReductions

3

Medicines Company

Context and Costs� Angiomax is a blood-thinning drug, an alternative to generic Heparin, which causes much less complications during the angioplasty surgery. Heparin is priced at $2 per dose.

� Determine the Price to charge for Angiomax

� Value of Angiomax to Various Patient Segments

� Other Objective Assessments

� Valuation by the Hospitals

� Strategy to Market Angiomax

� Understand the buying process of Hospitals

� Price and Promotion mix for Angiomax

� Industry practice: Ratio of price to cost of goods sold is 10.

� Variable cost per dose of Angiomax = $40 (P.9)

� Acquisition costs = $2 million(P.9)

� Development costs = $28 million (P.9)

� Marketing costs = $3 million (P.11)

� Total fixed costs = $33 million

4

Objective Value of Angiomax

Reduction in complications 3.5% 5.3% 13.6%

Cost of complications $8000 $8000 $8000

Savings from Angiomax $280 $428 $1088

Number of doses 1.45 1.45 1.45

Objective value of 1 dose of Angiomax $193 $295 $750

Number of patients 644000 322000 64400

Approximate revenue potential (Million) assuming selling only one dose per patient

Approximate Gross Profit (Million)

Fixed cost

Breakeven volume (#doses)

Other objective criteria for Angiomax over Heparin: Predictability; Speed; No Immune reaction.

Optional: Sizing the Customer Demand for Angiomax

Constant Elasticity Curve

Thus, Elasticity = -1.70

(for hospitals, not consumers)

y = 5E+09x-1.701

0

100000

200000

300000

400000

500000

600000

700000

0 200 400 600 800

Size of the market

Price per dose

5

How Much Hospitals are Willing to Pay for Angiomax?

� This depends on the choice of target market (patient type by risk).

� For example, if the very high-risk patients are the target, a price of $700 per dose may be

possible because of compelling value proposition, more focused selling effort, higher

margins, and low production volume.

� Similar arguments can be made for other patient types.

� Another factor is the subjective value of Angiomax as placed by the hospitals. Here

the variables are:

� Low price of Heparin,

� Doctor’s satisfaction with Heparin,

� Cost containment within the hospitals,

� Disbelief in clinical data, and

� Belief about own ability (for doctors with above average ability, Angiomax is of less value).

Strategy to Market Angiomax

� Need to understand the complexity of the selling task

� Several entities are involved: Doctors, pharmacists, and

administrators

� Focus efforts on doctors (cardiologists) first and then pharmacists.

� Recognize the cascading impact of one Angiomax adoption by a cardiologist.

� Recognize the difficulty with pharmacists (due to budget limitation).

� Recognize that the way to influence administrators is through the doctors.

� Identify a suitable price once the target and promotion strategy is

decided upon.

� Need to use experienced sales force.

� Recognize that the adoption process will be slow.

6

Value Pricing Framework

Use Value

Pricing ZonePenetration or Skimming

Relevant Cost

Maximum Price

Economic Value

Reference Price

�Fully Informed consumers

�Objective economic Value

Minimum Price

Value Pricing Framework

Realized C. Surplus

Unrealized Surplus

Use Value

Pricing Zone

Relevant Cost

Maximum WTP

Economic Value

Perceived Value

Reference Price

�Fully Informed consumers

�Objective Value

Marketing Efforts to tap

into Unrealized Surplus

Willingness to Pay

7

Height vs. Circumference

Which Bet will You Choose?

A: A chance of winning $4000 with probability 0.2

B: A chance of winning $3000 with probability 0.25

8

Consumer Biases

Reference / Anchoring / Order Effects

Heuristic / Availability / Substitute

Optimism / Overconfidence

Loss Aversion / Sunk Cost

Framing / Fairness

Small Gains Overvalued

-100

-50

0

50

100

-100 -50 0 50 100

Small Losses Strongly Overvalued

Prospect TheoryDaniel Kahenman and Amos Tverskey

Perceived Value Gains

Losses

Status Quo

Objective Value

1. Gains and losses from Reference point

2. Losses loom larger than gains3. Marginal diminishing utility4. Possibility and certainty effects

“Toward a positive theory of consumer choice” by Richard Thaler

Akerlof vs. Kahenman

Risk Averse

Risk Seeking

9

Framing Effects Gain vs. Loss

� Multiple Gains → x > 0 and y > 0

� v(x) + v(y) > v(x + y)� Segregation is preferred

� Multiple Losses → -x and –y where x and y still positive

� v(-x) + v(-y) < v(-(x + y))� Integration is preferred

� Mixed Gain → x > y

� v(x) + v(-y) < v(x – y)� Integration is preferred - cancellation

� Mixed Loss → x < y

� v(x) + v(-y) > v(x – y)� Segregation is preferred “silver lining”

Mixed Gain or LossesValue Function v(∗)

‘v(x) = xα if x > 0

v(x) = -λ(-xα) if x < 0

(with a typical α = 0.88 and λ = 2.25)

10

Prospect Theory(Kahneman and Tversky 1979)

(1) outcomes are valued as gains or losses relative to a current reference point instead

of final levels of wealth;

(2) the disutility of a loss is greater than the utility of an equivalent gain (referred to as

loss aversion);

(3) decision makers are risk averse over gains but risk seeking over losses;

(4) the value of an outcome is weighted not by the probability of its occurrence, p, but

rather by a weight of the probability, w(p), where w(p) > p for p near 0 and w(p)< p

for p near 1 (i.e., small probabilities are overweighed and large probabilities are

underweighted, which is referred to as the possibility effect and the certainty effect,

respectively; and

(5) there is an editing phase in which outcomes and their probabilities may be

simplified before applying the evaluation phase

Final Price Setting

Actively manage price expectations

�Establish credible reference prices

�Manage product price trends

�Encourage favorable comparison

�Product differentiation to avoid unfavorable comparison

Actively mange perception of goods sold

�Include and communicate fixed costs

�Bundling to avoid direct cost comparison

�Focus of consumer value

Total UtilityEconomic Utility

Transaction Utility

•Relative incentives(Weber-Fechner law)

•Context & cues(Reference price)

•Fairness (Cost of goods sold )

11

Fairness & Framing

First Chicago setting

the $3-per-visit fee for

customers who use tellers

more than four times a

month

"If nobody changed their behavior,

80 percent of my customers would

never see the $3 charge," said Jerry

Jurgensen. "For the other 20

percent, I want one of three things

to happen: I need for them to

change their behavior; I need for

them to be willing to pay more, or I

need for them to find another

bank."

Perceived Value / WTP

Small negative Differentiation are over valued

Small Positive Differentiation are under valued

ReferenceValue

Adjusted positiveDifferentiation

Value

Adjusted negativeDifferentiation

Value

Perceivedvalue

12

Why Consumers Don’t Buy

Find niche and move to right

Or drop

Slow Adoption,need good

communication

Segment and move to right

Or fight on price

Premium Pricing and

communication

Positive Differential Value

Ne

ga

tive

De

fere

nti

al V

alu

e

New tooth brush

Segway

Electric vehicle

Dvork keyboard

Online grocery

New Product Marketing Strategy

� Seek out un-endowed

� Make it behavioral compatible

� Find Believers

� 10 times improvement

� Eliminate old

� Brace for long time adoption