Academic journal article The McKinsey Quarterly

Setting Value, Not Price

Academic journal article The McKinsey Quarterly

Setting Value, Not Price

Article excerpt

The first task is to map benefits versus price - as the customer sees them

Bear in mind that equal value doesn't mean equal market share

The key decision: do you stay on the line of value equivalence, or get off?

A manufacturer of high-quality medical testing equipment introduces a vastly improved version of its best-selling diagnostic device at a price 5 percent higher than that of the older model it replaces. For three months, the new model is successful, gaining rave reviews from customers and increased market share. One month later, prices in the sector collapse and the company has to discount its superior new product just to maintain its traditional market share.

A highly regarded manufacturer of commercial paper prides itself on delivering extremely consistent quality and service. That consistency notwithstanding, the company is baffled by vacillations in its market share that accompany shifts from tight to loose supply in the industry.

A consumer packaged goods company executes one of the most common business tactics - it matches a competitor's price on a large contract to supply a leading food retailer. In the months that follow, a bitter price war breaks out, destroying almost all of the industry's profitability in this product category.

These disparate cases have at least one thing in common: apparently sound marketing strategies and tactics that produced unexpected and costly results. But could they have been avoided? Here we will explore how these and other common and expensive marketing missteps might be averted by applying a discipline called "dynamic value management" to the pricing and product positioning that are at the core of what most marketers do.

"Value" may be one of the most overused and misused terms in marketing and pricing today. "Value pricing" is too often misused as a synonym for low price or bundled price. The real essence of value revolves around the tradeoff between the benefits a customer receives from a product and the price he or she pays for it.

The management of this tradeoff between benefits and price has long been recognized as a critical marketing mix component. Marketers implicitly address it when they talk about positioning their product vis-a-vis competitors' offerings and setting the right price premium over, or discount under, them. Marketers frequently err along the two dimensions of value management, however. First, they fail to invest adequately to determine what the "static" positioning for their products on a price/benefit basis against competitors should be. Second, even when this is well understood, they ignore the "dynamic" effect of their price/benefit positioning - the reactions triggered among competitors and customers, and the effect on total industry profitability and on the transfer of surplus between suppliers and customers.

To illuminate the nature and magnitude of this missed value-management opportunity, value needs to be defined properly. Customers do not buy solely on low price. They buy according to customer value, that is, the difference between the benefits a company gives customers and the price it charges. More precisely, customer value equals customer-perceived benefits minus customer-perceived price. So, the higher the perceived benefit and/or the lower the price of a product, the higher the customer value and the greater the likelihood that customers will choose that product. (We will return to this later.)

Static value management

Many marketing and strategic assessments can be made by using a simple tool called a value map, and by considering how customers are distributed within the map for a given segment.

The value map explores the way customer value and the price/benefit tradeoff work in real markets for a given segment [ILLUSTRATION FOR EXHIBIT 1 OMITTED]. The horizontal axis quantifies benefits as perceived by the customer; the vertical axis shows perceived price. …

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