557-01b0 PVP Framework Annotated - Georgetown...

PVP FrameworkPrice - Value - Profitability

© K.E. Homa

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Professor Ken HomaGeorgetown University

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current MSB students in PVP(Price, Value & Profitability)

Any “pass along” of the material or its access information -- in any form – verbal, printed or simply viewed -- now or ever -- to anyone not currently enrolled in PVP-- is a breach of academic integrity policies and is subject to disciplinary action.

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The Value Map is at the center of the PVP Framework!


More specifically

Conceptually, a Value Map “calibrates” theFair Market Value (FMV) of Perceived Benefits.

More

• A Value Map is a visual representation of a market’s competitive products (the letters)• Horizontal axis: the combined magnitude of the “benefits bundles” a product delivers• Vertical axis: the perceived price of each product … i.e., what people think that they

are likely to pay for comparable products.

Conceptually, a Value Map “calibrates” theFair Market Value (FMV) of Perceived Benefits.

The Fair Market Value line is defined by the lowest priced products at the various “steps” along the benefits axis.

Products above the fair market value line have “value deficits”,i.e. their prices are higher than their benefit bundles are expected to command in the market, at the point in time …

The Fair Market Value line is defined by the lowest priced products at the various “steps” along the benefits axis.

Products deliver sought after benefits.

When they are priced at (or below) the FMV, they “create value” …

Value Creation

Value Creation

Pricing a “bundle” of benefits to deliverRelative Perceived Value to customersand extraordinary profits to companies

Value CreationPricing a “bundle” of benefits to deliver R.P.V. to customers and profits to companies.

Value CreationPricing a “bundle” of benefits to deliver R.P.V. to customers and profits to companies.

The Value Map conforms to the fundamental economic laws of supply and demand …

External Economics

Value Creation

Matching supply and demandin aggregate, and for specificbuyer and seller combinations.

Pricing a “bundle” of benefits to deliver R.P.V. to customers and profits to companies.

Details

External EconomicsMatching supply and demandin aggregate, and for specificbuyer and seller combinations.

External Economics• Supply curves generally slope upwards – since higher prices

entice more potential suppliers into a market and motivate existing suppliers to supply more.

• Industry demand curves generally slope downward – more buyers are willing & able to buy more at lower prices …

Willing= f (Value), Able= f (Budget)


External Economics• Supply curves generally slope upwards – since higher prices

entice more potential suppliers into a market and motivate existing suppliers to supply more.



Do all companies face downward sloping demand curves ?


• Supply curves generally slope upwards – since higher prices entice more potential suppliers into a market and motivate existing suppliers to supply more.



• Company-relevant demand curves may or may not slope downward, depending on the competitive structure of the industry … effective strategy can tilt the curve downward

External Economics


• Supply curves generally slope upwards – since higher prices entice more potential suppliers into a market and motivate existing suppliers to supply more.



• Company-relevant demand curves may or may not slope downward, depending on the competitive structure of the industry … strategy tries to tilt the curve downward

• At a macro level, in perfectly competitive markets, an “equilibrium price” balances supply and demand,

Q = f (P) and all firms are price-takers.

• When there are market inefficiencies , i.e. imperfectly competitive markets, some firms may be price-makers.

External Economics

From a firm’s perspective, a downward sloping demand curve is strategically beneficial since it provides latitude for “making” prices and for optimally managing capacity.

External Economics

Value Creation



A demand curve can be ‘tilted’ down for competitive advantage via strategies that identify or induce market inefficiencies.

Mega TakeAway

External Economics

Value Creation



Value Map reflects “leverage” from external market economics and, also, from internal economics, i.e. profit models …

Value Creation

Internal EconomicsProfit Models

Leveraging market economics & profit models to capitalize on the firm’s value proposition.



External Economics

Details



• Internal economics – are a reflection of company –specific Business Model Economics (BME)

• BME reduces to 3 basic factors:

(1) Magnitude of required investment

(2) Magnitude and composition of costs,I,e, high or low, mostly fixed or mostly variable, and

(3) Magnitude and nature or the revenue stream,e.g. single or multiple “streams”

More

Internal Economics



• Costs (C) are often a function of quantity produced due to scale economies, learning curve effects, and overhead absorption

• … and, as reflected in demand curves, quantity (Q) is a function of price, i.e. Q = f (P)

• .... so, costs (C) are a derived function of price, too …i.e. C ~ f (P)

• … which means that profit is ultimately a function of price … since price influences demand (directly) and costs (indirectly), i.e. π = f (P)

Internal Economics

Vertical axis of PVP Framework:

The impact of internal & external economic factors on Value Maps ...

Value Creation





External Economics

Value Creationstarts with

Benefits Fulfillment

Another Perspective …

Strategic Positioning

Balancing customer reqswith technical feasibility and profit potential

Benefits “Waterfall”

Comm.Gap

ExecutionGap


Understand

• Potential customers need (or want) products to deliver specific benefits.

• Key is understanding the benefits, their relative importance versus one another,, and the overlap or gaps in benefits’ delivery versus competing products

• Typically done via market research: surveys, one-on-one interviews, direct observation of products in use

• Subject to bad market research and management mis-interpretation …

More

Comm.Gap

ExecutionGap


Understand

• Question: Is it typically desirable for a company to try to deliver all of the benefits sought by all potential customers ?

Answer

Comm.Gap

ExecutionGap


Understand

• Question: Is it usually desirable for a company to try to deliver all of the benefits sought by all potential customers ?

• Answer: No

It is typically not both technologically feasible (“can’t do”) and / or economically justified (“don’t want to do”) to satisfy all benefits sought by all customers

More

Comm.Gap

ExecutionGap


Understand

More

• The process for translating customers’ desired benefits into product specifications is called QFD, Quality Function Deployment.

(See HomaFiles.com for QFD details)

DesignGap

Comm.Gap

ExecutionGap


QFD

Understand Design

• Process for translating customers’ desired benefits into product specifications is called QFD, Quality Function Deployment.

(See HomaFiles.com for QFD details)

• The “design gap” between customers’ desired benefits and the benefits that get specified into a product may be unintentional (because customer requirements are misinterpreted) or intentional(because delivery of the benefits is not technically feasible or economical)

DesignGap

Comm.Gap

ExecutionGap


QFD

Understand Design Produce

• An “execution gap” can happen between the benefits specified into a product and the benefits delivered by the final product.

• That is, the product is not “made to spec” because (1) the specifications are not feasible to produce or (2) production is simply outside of design tolerances.

DesignGap

Comm.Gap

ExecutionGap


QFD

Perceived Benefits ≠ Real Benefits

Understand Design Produce Promote

• The benefits that customers perceive that a product delivers may be different than the benefits that the product actually delivers

• …. that’s an avoidable “perceptions gap”, or “communications gap”,

More

DesignGap

Comm.Gap

ExecutionGap


QFD

Perceived Benefits ≠ Real Benefits


• The communications “gap” can be a positive – a perceived benefits surplus-- if a customer credits a product with

more benefits than it actually delivers.

• Eventually perceptions converge on realities … provided that a product survives in the market long enough.

Value CreationStrategic Positioning

Pricing a “bundle” of benefits to deliver R.P.V. to customers and profits to companies


Perceived Benefits are direct linked to the Value MapHere’s how



• The relationship between the benefits fulfillment “waterfall” and the value map can be visualized most easily by inverting the value map, i.e. swapping the axes ….

More

• Again, the Fair Market Value line is defined by the lowest priced products at the various “steps” along the benefits axis.

Linking Benefits Fulfillment & Value Creation



Perceived Benefits are one of the Value Map axes


More




• Ricocheting off the fair market value line calibrates the expected market price of the benefits bundle

• The process – from benefits fulfillment through fair market pricing is the essence of “Value Creation”

Value CreationStrategic Positioning



Value Creationends with

Profits Realization

Value CaptureValue Creation

Capturing some of the created value as profits starts with FMV … from the Value Map


Price – Profits Realization

Calibrate Decide

• Companies may set a “target price” at FMV or below FMV ... The latter is called “ceding value” … gives buyers a good deal.

• Above FMV, few or no sales should be expected … since product is a bad deal for customers

More


Calibrate Decide

• Companies may set a “target price” at FMV or below FMV ... The latter is called “ceding value”


• Question: why would a company ever price below FMV rather than pricing “to the market”?

Answer


Calibrate Decide

• Companies may set a “target price” at FMV or below FMV ... The latter is called “ceding value”


• Question: why would a company ever price below FMV rather than pricing “to the market”?

• Answer: To build short-term market share, perhaps to establish a broad installed base that can be strategically leveraged into follow-on or ancillary sales, e.g. next generation upgrades, razors & blades

Note: long-run, competitors are likely to react, may “recalibrate” the FMV relationship, and neutralize gains


Calibrate Decide Execute

• Realized price is that portion of the target price that is actually “pocketed” – so, it is sometimes called the “pocket price”.

• The ratio of realized price to target price is called the transaction yield, or price yield.

More


Calibrate Decide Execute

• The difference between the target price and the realized price is called “leakage”, or sometimes referred to as “holes in the pricing bucket”.

• The leakage occurs mostly due to unplanned discounting (to close sales) and non-price concessions (e.g. extended dating terms)


VariableFixedC-T-S

Calibrate Decide Execute Realize

• The ultimate objective is profits !

• Different customers have varying costs-to serve (CTS) -- some customers may require extra services, special logistics, etc.

• Final step: subtracting full cost – including the appropriate allocation of fixed costs –from realized price to determine net profit

Vertical axis of PVP Framework:Value Creation > Value Map > Value Capture

Value Creation TransactionalEffectiveness


Maximizing profitability by capturing some part of the value created.

StrategicPositioning


Putting It All Together …

Adding some detail …

PVP Framework

Q. F. D.Target CostingCustomization

Price-Yield Management

CompetitiveStrategy

DemandManagement

Price–ShareLeverage

Cost –PriceLeverage

© K.E.Homa

That’s the PVP Framework !

557-01b0 PVP Framework Annotated - Georgetown...

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