Question

McDermott Company has developed a new industrial component called IC-75. The company is excited about IC-75 because it offers superior performance relative to the comparable component sold by McDermott’s primary competitor. The competing part sells for $1,400 and needs to be replaced after 2,200 hours of use. It also requires $300 of preventive maintenance during its useful life.

The IC-75’s performance capabilities are similar to its competing product with two important exceptions—it needs to be replaced after 4,400 hours of use and it requires $400 of preventive maintenance during its useful life.

Required:

From a value-based pricing standpoint:

1. What is the reference value that McDermott should consider when pricing IC-75?

2. What is the differentiation value offered by IC-75 relative the competitor’s offering for each 4,400 hours of usage?

3. What is IC-75’s economic value to the customer over its 4,400-hour life?

4. What range of possible prices should McDermott consider when setting a price for IC-75?

Answer 1

Value based pricing - It is a strategy of setting prices primarily based on a consumers perspective. i.e the value the costumer is willing to pay for a product/services.

1.The Reference value that MCDermott should consider is $1400.

2.There are some benefits of buying IC-75 :-

a.The customer can have extra 2200 hours to use before replacement compared to competitive product.

b.Also saving in preventive cost as calculated below.

Preventive Maintenance cost for 4400 Hours: IC 75   

$400 * (4400hours / 4400hours) $ 400

Preventive Maintenance cost for 4400 Hours: Competing Product

$300 * (4400hours / 2200 hours) $600

Thus Total Differentiation Value = $1400 + $200 = $1600   

3. Economic Value to the customer = Refernce value + Differentiation Value

Economic Value to the customer = $1400 + $1600

EVC = $3000

4. Range of prices that MCDermott should consider is as follows.

Reference Value ≤ Differentiation Value ≤ Economic Value to the customer

$1400 ≤ $ 1600 ≤ $3000