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 $1,360 and needs to be replaced after 2,160 hours of use. It also requires $280 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 4,320 hours of use and it requires $380 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 4,320 hours of usage?

3. What is IC-75’s economic value to the customer over its 4,320-hour life?

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

Answer 1

Answer:1

The reference value that McDermott should consider when pricing IC-75 is as below

• The unit service charge per hour should be considered when pricing IC-75 because the market perceived the product based on its hour life in the market and its maintenance cost to the customers.

• Thus for current product the selling price =$1360, Maintenance cost = $280, life = 2160 hours. This means total cost to customer is $1640 for 2160 hours of operation/service life. Cost for one hour = 1640/2160 = $ 0.759

• Thus for value based pricing for IC-75, the cost to customer is $ 0.759 / hour should be considered. Because this is the comparison point of products based on their cost to service hours.

• The reference cost to customer for IC-75 product = $0.759*4320 = 3278.88 ~ $3280.

Answer:2

The differentiation value offered by IC-75 relative the competitor’s offering for each 4,320 hours of usage are as below

• Comparatively low selling price based on value based pricing approach.

• Lower maintenance cost $ 0.879/hour ($380 for 4320hours = $ 0.0879/hour) compared to existing competitor products $0.129/hour ($280 for 2160 hours =$0.129/hour)

Answer 3:

IC-75’s economic value to the customer over its 4,320-hour life is the cost per hour is less than the current competitor cost for one hour = 1640/2160 = $ 0.759/hour. Thus any cost lower than $0.759/hour will be the economic value to customer over 4320 hours of life.

Answer 4:

• The range of possible prices should McDermott consider when setting a price for IC-75 is based on the value based pricing with respect to the competitor product. The reference selling price for IC-75 product could be equal to = $0.759*4320 = 3278.88 ~ $3279. Thus any price below $3279 will be the range that can be used for IC-75 product.