The Price of Value

ArenaIf you want to see sports this summer, time your ticket purchases wisely. The Cincinnati Reds are employing “dynamic pricing” in their ticket sales. So are the Michigan Wolverines. Tickets for high-demand games get more expensive, and for lower-demand games get cheaper.

This is a simple version of a complicated business reality, a reality highlighted by a set of McKinsey Quarterly “classics” that showed up in our inbox recently. The lead selection, “Setting Value, Not Price,” originally published in 1997, urges companies to think less about “pricing” in isolation and instead think about “dynamic value management.”

“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,” wrote the authors, Ralf Leszinski and Michael V. Marn. “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.”

As the authors relate, rather than simply resorting to price cuts to beat competitors, wise companies look carefully at what customers value and then decide how to retool their offerings. Sometimes that means a price cut, but other times it means a price rise and an expanded set of benefits. “Value maps are shifting at faster rates than ever,” they declared, and companies must be just as agile.

Peter Drucker lamented how few companies recognize the importance of simply asking themselves what their customers value. “It may be the most important question,” Drucker noted in Management: Tasks, Responsibilities, Practices. “Yet is the one least often asked.”

One reason for this is that companies think they already know. “Value is what they, in their business, define as quality,” Drucker wrote. “But this is almost always the wrong definition.” For example, for a teenage girl, “value in a shoe is high fashion,” while durability and price matter little.

“Another reason why the question ‘What is value to the customer?’ is rarely asked is that the economists think they know the answer: Value is price,” Drucker added. “This is misleading, if not actually the wrong answer.”

For instance, electrical contractors, while famously price-conscious, may prefer one of the most expensive fuse boxes on the market. “To the contractor this line is actually low-priced because it is engineered to be installed fast and by relatively unskilled labor,” he explained.

The ultimate lesson is simple but not easy: “The customer never buys a product,” Drucker wrote. “The customer buys value.”

Which companies do you think have the best and worst sense of pricing?