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.

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 $1,420 and needs to be replaced after 2,220 hours of use. It also requires $310 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 4,440 hours of use and it requires $410 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 4,440 hours of usage?

3. What is IC-75’s economic value to the customer over its 4,440-hour life?

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

Explanation

1.

The reference value is the price of the competing alternative, which is $1,420.

2.

The differentiation value has two components. First, customers who purchase an IC-75 rather than the competing alternative would avoid the need to buy a second component part for $1,420 to achieve 4,440 hours of usage. Second, customers who purchase an IC-75 rather than the competing alternative would realize preventive maintenance savings of $210 over a 4,440-hour period, computed as follows:

	Competing Equipment			IC-75
Preventive maintenance cost for 4,440 hours:
$310 × (4,440 hours ÷ 2,220 hours)	$	620
$410 × (4,440 hours ÷ 4,440 hours)				$	410
Differentiation value		$	210

Thus, the total differentiation value is $1,420 + $210 = $1,630.

3.

The economic value to the customer (EVC) is computed as follows:

EVC = Reference value + Differentiation value

EVC = $1,420 + $1,630

EVC = $3,050

4.

The range of possible prices is as follows:

Reference value ≤ Value-based price ≤ EVC

$1,420 ≤ Value-based price ≤ $3,050

Thanks