Wednesday, November 18, 2009

How does a Customer Determine Product Value

One of the most difficult aspects of the product role is setting product price, but before that conversation can happen you need to have a good understanding of the value to the customer.

There are many flawed practices when understanding the value to the customer, such as taking into account development/products times or cost, "coolness factor", size of the customer's business, number of customer units etc.

The reality is that the maximum amount a customer is willing to pay (the Economic Value to the Customer or EVC) can be calculated with a simple formula:

EVC = Reference Value + Differentiation Value

The Reference Value is the price of the closest perceived substitute.  This is extremely important - understand what alternatives and substitutes the customer sees in the market.

The Differentiation Value is the value of your product's attributes that exceed the reference value. These attributes includes features and functionality, time to market, size, cost, licensing, support etc.  You also need to ensure that the customer is fully informed of all of the differentiation you provide.

As an example, when I moved to California two years ago I needed to buy a new car for commuting in the bay area.  Initially, I was thinking about a BMW M3 convertible (my requirements list has convertible as mandatory), and went to talk to the BMW dealer, took a test drive etc.  From memory the M3 was about $70K.

After driving the M3 I decided to check out the Mini Cooper S convertible, and found that it met my needs and had a total price of approx $35K.  So the Mini Cooper S became my Reference Value.  Although the BMW M3 was clearly a better car than the Mini, I couldn't determine $35K of differentiation value.   The Mini had the same three year service plan included, had a cabin size roughly the same as the BMW, had an automatic roof, had more than enough power.  So purchased the Mini and I have been very happy with my decision.

Remember in the technology space that any company can copy and build any other product, unless it is protected by patents.  And in the days of open source, there is often a reference value of zero, which has significantly disrupted pricing dynamics.  The take away here is that you must get inside your customer's head and understand what they see as the reference value.

At the Hass Business School Strategic Pricing Course, Professor Teck-Hua Ho listed three "Magic Bullets" for affecting price sensitivity:
  1. Substitutes Awareness Effect - Buyers are more price sensitive the higher the price difference between this product and the percieved substitute.
  2. Difficult comparison effect - Buyers are less price sensitive the more difficult it is to compare competing offers.
  3. Switching Cost Effect - Buyers are less price sensitive the greater the sunk investment they have made in anticipation of it's continued use.
Each of these points can be converted to a takeway:
  1. If your strategy is to price high above the reference value then you must focus intensely on informing your customer of your differentiation, and be prepared for a longer sales cycle as the customer grapples with the difference between Reference Value and EVC.
  2. Get out of crowded markets and into a market where you have a unique solution and the customer finds it difficult to come up with the EVC.
  3. "Sticky" products are best - look at how difficult it is to be displaced after you make a sale.
So the next time you are sitting in a room discussing pricing, try raising your hand, and asking what is the Economic Value to the Customer (EVC) of your solution.  See how many blank looks you get, and then go back to basics and calculate EVC.

Tuesday, November 3, 2009

Business Fables - The Monkeys and the Bananas

I was talking with Ed Ryan the other day, an ex-colleague from Novell (in fact he was my first Product Management boss at Novell, and easily the best I have ever had), and we were discussing company culture and why it can be so difficult to change or evolve, even when it's clear things need to change.

Ed related the parable of the monkeys and the bananas:

Put ten monkeys in a cage, and then dangle a bunch of bananas through a hole in the roof.  As the monkey's charge the yummy bananas, hit them with a fire-hose. Keep doing this until finally, you lower the bananas and the monkeys stay well away because they don't want to be given a good soaking.  

The monkeys are smart and they have learnt their lesson, so know that banana=soaking.

Now take one of the monkey's out of the cage and replace it with a new one who has never been soaked.  As you lower the bananas down the new monkey will make a beeline towards the bananas.  The other monkey's however will shriek in horror and hold the new one back, as they don't want to get soaked.

Keep replacing monkeys one at a time, and the same thing happens.  Pretty soon you have ten monkeys who have never been hosed down, who won't touch the bananas.  None of them really understand why, but the behavior has been reinforced - don't touch the bananas.

This is a good analogy of company culture, and why it's so hard to change - once a culture is established, new employees don't understand the reasons why, but help to perpetuate and indoctrinate new employees who come in with new ideas and viewpoints.

This is also why a "hero" CEO cannot save a company by themselves - one person, even the CEO, will find the management team acting like the monkeys in cage, and resist the change.

The solution here is for the CEO to bring enough of a replacement management team - imagine if instead of putting one new monkey in the cage we add four or five - these will be able to band together and hold back the monkeys from stopping them getting the bananas.  I have spoken to a number of CEOs of public and private companies who wish they had followed this in the past, and swear that they will bring their own management team next time.

This parable is also why starting innovative new products inside an existing product group is so hard - the monkeys keep focusing on the existing rules and culture, that may not apply to the new thing.

The solution here is start the innovative new product outside of HQ, and let it build its own fast moving culture.  This could also be achieved by acquiring a smaller company as the seed of the new organization, and keeping the management team in place to grow the new business - this is a model that Citrix uses effectively with companies like Net6 (Access Gateway), NetScaler, and XenSource (XenServer).  In monkey terms we are getting a second cage and putting the new monkeys in that.  Perhaps over time we'll move the old monkeys into the new cage, and they will have to adapt to the new culture.

Thanks Ed for relating this parable, and I always keep this in mind when confronting change.