Value for the Company and the Customer

Capsule: The Company estimates its costs for each innovation and sets a price for the innovation. Then it evaluates the sales volume customers might bring to the Company as a result of the innovation by checking the innovation's net value to the customer after the customer has paid the price of the innovation. The Company ranks these innovation alternatives; first, according to the market share change each should create and, second, by the profitability of the innovation.

The Company specifies how each of its performance innovations would produce a good return while, at the same time, giving the customer a good value. The Company must identify its cost for each innovation, determine how it will recover those costs, and then ensure that the value proposition offered to the customers with each innovation creates an attractive net value to the customer.

The Company's innovation costs include capital, as well as operating costs. Both costs must be recovered over the effective life of the innovation.

Value for the Company and Customer Questions

  • Does the innovation require capital investment by the Company? If so, how much is the investment required?

  • What operating costs does each innovation entail for the Company? These are the costs of people and purchases, which form the ongoing annual costs of offering the innovation.

The Company determines how it plans to recover the costs of innovation over the innovation's effective life. This cost recovery comes by way of a change in price or sales volume. A change in pricing either will raise prices in some way to recover the added costs of any new benefits or will reduce price to recognize the removal of benefits from the product. More commonly, the Company would look to a sales volume improvement to recover increased costs. (See Symptom: "Some competitors proliferate products around the heart of the market.") If the Company looks to a volume increase in order to recover additional costs, it would plan to recover those costs using the pretax operating profits on the increased volume to pay for its capital investment, if any, incurred with the innovation. If the Company expects a fall-off in volume as a result of the removal of benefits and their costs, it would expect its marginal contribution on the volume lost to be smaller than the operating cost saved by the benefits removed.

More Value for the Company and Customer Questions…

  • What price change will each innovation require the Company to make in order to cover the cost of the innovation?

  • What volume change is required for the Company to break even on its product and service innovation?

The Company must recover these costs over the effective life of the innovation. (See Symptom: "Competitors are emphasizing reliability in product quality.") This effective life of the innovation may be much shorter than the life of the product. The effective life of the innovation lasts only as long as less than half of the competitors in the market offer the benefit that the innovation produces. Once more than half of the competitors in the marketplace offer the innovation, the innovation will no longer support further price premiums or further increases in volume. It may, however, prevent the loss of some current customer volume through "failure" in the customer's eyes.

More Value for the Company and Customer Questions…

  • What is the likely effective life of the innovation in the current market? For an estimate of this effective life of the innovation the Company may use the analysis from the Customer Buying Hierarchy or make a specific estimate for each of its innovations.

  • Does the effective life of the innovation allow the company enough time to recoup its investment in the innovation, including a good return on its capital?

  • If the innovation may not be economically attractive, can it be changed to make it so?

The Company then checks its value proposition for customers. It compares its planned performance innovations and pricing changes to the customers' current system of costs to ensure that the customer receives a good net value for the innovation. This step in the process requires the Company to assess how much of the customer's cost the Company must save with each innovation's value proposition in order for the customer to be willing to buy the product with the innovation.

This analysis should consider the net value of the innovation for a representative customer in the largest target customer size/supplier role segment. Innovations producing customer savings that are one-time or fixed in nature have different impacts on different size segments. The larger customers may have the greatest cost savings because of the size of their purchases but these savings may translate into a very small per unit price premium potential because their savings are spread across such large volume. The opposite may hold for the smaller customer. On the other hand, innovations producing customer savings in variable costs are likely to have a similar value for each customer.

More Value for the Company and Customer Questions…

  • What is the net value to the Company and the largest target customer segment of the innovation at various potential pricing and volume assumptions over the effective life of the innovation?

  • What final combination of pricing and volume change will the Company assume for each innovation?

  • What market share change will each innovation produce?

  • What is the net present value or profit potential of each prospective innovation?

Basic Strategy Guide Users Return To: Step 18

Summary Points

Next: Capacity for Innovations