Targeting Process Improvements for Value-Based Pricing
I’ve written extensively in previous columns about the paradigm shift in process improvement programs, with those programs shifting from an emphasis on defect and cost reductions to an emphasis on superior customer value, revenue growth, and market share. And, last month, I described several of the new tools and skills required to measure and analyze the Voice of the Market (VOM) in order to achieve that paradigm shift. These are the tools that belts must learn to use and interpret in order to identify value-based, market-focused priorities for process improvements leading to revenue growth.
But there is one other significant implication of this paradigm shift. The company that learns to use these tools to improve the quality of their products and services may also be able to command premium prices while still providing superior value. This is the very essence of value-based pricing leading to both increased profitability and market share. Let me illustrate how this works with a brief case study and a Market Value Simulator™.
XYZ Paint is an automotive paint distributor that supplies paint and related supplies to auto body repair shops. In order to better understand the drivers of quality and value in its targeted market segments, XYZ Paint conducted a Voice of the Market study, asking targeted auto body shops to rate the performance of their paint suppliers on a variety of quality, image and price attributes. The resulting value model revealed that price was the primary driver of value (52 percent), followed closely by various aspects of quality (37 percent). The key critical-to-quality (CTQs) factors included:
- The ordering and delivery processes (32 percent)
- The quality of the paint itself (20 percent)
- Business support processes (19 percent)
- Training and problem solving processes (19 percent), and
- Technical support processes (10 percent)
XYZ Paint’s performance on these CTQs was rated quite high, with scores ranging from 8.5 to 9.35 on a 10-point scale. (Click on image to enlarge.)
Of course, as regular readers of this column already know, those performance ratings are meaningless in the absence of competitive performance ratings. Fortunately, VOM data provide that information which VOC data cannot. As it happened, XYZ Paint outperformed its competition on virtually all aspects of both quality and price, making XYZ Paint the value leader in this particular market segment. (Click on images to enlarge.)
Based on this analysis, XYZ Paint decided to target Competitor B in order to leverage XYZ’s superior value proposition into market share gains. An analysis of quality performance gaps (both positive and negative) revealed that XYZ Paint needed to improve performance on their order and delivery processes, and leverage their advantage on business support processes. (Click on image to enlarge.)
At this point, it becomes very useful to estimate the impact of those targeted process improvements on XYZ’s value proposition. What if XYZ Paint could attain a half-point performance improvement on each of the targeted CTQs by conducting a few, very focused Six Sigma projects? The use of a Market Value Simulator™ can provide a realistic estimate of that impact. (Click on image to enlarge.)
Two things are worthy of note at this point. First, notice that XYZ Paint not only improved its position on quality by improving performance on two of the CTQs, but it also improved its position on price. That’s because quality and price are highly correlated in most value propositions. In this case, r = .72. So, for every point of increase on quality, XYZ will realize a .72 increase in the market’s evaluation of its price. Second, notice that not only did XYZ Paint move to the northeast on the Competitive Value Matrix, but all of XYZ’s competitors moved to the southwest. That’s because the cross hairs represent the market means, so any change in one competitor’s position will result in changes for everyone else as well. In essence, XYZ Paint is now "managing" the value proposition of each of its competitors!
"Value-Based Pricing" means that you don’t want to leave money lying on the table! If you have invested to improve the quality of your products and services, you may be able to realize a price increase while still maintaining a superior value proposition. Again, you can estimate the impact of a price increase by using a Market Value Simulator™. Suppose you were to realize a 10 percent price increase. What impact would this increase have on market evaluations of your price compared to those of your competition? What if the result were a ½-point decrease in the market’s evaluation of your price? (Click on image to enlarge.)
The result would still leave you in a position of value leadership, with the attendant gains in market share and revenue.
The new paradigm for Business Process Excellence requires an external focus on customers and on value. This external focus will ensure that you understand quality and value from the perspective of your targeted market segments, and that you target your improvement initiatives on those processes that will have the greatest impact on quality. This strategic focus on CTQs from a market perspective provides the opportunity to manage the price of your products and services in order to maximize the value you provide your customers, while also maximizing the profits you provide your shareholders.