Are you working out whether or not to charge more for a new product or service? Are you trying to avoid creating a negative pricing spiral in your industry? Are you trying to increase your market share?
The information from research-based value equivalence line analysis helps you make all these decisions with a higher level of confidence.
What is the value equivalence line?
To make best use of this model in your decision making, it’s important to ensure understanding of ‘value’ in this context. The originator’s of the value equivalence line tool describe this as:
“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.” —McKinsey’s ‘Setting Value, Not Price.’
The value equivalence line is a way to measure this and display it on a graph with a vertical axis representing perceived price and a horizontal axis of perceived benefits. The VEL is a straight line, at a 45 degree angle that bisects the two.
It’s best understood with an everyday example.
Three people go out to get a burger.
- One goes to a drive-thru and pays $5.50
- The second person eats in their local restaurant and pays $15
- The third person treats themselves to a 9oz Wagyu burger at a high-end restaurant for $50
All three consider their burger to be value for money, despite the very different price tags.
On a value equivalence line diagram, each restaurant sits right on the 45 degree value equivalence (VEL) line. They all consider that the relationship between the benefits and price of their meal are appropriate.
It’s very important to state that ‘value’ in this context doesn’t mean low or bundled pricing. An item can sit comfortably on the VEL from the budget, mid or luxury range. It’s all about perceived value for money.
- The $5.50 burger delivered on consistency of quality and speed of service, with no expectation of a restaurant experience.
- The $15 burger also delivered on consistent quality, with the additions of friendly service and a familiar setting.
- The $50 burger delivered on deliciousness, excellent service and a beautiful venue.
Result – everyone’s happy with the value for money of their burger of choice. The relationship between the perceived benefits and price are appropriate at all three levels.
In your B2B transactions, these nuances of perceived benefits and price are harder to wheedle out than in this kind of B2C situation. But the essential premise is the same:
Customer value = customer perceived benefits – customer perceived price
This concept and equation was first defined by McKinsey in an article called ‘Setting value, not price’ by Ralf Leszinski and Michael V. Marn. It’s a particularly useful tool for getting to the heart of the drivers that influence your buying teams. Insights are presented visually, with a simple line graph showing where you and your competitors sit on the VEL.
To be truly useful, you need to ask your actual customers how they perceive your product or service and its pricing. There’s no point looking at a graph that’s based on your company’s internal assumptions of your clients’ perceptions. You need reliable market research.
What if our product or service doesn’t sit on the value equivalence line?
Not all products or services are placed on the value equivalence line. And the consequences of being on its left or right are equally significant:
- If you sit to the left of the VEL line, customers feel that you’ve got a ‘share loser’ that’s priced too high for the perceived benefits. It’s highly likely that you’ll lose market share as you’re not seen as delivering good value for money.
- If you’re on the right side of the VEL, clients consider that you’re delivering more value for money than competitors at the same price with a ‘share gainer’. By retaining this position, you’re highly likely to increase market share and become a market leader.
Wherever you are on the VEL, you’ve got options. The importance of the word ‘perceived’ comes into play because it’s all based on the perceived value your clients and prospects hold – you can change those perceptions.
Importance of the value equivalence line research
Value equivalence line research is one framework you can use to inform your strategic decisions.
The first step is to measure your clients’ and prospects’ current perceptions of your brand value using 2 simple questions:
- How do you rate ‘X’ on benefits you get, compared with other companies?
- How do you rate ‘X’ based on price, compared with others in the same market?
Respondents give their answers on a scale from ‘significantly better’ to ‘significantly worse’. Within your wider pricing research strategy, this is supplemented with deeper questioning to give insights into why respondents hold these views. It’s the ‘whys’ that inform action. By asking these same questions about your competitors, you get an overview of where you sit in comparison with other brands.
Whatever you learn, you can use your VEL results to better your position.
If you’re substantially ahead of the VEL, you can stay there and consolidate your dominant position. Your other option is to increase prices and drop back onto the VEL – sacrificing a market leadership position to increase revenue.
Right on the line
If you’re on the VEL, you can identify how to sustain your position, even when you’re introducing new products, features or services. Using thorough market research insights, you can check that clients want the new feature, and are prepared to pay the higher price tag, before going into full development.
If you’re behind the VEL, you can figure out why. You’ll either need to decrease prices or increase benefits to maintain a presence in the market with your current product or service. But you also need data about the wider picture. Do clients just not know about all the features and attributes included in your product/service? You’ve got a campaign to write! Is there a misconception that your product is overpriced, when it actually lasts longer than comparable products? Get your comms team on it!
The whole point of any market research is to drive better-informed decision making that boosts your business. Value equivalence line research insights aren’t just bare statistics. VEL analysis informs product development, marketing and pricing decisions as part of your overall market research strategy.