Thoen Heavy Machinery Corporation has developed a new drill press-model OU-84-that has been designed to outperform a competitor's best-selling drill press. The competitor's product has a useful life of 30,000 hours of service, has operating costs that average $1.60 per hour, and sells for $189,000. In contrast, model OU-84 has a useful life of 120,000 hours of service and its operating cost is $1.00 per hour. Thoen has not yet established a selling price for model OU-84.Required:From a value-based pricing standpoint what range of possible prices should Thoen consider when setting a price for model OU-84?
What will be an ideal response?
The range of possible prices is determined as follows:
Reference value ? Value-based price ? EVC
The reference value is the price of the competing alternative, which in this case is $189,000.
The economic value to the customer (EVC) is determined as follows:
EVC = Reference value + Differentiation value =
The differentiation value has two components. First, customers who purchase a model OU-84 rather than the competing alternative would avoid the need to buy four drill presses for $189,000 rather than just one OU-84 to achieve 120,000 hours of service. This is a savings of $567,000 (= 3 × $189,000) for the additional drill press that would have to be purchased. Second, customers who purchase a model OU-84 rather than the competing alternative would realize operating cost savings computed as follows:
| ? | Operating costs for 120,000 hours of service: | ? |
| ? | Competitor's product (120,000 hours × $1.60 per hour) | $192,000 |
| ? | Model OU-84 ((120,000 hours × $1.00 per hour) | 120,000 |
| ? | Operating cost savings | $72,000 |
Differentiation value = $567,000 + $72,000 = $639,000
EVC = Reference value + Differentiation value = $189,000 + $639,000 = $828,000
Reference value ? Value-based price ? EVC
$189,000 ? Value-based price ? $828,000
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