Question

McDermott Company has developed a new industrial component called IC-75. The company is excited about IC-75 because it offers superior performance relative to the comparable component sold by McDermott’s primary competitor. The competing part sells for $1,280 and needs to be replaced after 2,080 hours of use. It also requires $240 of preventive maintenance during its useful life.

The IC-75’s performance capabilities are similar to its competing product with two important exceptions—it needs to be replaced after 4,160 hours of use and it requires $340 of preventive maintenance during its useful life.

Required:

From a value-based pricing standpoint:

1. What is the reference value that McDermott should consider when pricing IC-75?

2. What is the differentiation value offered by IC-75 relative to the competitor’s offering for every 4,160 hours of usage?

3. What is IC-75’s economic value to the customer over its 4,160-hour life?

4. What range of possible prices should McDermott consider when setting a price for IC-75?

1.	Reference value
2.	Differentiation value
3.	Economic value to the customer
4	Range of possible prices		<=	Value-based price	<=

Answer 1

1	Reference value=Price of the competing part=$ 1280
2						$
	Preventive maintenace cost-Competitive part
	240*(4160/2080)					480
	Preventive maintenace cost-IC 75
	340*(4160/4160)					340
	Difference in preventive maintanace cost					140
	Differentiation value=1280+140=$ 1420
3	Economic value to the customer (EVC)=Reference value+Differentiation value=1280+1420=$ 2700
4	Range of possible prices=Reference value to EVC=$1280 to $2700