McDermott Company has developed a new industrial component called IC-75. The com
ID: 333281 • Letter: M
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 $1,360 and needs to be replaced after 2,160 hours of use. It also requires $280 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 4,320 hours of use and it requires $380 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 the competitor’s offering for each 4,320 hours of usage?
3. What is IC-75’s economic value to the customer over its 4,320-hour life?
4. What range of possible prices should McDermott consider when setting a price for IC-75?
Explanation / Answer
1. Reference value - The price of perceived closest substitute
= price of unit (s) which run for equivalent time as compared to the product
= 4320 / 2160 = 2 units of competing products
effective price of 2 units = 2x 1320 = 2640
= 2x1320 = 2640
2. Differentiation value = Value of a product’s attribute difference between company's offering and the closest substitute
= Savings on maintenance = 2x280 -380 = 180
3. Economic value for the customers = Reference value + Differentiation value
= 2640+180 = 2820
4. Value incurred by the customers before IC - 75
2640 + 560 = 3200 for 4120 hours
Hence the price of the product should be kept below 2820 to achieve competitive advantage.