McDermott Company has developed a new industrial component called IC-75. The com
ID: 333603 • 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) The reference value that McDermott should consider when pricing IC-75 is the pricing of the competitor for the comparable component. Further, they have to consider - manufacturing cost, distribution cost and promotions cost while setting up Ic-75 prices.
2) Differentiation value offered by IC-75 is
3. The economic value to the customer over its 4,320-hour life is two-fold:
4. Competitor product runs for 2160 hours and requires $280 preventive maintenance.
Assume a customer needed product for 4320 hours, then his total cost = 2*1360 + 2*280 = $3,280
For Ic-75, cost to customer for 4320 hours = Price (X) + $380
For zero value differentiation between products , X + 380 = 3280
X = $2900
If IC-75 is priced at $2900, then there is no differentiation value between IC-75 and competitor's product. Since, the customer, in general, would co-relate number of hours to price, the product can be priced at 1360*2 = $2720. The product still creates value for the customer of around $180 by reduction of preventive maintenance cost over 4,320 hours.