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Customers are willing to pay more for products and services that have an economic value, or, more plainly, for products and services that save them money. To determine a product’s eco-nomic value, we first need to determine its life-cycle cost , which is the sum of the purchase price and the costs of acquiring, using, owning, maintaining, and disposing of the product.

Acquisition Costs

Usage Costs

Ownership Costs

Disposal Costs Maintenance

Costs Price

Life-Cycle Cost Paid     

To arrive at a product’s economic value, a company then compares its product’s life-cycle cost with that of the main competing product. The difference in the two products’

life-cycle costs is the economic value of the company’s product. Because customer value is essentially a product’s total benefits minus the cost of acquiring those benefits, a prod-uct with economic value, despite its higher price, typically has more customer value than a competitor’s similar product. Delivering economic value requires that the customer achieve a net economic gain over the product’s life cycle.

Economic Value = Competing Product>s Life@Cycle Cost - Our Product>s Life@Cycle Cost

We saw how Weyerhaeuser developed a product with economic value for furniture makers. Weyerhaeuser’s conventional product, even though it was of high quality, could not compete on cost among furniture makers, but the new product—in essence a spe-cialty product—can now do so. Even though Weyerhaeuser’s new product costs more than competitors’ products, its economic value is greater. The money that furniture mak-ers save by using the Weyerhaeuser product, instead of a competitor’s less expensive product, more than offsets the higher purchase price. Weyerhaeuser gained a competitive edge by first looking for an unmet customer solution, then providing the solution.

In Figure 4-10 , the total life-cycle cost of a competing telecommunications switch is

$1,000. This cost is derived from a $300 price per unit, a $200 installation cost, and a

$500 usage and maintenance cost. The company’s switch, despite its higher price, offers an economic value of $125 because the other costs contributing to its life-cycle cost are lower. ²¹

Economic Value= $1,000 Life@Cycle Cost (Competitor) - $875 Life@Cycle Cost (Company)

= $125

In this case, both the customer and the company win. The customer saves $125 per switch, and the company receives a price that is $75 higher than that of a competing prod-uct. Both the customer and the company will be more profitable as a result. ²²

Figure 4-11 outlines the six major cost categories that contribute to the life-cycle cost. The purchase price for a product or service stands out as the most obvious cost, and it is the one that businesses most commonly use in communicating economic value to customers. Customers have no difficulty understanding that a product of the same quality as a competitor’s product but with a lower price offers more economic value. But other sources of value can, from a customer’s perspective, be even more important. Cus-tomers may immediately recognize that they can save more money by choosing a prod-uct with a benefit that eliminates a time-consuming step than by choosing a lower priced

Life-Cycle Cost

$375 Price

$300 Price

Economic Value of $125

$400 Usage and Maintenance

$500 Usage and Maintenance

Company's Switch Competitor's Switch

$100 Installation

$200 Installation

$1,000

$500

$0

FIGURE 4-10 LIFE-CYCLE COST AND ECONOMIC VALUE

product. By spending a day in the life of a customer, marketers can discover the value-creation opportunities that may be present in any of the six major cost categories of the life-cycle cost.

Price Paid

Quite often, the price or payment terms destroy customer value. A product may offer an excellent customer solution, but its price may be too high relative to the benefits pro-vided. For example, DuPont found that large hospitals could justify the higher price of its more expensive blood analyzers in light of the overall benefits they offered. Small hospi-tals, however, had lower volumes of blood chemistry work—not enough to justify pur-chasing the more sophisticated and more costly blood analyzers. DuPont ran into another problem when it rolled out a still more advanced blood analyzer. The company met resist-ance from the large hospitals, which said they could not justify the expense because their present blood analyzers were adequate and still fairly new. This situation led to a strategy in which DuPont offered to buy back the large hospitals’ current blood analyzers when the hospitals purchased new analyzers. DuPont then refurbished the analyzers it bought back and resold them to small hospitals. In this way, the company created a combination of benefits that was affordable for both large and small hospitals.

Acquisition Costs

American Hospital Supply found that half of every dollar spent by hospitals on pharma-ceuticals, chemicals, and equipment went to the purchasing process and inventory of these products. Acquisition costs, as shown in Figure 4-11 , are a part of the total life-cycle

Components of a Product’s Life-Cycle Cost

DuPont's buy-back and refurbishing program reduces price of its blood analyzers for hospitals.

Maintenance Costs Usage Costs Acquisition

Costs Price Paid

Disposal Costs

Rohm-Haas’s Kathon MWX cuts cost of disposal of machine fluid waste in half.

American Hospital Supply reduces a hospital’s cost with a computerized customer order program.

Sealed Air reduces labor costs in packaging with AirCap.

GE Capital works with customers to create affordable ownership.

Loctite’s Quick Metal significantly reduces maintenance costs and machine downtime.

Financing and Insurance Costs

FIGURE 4-11 SOURCES OF ECONOMIC BENEFIT AND VALUE CREATION

cost. By placing computers in hospitals to streamline order entry, logistics, and inventory procedures, the company created economic value for its products by making them less expensive for hospitals to order, track, and inventory. As a result, American Hospital Supply won a large share of the market for its products.

Usage Costs

A product that will eliminate or significantly reduce the usage costs that customers pres-ently incur offers a substantial economic value. For many businesses, this is the source of their products’ economic value. By reducing the manufacturing costs for furniture makers and thereby giving its product economic value, Weyerhaeuser was able to deliver superior customer value with its new particleboard, even at a higher price. The same is true for the telecommunications switch in Figure 4-10 . The competitor’s switch had a total life-cycle cost of $1,000. The purchase price was only $300, but installation and start-up costs amounted to an additional $200, and usage and other after-sale costs came to $500. The new switch offered customers a solution that would cut start-up costs in half and reduce the usage cost by $100. This solution would create an economic value of $200 at the same $300 price as the competitor’s switch. However, the product had to be priced in a way that offered customer value while improving profit. In response, the company set a price of $375, com-pared with the $300 price for the existing customer solution. The price was $75 higher, but it created a customer solution that reduced the life-cycle cost by $125 per switch.

Figures 4-12 and 4-13 present another example of creating economic value by reduc-ing usage costs. The lower freight and labor costs made possible by a particular packagreduc-ing material more than offsets its higher price. Sealed Air’s AirCap packaging material costs

Life-Cycle Cost Components

Specific Cost

Company AirCap

Competitor Cardboard

Cost Difference

Price Paid Direct Purchase $1.05 $0.80 $0.25

Discounts/Rebates (negative number)

Delivery Shipping Cost $2.40 $2.60 −$0.20

Installation

Shipping Materials Shipping Carton $0.55 $0.55 $0.00

Inventory (Holding Cost) Financing Cost (Loan Interest) Owning Cost (Insurance)

Usage Cost (Cost of Use) Labor per Shipment $0.13 $0.83 −$0.70 Maintenance Cost

Replacement Cost Disposal Cost

Resale Value (negative number)

Life-Cycle Cost $4.13 $4.78 −$0.65

Life-Cycle Period for Product: 1 Shipment

FIGURE 4-12 ECONOMIC VALUE ANALYSIS

the manufacturer 25 cents more per carton to buy than a competing product, but AirCap produces an economic value of 65 cents with each carton the manufacturer ships to a cus-tomer. This means that, compared with the lower priced competitor’s product, the AirCap material saves the manufacturer 65 cents per shipment.

One more example of a company that reduces usage costs for its customers is Kyocera. To communicate the savings, Kyocera created its TCO Tracker web site where potential customers can compare the total cost of buying and using a Kyocera printer with that of any competing printer. ²³ As explained in Figure 4-14 , site users input their printing needs, and the site shows the TCO (total cost of ownership) for the best-suited Kyocera printer and any competing printer for a 3-year product life. As Figure 4-14 shows, the Kyocera printer in the example offers a customer savings of $808 over the competing model. Potential customers immediately see that they would save not only on the purchase price but also on the cost of color and black inks over the 3 years.

Financing and Insurance Costs

Products with high ownership costs are typically expensive items that buyers finance and insure. The interest and premiums paid over time account for the high ownership costs.

Many years ago, General Electric (GE) developed GE Capital to create affordable owner-ship with financing. GE Capital became highly successful and today is a large business that serves both GE and non-GE customers. A business that can make owning its product

Cost per Package

Competitor Freight

$2.60

Carton $0.55 Labor

$0.83 Inner Packing

$0.80

$4.78 $4.78

AirCap Freight

$2.40

Carton $0.55 Inner Packing

$1.05 Economic Value

$0.65 Sealed Air—Economic Value of Lower Usage Cost

Labor $0.13

FIGURE 4-13 COMMUNICATING ECONOMIC VALUE

Courtesy of Sealed Air Corporation.

less expensive than owning a competitor’s similar product gives its product economic value. The initial purchase price of the product might be more, but the total life-cycle cost to the customer is less because ownership costs are lower.

Maintenance Costs

Maintenance and repair is another area where economic value can be added to a product.

Products with good performance records or those with all-inclusive warranties may cost more to buy but will have a lower total cost of ownership. To guarantee lower mainte-nance costs, many products come with a manufacturer’s warranty and maintemainte-nance con-tract. Electronic document processing equipment, for example, can be expensive to repair. In response to this risk, Xerox created a customer satisfaction program that guar-antees product performance for an extended period.

In addition, any product that can reduce a customer’s maintenance and repair costs has economic value for the customer. Loctite’s Quick Metal, one of the examples in Fig-ure 4-11 , can be applied to worn or cracked machine parts to avoid an extended shutdown.

Quick Metal’s value proposition, “ Keep the machinery running until the new part arrives ,”

tells customers how Quick Metal can create a major savings (economic value) for them.

Disposal Costs

Another source of potential economic value lies in the disposal costs of a product. By reducing or eliminating a customer’s disposal cost, a business creates economic value in the product. FP International (FPI), a manufacturer of styrene packaging materials, picks

Kyocera TCO Tracker —

Calculate Your Total Cost of Ownership Whether you're ready for a fully managed print services program or you are simply looking for more cost-effective print alternatives, test drive the Kyocera advantage through our exclusive TCO Tracker.

The TCO Tracker compares your current printer's running costs with a comparable Kyocera ECOSYS printer. What makes the TCO Tracker unique is that it is the only printer cost comparison tool in the industry utilizing IDC market data to compare the cost of the printers, including supplies and maintenance kits, based upon your typical monthly print volume.

The Kyocera customer savings in our example is $808 over a 3-year ownership life.

3-Year Total Cost of Ownership

$9,000

up waste styrene packaging from its customers and then sells the recycled packaging back to its customers at a premium price. Because FPI lowers the total cost of the product by solving its customers’ problem of disposing of the waste packaging, the company can charge a higher price and still offer an attractive customer value.

Figure 4-15 describes another example. Kathon is a product that creates economic value for machine shop owners by extending the life of metalworking machine fluids.

The longer life of the fluids reduces the annual cost of machine fluid disposal.