The current trend in business shows that the methodology of assigning prices to products is increasingly moving away from the old paradigm of the cost and budget structure. According to this old paradigm, the selling price of a product must reflect the total production and transaction costs of the product to which must be added the profit margin for the investor.
theory-of-value-utilityAt present, the predominance of this criterion has been set aside to impose the useful value perceived by the client as a determining factor of the market price structure.
Another aspect that we can observe is that the majority trend of organizations is towards the considerable reduction of total costs through the management of operational effectiveness and the increasing processes of automation of production activities or value creation, at the same time as the Customers become more and more exquisite in the valuation of products and / or services demanding more useful value at a lower price.
As a consequence of the phenomenon of globalization of the economy and the exponential increase in competitiveness in the markets and the high degree of diversification of the products offered through it, consumers considerably increase their perception of the attributes of the products. products that we will call for the purposes of supporting the present theory as the Useful Value Perceived by the client, a concept that begins to have a transcendental importance in the design of business models in the era of globalization.
To analyze in detail this observation of the current reality, let us begin by defining relative useful value as the relationship between the value perceived by the customer and the monetary value of the product (price that the customer pays for the product), also known as the Transaction Value.
(VUR) = …….. …………. (one)
VUR: Relative useful value.
VUP: Useful Value Perceived by the client. It is the subjective assessment that the client makes at the time of purchasing a product regarding the properties or attributes of the product (quality) that automatically compares with the sale price, asking the question: is it convenient to buy this product at this price?
The perceived value is key when deciding to buy a product, it is also related to the levels of customer satisfaction for products already consumed or for the marketing strategy based on quality and differentiation.
VT: Value of the transaction (Price paid by the customer for the product). It is the amount that the client is willing to pay for the product that may partially or totally include the total costs of the product.
Both values (VT and VUP) are defined by the client through the laws of the market (supply and demand) and the new culture imposed by global trade in the world economy.
In our reality, it happens that the entrepreneur or investor sets the sale price of their products above the monetary value that the client is willing to pay with the sole purpose of generating a higher profit margin, this fact works only under two circumstances: in a monopoly economy or in states of disinformation and high transaction costs. However, with the predominance of information and communication technologies that impose a new global culture and a greater diversification of the market with a significant reduction in transaction costs, the generalized tendency is to link sales prices with sales prices. value that the client is willing to pay.
There is also, as indicated above, a sustained reduction in total costs due to factors that we indicated. According to this, the current trend of organizations is then to give more useful value at lower total costs.
In this way we will have an increasing curve for the monetary value and a decreasing curve for the total costs of production and sale. Both curves must be intercepted at a point where the monetary value equals the total costs that we will call the point of indifference where the investor's profit becomes zero and the customer's interest in the product becomes indifferent, that is, it does not matter to him buy or not the product.
But at this point, when both values are equal, the relative useful value for the client becomes equal to 1. From this point on, the investor will try to add more useful value to the product so the client will awaken his interest to pay. a little more for the product which results in the possibility of a sustained increase in the investor's profits as long as they maintain a sustained policy of cost reduction in order to maximize their profits.
The subsequent question is what happens if the investor does not develop a sustained policy of reducing total costs? You simply won't be able to maximize your returns at the risk that the point of indifference shifts along the money value curve while maintaining zero profit to the investor at best.
If the investor decides to keep his costs constant then the maximization of his profits will basically depend on the amount of useful value that the product adds. To be more didactic, let's review illustration 43.
From this graph we can draw some important conclusions that are indicated in the following table.
Variations in the relative useful value and their implications in the business statements. (Source: self made)
| USEFUL VALUE
RELATIVE (VUR) |
RELATION BETWEEN (VT) AND (VUP) | STATUS OF THE BUSINESS |
| [0, 1)
one > 1 |
VT> VUP
VT = VUP VT |
Customer dissatisfaction.
Unviable business Indifference Customer satisfaction. Business growth |
Transaction Value Vs. Perceived Useful Value (Source: Own elaboration)
In the same way, we will define the Product Positioning Matrix in the Market through the relationship between the monetary value (value that the customer is willing to pay) and the useful value of the product perceived by the customer.
Product positioning matrix. (Source: self made)
Useful value perceived by the customer
The transactional frontier and sustainable profitability
To analyze this point in detail, let's start by defining the following terms:
List Price (PL): Price set by the investor generally established above the total costs (production and sale) and which seeks to satisfy the profitability expectations of the business.
Transaction Value (VT): also known as the Monetary Value that the customer pays to secure the transaction.
Relative Price (PR): It is the quotient that results from dividing the Transaction Value by the List Price.
(??)
(PR) = …….. …………. (two)
Like the Relative Useful Value, we will analyze below the variability of the Relative Price and later we will analyze its implications on the business.
Relative Price variability and its implications on the business.
| PRICE
RELATIVE (PR) |
RELATION BETWEEN
(VT) AND (PL) |
STATUS OF THE BUSINESS |
| [0, 1)
one > 1 |
VT <PL
VT = PL VT> PL |
The client perceives a low useful value, therefore the profitability of the business could be at risk. The business at some point could not cover its full costs.
The customer receives a fair price. The entrepreneur has met his expectations but is not sure that he has optimized his profitability. The customer perceives a high useful value, therefore a sustainable profitability for the business could be ensured. |
Let's now make a linear analysis of the relationship between Total Costs, the List Price and the Transaction Value.
Illustration 1: Linear analysis of the relationship between costs, useful value, list price and transaction value.
A: The Perceived Useful Value is above the list price, in this case there is a predisposition of the client to pay something more for the product so there is the possibility of raising the list price as a result of a positive negotiation with the client. The problem is how much more can the list price be increased while maintaining a high Perceived Useful Value.
B: It is the state in which the Perceived Useful Value is below the List Price but slightly above the Total Cost. The probable causes are that the client has not yet fully perceived the attributes of the product, so it is necessary to strengthen the marketing strategy. However, this is not always the case, it may also be due to the few attributes of the product that the customer values as insufficient.
C: The Perceived Useful Value is below the total costs, in this case the customer perceives a bad product but buys it out of necessity in the best of cases.
The positive negotiation margin is presented when the Perceived Useful Value is above the List Price, therefore the entrepreneur can positively negotiate a higher price with the client, thus maximizing his profits in exchange for a higher Transaction Value..
The negative negotiation margin occurs when the Perceived Useful Value is below the list price, in this case the entrepreneur will be forced to reduce his list price and obtain a Transaction Value lower than expected.
The concept of Transaction Value is key in business. As we already pointed out, the final value that the customer pays for the merchandise. This value in certain cases may be the same as the list price, that is, with the profitability expectations that the investor manages, but generally it is not; This value may be above or below the investor's expectations and it all depends as expected on the useful value estimated by the client.
The Transaction Value is obtained as a product of the negotiation between the buyer and the seller, if the useful value perceived by the client on the product is high, he will pay without objection the price established by the seller and logically express his satisfaction with the transaction. At this point the problem arises for the seller who will try to maximize his profitability by raising his profitability expectations through a positive negotiation with the client to increase the value of the transaction that should be reflected in a higher list price.
If the negotiation tends to establish a transaction value below the list price, this means that the customer's valuation is low or there are bidders who offer the same product at lower prices, in both cases the product differentiation is minimal and the factors of assurance of the total quality of the product are easily copied by the competition. In some cases, the value of the transaction could be well below the total costs of the products, as occurs in productive units or micro-enterprises in our country.
Next, let's analyze the relationship between the Useful Value and the Relative Price in order to determine the degree of sustainability of the business. In illustration 48 we see the following:
The Transactional Frontier is the line of business through which it tries to maintain a balanced relationship between the Relative Price and the Relative Useful Value that allows you to optimize your sustainable profitability.
When the relationship between the PR and the VUR remain equal to 1, sustainable profitability is obtained by moving the Relative Useful Value curve along the equilibrium line.
In equilibrium the following mathematical relationships are presented:
(PR) = (VUR) = 1 (VUP) = (VUP) = PR = ……………………. (4)
From equations (1) and (2) we obtain the following expression:
The expression closed in parentheses is a quotient between the customer's expectation of the product expressed as a monetary value divided by the list price, which is nothing more than the investor's expectation. To this expression denominate coefficient business profitability K R.
K R ….. ……………. (5)
| COEFFICIENT
OF COST EFFECTIVENESS (K R) |
RELATIONSHIP
BETWEEN (VUP) AND (PL) |
STATUS OF THE BUSINESS |
| [0, 1)
one > 1 |
VUP <PL
VUP = PL VUP> PL |
The client perceives a useful value below the investor's expectations, therefore the client would not be willing to purchase the product.
The customer believes that the price is right. However, it could buy from the competition at a lower price, against which the investor must enhance its differentiation strategy. The client considers that the price of the product should be high, with a low list price, the investor has the option of insuring the transaction. |
Replacing (5) in (1), we get the value of the relative price as a function of the relative useful value.
PR = ……………………. (6)
The Transactional Frontier and Sustainable Profitability. (Source: self made)
Under these circumstances, it is possible to estimate the useful value perceived by the client through relation (3), keeping the list prices constant and recording the transaction value for a given period.
When the PR> VUR it is necessary to move the line of the Transactional Frontier towards the equilibrium line, for this it is advisable to strengthen the marketing strategies to raise the Relative Useful Value, subsequently the positioning of the profitability curve should be studied to move it to achieve sustainable profitability positioning.
When the PR
Moving the profitability curve from the table of profitability at risk to the table of sustainable profitability is only possible through the strategies of assuring total product quality and the development of organizational intelligence and operational effectiveness.
Determination of the optimal transaction value (TV)
When the useful value perceived by the client is above the investor's profitability expectations expressed in the list price (PL), the problem is to find a relationship that defines the optimal value of the effective price that the client pays for the product (VT). To analyze this problem, let's look at the following graph.
Optimal Transaction Value.
When (PR) = (VUR) the relation (3) is obtained from which we solve for VT and we obtain the following relation:
VT = ?? (???) …………………. (7)
Solving for VUP from equation (5) and replacing in equation (7) we obtain:
VT = PL ………………………… (8)
Equation (8) allows monitoring the optimal value of VT by multiplying the list price by the profitability ratio of the business. As we know, this coefficient is between 0 and one, and greater than one. In the first interval we are faced with a low profitability coefficient or profitability at risk and in the second interval we are facing a sustainable profitability.
Useful Value Theorem
When the useful value expressed in monetary terms, that the customer assigns to a commodity is greater than the monetary amount that he pays for said commodity, the sale price becomes independent of the total costs of production and sale. Under these conditions, the maximization of the profitability of the business will depend fundamentally on the degree of customer satisfaction and the optimal and positive difference between the perceived value and the monetary value that the customer pays for the merchandise.
Seen in another way, when customers are willing to pay a price higher than the sale price of a product, said sale price becomes independent of the total management and transaction costs of said product.
In this way, the selling price of a product and / or service ceases to be a function of the total costs of production and sale, to become an exclusive function of the customer's expectations, according to which they will value the product.
But in reality it happens that the total costs will always be present in the good (product or service) therefore it will maintain a certain degree of influence on the price paid by the applicant, therefore, the price trend The final goal aimed at maintaining its independence from costs must necessarily be reflected in a pressure on companies to maintain a structure of decreasing marginal costs, thereby promoting operational effectiveness and the company will be able to enter the gap of maximizing its benefits.
The implications of this theorem are diverse. We will point out some of them below.
- The first implication of this theorem is the predominance of customer expectations over the simple satisfaction of their needs. In this way, the value that is linked to everything that means the satisfaction of human and social needs based on the scarcity of resources in an economy where supply is equal to or greater than demand, is transferred to the expectations of the client who seeks maximize the full satisfaction of needs and expectations.When in the statement of the Theory of Useful Value we point out that the investor maximizes his benefits when he maintains a structure of decreasing costs,Said cost variability comes from internal factors of the organization aimed at maintaining a state of increasing operational effectiveness in order to prevent its inefficiencies from being transferred to customers. In this way, the structure of decreasing costs, coming from internal factors of the organization, maintains its independence from the valuation of the product by customers, a phenomenon that comes from external factors. Therefore this statement does not contradict the Theorem.
The importance of the Theorem lies in the fact that it is constituted as a fundamental strategic diagnostic tool for companies, with which they will be able to measure their relationship with customers through the estimates made of the customer's assessment of the products and / or or services that are offered in the market.
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