Download Monetary Value Estimation: An Illustration

Monetary Value Estimation: An Illustration
Category: Value Creation
GenetiCorp (a disguised name) creates innovative products that accelerate the process of genetic testing.
Monetary value estimation determines the financial impact that those breakthroughs actually deliver to
different types of institutional customers.
One GenetiCorp product, Dyna-Test, synthesizes a complementary DNA strand from an existing DNA sample,
significantly reducing DNA molecule degradation and enhancing the precision of a DNA analysis. Dyna- Test
preserves sample integrity much longer than does its primary competitor, EnSyn, thus improving DNA test
yields and accuracy in a variety of applications. For example, criminal investigators use DNA to match hair,
blood, or other human samples. Hospitals and medical professionals use DNA to diagnose diseases.
Pharmaceutical manufacturers use DNA analyses to target genes susceptible to new drug treatments. In all
applications, test failures can be costly. For criminal investigators, getting a “fuzzy picture” in a criminal
investigation may produce a false-negative result, requiring a retest that might take several weeks. Retests
for investigators are problematic because tissue sample sizes in criminal cases are very limited, often
precluding repeated tests. Similarly, for a pharmaceutical company, getting a fuzzy picture when analyzing a
DNA strand may cause drug researchers to miss their true target, the genetic portion of the DNA suspected
of triggering a disease.
Unfortunately, when it first marketed Dyna-Test, GenetiCorp did not have a clue about its product's monetary
value. It set prices based on a high markup over costs and then discounted those prices under pressure from
purchasing organizations that could buy large volumes. To improve its profits, GenetiCorp decided to learn
what its product is really worth to customers: Dyna-Test's reference value (the price of what the customer
considers the best alternative product) plus its positive and negative differentiated values (the customer use
value of the attributes that distinguish Dyna-Test from the next best alternative). Buyers will pay no more than
the reference value for features and benefits that are the same as the competing product's. When multiple
competitors offer customers the same benefits, those benefits are commoditized; a customer need not pay
anything close to a product's worth because it can get the product elsewhere. A product earns a price premium
over the reference value only for the extra performance — the differentiated value — it alone delivers. The
sum total of reference and differentiated values is the monetary value estimate.
Dyna-Test has more than one monetary value driver because different types of users have different reference
alternatives and receive different use value from Dyna-Test's distinguishing features. Let's examine the value
estimation components in two different market segments, commercial researchers and nonindustrial markets.
Commercial researchers in pharmaceutical and biotech firms most often consider EnSyn the best alternative
to Dyna-Test. EnSyn sells for $30 per test kit; that's the product category's reference value for such users. To
determine Dyna-Test's differentiation value, GenetiCorp studied the five primary drivers of Dyna-Test's
positive differentiation value among commercial researchers.
Value Driver 1 — Yield Opportunity Costs: Dyna-Test provides a greater yield of full-length cDNA, the
compound DNA structures used for analysis, which is extremely valuable. With more full-length cDNA to work
with, drug researchers can reduce the number of experiments needed to find the relevant portions of DNA,
saving an average of a week's valuable research time, according to GenetiCorp's customer interviews.
GenetiCorp studied its pharmaceutical industry customers' business models and found the annual revenue
from a successful commercial drug ranges from $250 million to $1 billion. GenetiCorp used a conservative
estimate of $400 million in revenue for one drug, which, with a 75 percent contribution margin, generated $300
million in annual profit contribution. The cost of developing a typical drug was approximately $590 million.
These contribution and cost estimates yield an average net present value of $41 million a year profit for a
successful drug over a 17-year patent life. But it takes 500 target tests on average to finally identify the gene
sequence leading to a successful new drug, so each target test eventually is worth $82,000. With a 260-day
work-year (approximately 2,100 hours), the value of a target test is $39 per hour. If using Dyna-Test saves
the researcher an additional week that can be devoted to another new drug, the value of those additional 40
hours is $1,560.
Value Driver 2 — Yield Labor Savings: Dyna-Test's cDNA yield superiority over EnSyn also produces more
efficient laboratory staff work. Customer interviews indicated that using Dyna-Test saved 16 hours of
processing labor compared to using EnSyn. Because laboratory personnel receive an average of $24 per
hour, labor savings from Dyna-Test are about $384.
Value Driver 3 — Quality Control Labor Savings: Prior to Dyna-Test, researchers frequently checked testchemical batches for quality, sterility, and reproducibility, adding two hours to a test. However, Dyna-Test
maintained uniform quality and performance over several years, assuring researchers that they could
eliminate these quality-control checks. In interviews, customers said “I am confident with Dyna-Test because
it is a quality and tested product” or “Dyna-Test has been around long enough; you know it works. If someone
says they ran the experiment with Dyna-Test it must be right.” High quality produced two hours of customer
cost savings totaling $48.
Value Driver 4 — Sample Size Opportunity Costs: Using traditional methods, analyzing a DNA sample
usually requires using some “starter” sample material at the outset. Often, the amount of original sample
material is very small; gathering more on an emergency basis might take about three weeks of lost research
time. But the Dyna-Test kit has a two-step system that reduces the need for starter samples, making available
more testable original sample material and freeing researchers from the search for more. Using the value per
week of Dyna-Test usage, GenetiCorp estimated the opportunity cost of searching for new material at $4,680
(3 × $1,560) per project. But because such emergency searches happened only about 10 percent of the time,
the likely opportunity cost averages to $468.
Value Driver 5 — Sample Size Labor Savings: Similar to Driver 4, gathering additional emergency starter
material requires researchers to repeat the entire analytical test — an extra 16 hours of research labor time
— about 10 percent of the time. But with the Dyna-Test kit yielding more usable material and with labor costing
$24 per hour, the value of using Dyna-Test on this dimension is $38 ($24 × 16 × 0.1).
In sum, for pharmaceutical and commercial biotechnology firms, the estimated total economic value of DynaTest is calculated by adding together the reference value of $30, plus the estimates of differentiated value
associated with each value driver, yielding a total estimated economic value of $2,528. In other words,
purchasing the new Dyna-Test kit instead of the EnSyn kit would produce $2,528 in cost reductions and new
product profit gains for a commercial researcher. illustrates the monetary value estimation for that industrial
buying segment.
Nonindustrial markets such as academic institutions and government laboratories estimate economic value
in a similar fashion. Their reference value is also the $30 price of the EnSyn test kit; however, the most pricesensitive among them simply have lab assistants — essentially free student labor — make DNA test products
from scratch. Their differentiating value drivers are similar to those of industrial customers, but modified to
reflect the business model in this market, which has a different research environment and economic reward
structure.
EXHIBIT 2-5 Monetary Value Estimation for Dyna-Test Industrial Buyers
Value Driver 1 — Yield Opportunity Costs: The yield opportunity cost avoided by using Dyna-Test is $1,055,
somewhat less than for commercial researchers because of the lower economic rewards from breakthroughs
in primary research.
Value Drivers 2, 3, 4, and 5: The yield labor savings of $231, quality control savings of $29, sample size
opportunity cost avoided of $317, and sample size labor savings are also less because of the reduced cost of
labor within university systems.
Thus, the estimated total economic value of Dyna-Test for academic laboratories is calculated by adding the
reference value of $30 plus the estimates for each value driver, yielding a total monetary value estimate of
$1,685. illustrates the relationships.
Remember that the economic value derived from monetary value estimation is not necessarily the perceived
value that a buyer might actually place on the product. A customer might not know about a reference product
and won't be influenced by its price. A buyer might be unsure of a product's differentiating attributes and may
be unwilling to invest the time and expense to learn about them. If the product's price is small, the buyer may
make an impulse purchase without really thinking about its economic value. Similarly, brand image and equally
unquantifiable factors can influence price sensitivity, reducing the impact of economic value on the purchase
decision, as in the case of Rolex watches. Ultimately, a product's market value is determined not only by the
product's economic value, but also by the accuracy with which buyers perceive that value and by the
importance they place on getting the most for their money.
EXHIBIT 2-6 Monetary Value Estimation for Dyna-Test Academic and Government Buyers
This limitation of monetary value estimation is both a weakness and a strength. It is a weakness because
economic value cannot indicate the appropriate price to charge. It only estimates the maximum price a
segment of buyers would pay if they fully recognized the product's value to them and were motivated to
purchase. It is a strength, however, in that it indicates whether a poorly selling product is overpriced relative
to its true value or is under-promoted and unappreciated by the market. The only solution to the overpricing
problem is to cut price. A better solution to the perception problem often is maintaining or even increasing
price while aggressively educating the market. That is what GenetiCorp did with Dyna-Test. After previously
cutting price to meet the demands of its apparently price-sensitive buyers, GenetiCorp raised prices two- to
fivefold, at the same time launching an aggressive marketing campaign. While customer purchasing agents
expressed dismay, sales continued growing because even the new prices represented but a small fraction of
the value delivered. Profits increased significantly in the following year as purchasers learned about DynaTest's superior economic value to their institutions and accepted, sometimes grudgingly, the need to pay for
that value.
GenetiCorp's experience also shows how value can vary among market segments. To determine a pricing
strategy and policy for a product, you must determine the economic value delivered to all segments and the
market size of each. With that information, you can develop an economic value profile of the entire market
and determine which segments you can serve most profitably at which prices. profiles the economic value and
market potential for each Dyna-Tech market segment.
Monetary value estimation is an especially effective sales tool when buyers facing extreme cost pressures are
very price sensitive. For example, since health-care reimbursement systems began giving hospitals and
doctors financial incentives to practice cost-effective medicine, pharmaceutical companies have been forced
to add cost and performance evidence to their traditional claims about a drug's clinical effectiveness. Some
now offer purchasers elaborate tests to show that greater effectiveness is worth a higher price. Johnson &
Johnson's invention of the medicated arterial stent, for instance, initially appeared expensive at $1,300 per
stent. J&J successfully countered customer resistance by demonstrating that dramatically reducing the
probability of an artery reclogging was worth at least $3,500 per treatment in avoided surgery and hospital
costs.
EXHIBIT 2-7 Monetary Value Profile for Dyna-Test