Wednesday, 25 February 2009

Word cloud, B2B pricing and value modelling

Thanks to all Marginal Revolution readers who have stopped by in the last couple of days. I am looking forward to generating next week's economics word cloud on Sunday and will summarise whatever trends emerge in comparison to this week.

Eric Mitchell at the Professional Pricing Society has an interesting article about pricing in a B2B environment. I broadly agree with the comments of John Burdass and Rick Robinson; pricing should, as far as the supplier can influence it, be driven by value and not by either cost or competitive comparisons.

However they imply a focus on objectively demonstrable financial value. For me, value is highly subjective; and perceived value is driven by framing and other cognitive factors distinct from the objective attributes of a product. This is especially true in B2B service provision where direct comparison of a service - either against another supplier or against a similar service purchased in the past - is difficult.

Much of our recent research at Inon has been in this area. We use a technique called value modelling to build a hierarchical representation of subjective value for a given customer. For example, some customers may place a high value on winning new business; others on getting home on time each day. These values in turn can be expressed in terms of simpler, lower-level drivers such as material gain or pain reduction. The structure of the hierarchy, and the weighting of different factors, has a strong influence on decision-making.

Pricing interacts with this decision process in a complex way; we cannot yet model the whole process in detail but we do have some insights into it, and we have spend the last 18 months building software tools that provide a framework for setting prices so people are more likely to make the decision to buy.

I think that over the coming years we will see more real-world applications like this of behavioural economics and decision theory; as the models become better understood and closer to reality, the field has the potential to enable powerful microeconomic applications.

It's fascinating to engage with the theory in these two distinct ways: from the pure theoretical side of designing and exploring the models; and from the application side, making the models tractable and creating tools usable by people not trained as economists. If you are working purely on theory, or purely on tools, I recommend engaging with those on the other side too.

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