This is the first of a two-part series on capital equipment value models
The economics of virtually all capital equipment purchasing decisions can be described using a value metric derived from the comprehensive value expression for capital equipment. (For a primer on the value metric, see this post.)
However, a piece of capital equipment can play a variety of roles in the buyer’s pursuit of profit. These different roles require different value models. Value models capture the portion of your customer’s profit-making process that must be modeled to express the economics of their buying decision. To determine the best value model for your equipment type, consider these questions:
- Is the buying decision limited to the economics of the operation that your equipment performs?
- Does the decision to buy your equipment include consideration for how it affects the economics of other equipment or operations?
- Is equipment being purchased to generate profit or to get ready to generate profit?
- Is your piece of equipment employed to produce a profit or to resolve failures in the production of profit?
- Does the buying decision for your equipment include consideration for some future revenue source with different process requirements?
Your answers to these questions determine the value model that you will use to define your value metric. The number of value model variations you may come across in your capital equipment career is probably uncountable. However, you are likely to encounter these five at some point in your capital equipment marketing career.
- Adjacent affects
- Defect processing
- Getting ready
- Capital life
In this post, I’ll take you through the first two. I’ll hit the remaining three in next month’s post.
Simple Value Models
Of the capital equipment value models, the most common is the simplest. In the simple value model, the buying decision considers the time from the moment the workpiece enters your equipment to the moment it exits. The simple value model may apply if the process your equipment performs alone drives the economics of the purchasing decision, and your equipment operates in series with the customer’s primary profit-making process. See Figure 23.
With the simple value model, you need to apply the comprehensive value expression elements for only the operation your equipment performs. The Mr. Melty example used in this post about the comprehensive value expression and the value metric is an example of this simple value model. See the figure below.
Adjacent Effects Value Models
Your value metric must incorporate adjacent effects when the purchasing decision for your type of equipment also considers the economics of adjacent equipment or operations. You will need to apply an adjacent effects value model anytime that a decision to buy your equipment type includes any element of the comprehensive value expression for any other equipment or operation in the profit-making process. For example, if your equipment affects the economics of the operations immediately up and downstream of your equipment, your value model would take the form shown in the figure below.
The adjacent effects model may apply if any of the following are affected in a significant way by your customer’s selection among alternatives to your equipment:
- the economics of workpiece preprocessing
- the economics of downstream operations
- number of upstream or downstream operations required
- the value of the customer’s product
- the yield of part or all of the customer’s profit-making process that is not performed by your equipment
For example, suppose an airline is considering purchasing several jumbo passenger jets. The airline’s choices are the Airbus A380 and the Boeing B747. One unique feature of the A380 is that it has two passenger decks that run the full length of the aircraft. The two full-length decks are the source of its capacity advantage over the B747, which only has a small second deck in the front.
However, to load and unload passengers from the A380’s top and bottom decks in parallel, its buyers will need to build and install special two-story jet bridges. The B747 does not require these special jet bridges. It only loads and unloads passengers from the main deck. Assuming that the purchasing decision for the jumbo jet considers the economics of flying plus loading and unloading passengers, the adjacent affects value model would be appropriate. See the figure below.
An extreme case of an adjacent effects value model is when the economics of the buyer’s entire profit-making process drives the buying decision for a single piece of equipment. In this case, the value model will include all equipment and operations. This extreme case usually appears when the revenue the equipment buyer can obtain for each unit of its product or the yield of its entire operation drive the buying decision.
Here’s an example. Solar cell manufacturers are in the business of selling power. The amount of power produced by a solar cell determines its price. A cell that produces twelve watts of power may sell for $12.00, whereas a cell that produces ten watts of power may sell for $10.00.
Dozens of equipment types are required to turn a bare silicon wafer into a solar cell. Suppose you sell one of these equipment types and its primary buying criteria include the amount of power, and therefore revenue that each solar cell produces. The value metric for your piece of equipment must consider the entire profit-making process because it will include the revenue-per-unit factor. It takes a whole factory to produce revenue.
In this case, the value metric for your equipment is something like that shown in the figure below.
To express the economic benefit of your equipment, you can use this value metric to construct a value model like the one shown below.
|Units||Your Equipment||Competitor’s Equipment|
|Your equipment type cost||$M||30||15|
|All other equipment cost||$M||200||200|
|Total equipment cost||$M||230||215|
|Depreciation expense (5 Year)||$M||46||43|
|All other cost of goods||$M||50||50|
|Total cost of goods sold||$M||96||93|
|Total gross profit||$M||24||7|
In this case, your value proposition is that spending $30M on your equipment will produce more than three times more annual gross profit than spending $15M on your competitor’s equipment.
Did you notice the incredible pricing leverage you have in this example? This leverage occurs when the financial outcome of the entire profit-making process drives the buying decision, and your equipment is a small fraction of the total cost.
In general, the broader your adjacent-effects scope, the more value-based pricing leverage you will have. However, the difficulty of substantiating your value during a sales process is also directly proportional to the scope of the adjacent effects. Take the solar cell example above. To substantiate your value, you would need to
- understand the economics of the entire profit-making process, not just the economics of your equipment and
- substantiate that your equipment deserves credit for the added profit.
No small task, but as you can see it can be worth it.
Click here for Part II of this series where I review “Defect processing,” “Getting ready,” and “Capital life” value models.