I drew this a while back to help myself remember the anatomy of the heart. It’s essentially a coronal view. I’m always amazed by the complexity of the human body.
If you’re developing a product or service you’ve probably come across the term Quantifiable Value Proposition (QVP). What is QVP and why is it important?
Your QVP is a measure of the value that you provide to your customers and clients through your products and services. As the name implies, the key concept of QVP is that the value you provide is quantifiable (ad hoc) – and it’s best if your QVP is also measurable (post hoc).
Your QVP should be aligned with your customer’s priorities and aspirations. If your customer’s #1 priority is increasing their sales conversions and your QVP is increasing sales conversions then your offering benefits are aligned with your customer priorities. If, on the other hand, your QVP was focused on increasing the number of leads, the conversation with the customer will be an uphill struggle. In this case, there’s misalignment between the customer’s priorities (sales conversion) and the QVP that you are promoting (lead gen).
Quantifying your value proposition helps you paint a vision of the future for your client. You are saying “through the use of our offering, you can expect XYZ benefits.” Measuring is important because it allows the customer to reflect on the purchase to determine if it met expectations.
Sometimes quantifying and measuring your value proposition is easy. As an example, let’s say your customer is a product development department in a medical device company. Your offering has the ability to help them save 3 weeks of time in the product development process through increased efficiencies. The QVP is that through the use of your product the customer will be saving 3 weeks in product development time. The QVP is also easily measurable by the client. At the end of their product development they compare to a previous estimate or similar project and see if they indeed saved time using your offering.
Sometimes your value proposition is not so easy to quantify – particularly when dealing with subjective experiences like taste, feeling, or satisfaction. In these cases, it is helpful to consider how your offering improves the customer’s condition. Are there simple ways to show they are better off with your product or service than without it? Does your product or service help your customer deal or cope with a problem and reduce its negative impacts?
Your QVP begins with understanding your clients top priorities and aspirations. Once you have a clear understanding of what matters most to your client you can then craft a QVP that helps them paint a vision of the future with your product or service. Your QVP will help you in determining your pricing and once you have settled on your business model you can Calculate your Customer Lifetime Value.
Customer lifetime value (LTV) is an important measure of unit economics for MedTech and HealthTech companies. LTV is a measure of your product or service offering’s profitability over a length of 3 to 5 years. Since the LTV is calculated over a time period, the profits are discounted to come to a net present value for each additional customer. Note that LTV does not take into account the costs associated with acquiring a customer (CAC), which is an important consideration that helps determine your sales and marketing expense.
The first step to determining your LTV is to decide on your business model. Do you plan to sell your product or service offering as a one-time fee? Do you have a razor-blade model where you sell a device with ongoing consumables? Will you have a subscription and ongoing service? Or maybe you have some combination all of the above? There are many business models to choose from and your choice will depend on your product or service offering and the core strengths of your team. Your choice of business model will also have an important effect on your LTV calculations.
Once you have decided on your business model, calculating the LTV requires a few key pieces of information:
1. Your product pricing and revenue streams: What is the price of your product? How much product do you expect your average customer to buy? Is there a one-time revenue stream, a recurring revenue stream or both? Do you have any upselling opportunities once you have landed a customer that do not require much work on behalf of the sales and marketing team?
2. Product repurchase rate: For one-time revenue streams, how frequently you think your customers will be repurchasing your product over a 3 to 5 year window?
3. Your customer retention rate: For recurring revenue streams, what percentage of customers will continue paying a recurring fee for use of the product or service?
4. Your cost of goods sold (COGS): How much does it take to produce or make each of your individual products? Note that this does not include costs associated with sales & marketing, R&D or administration.
5. Weighted average cost of capital (WACC): The WACC an estimate of how much of a premium investors place on investing today in your solution. The number is highly variable, but generally somewhere between 35 and 75 percent depending on the offering, financial markets and experience on the team. A high WACC means that revenues in later years become less important and this is one of the reasons you typically don’t see LTV calculations go beyond 5 years.
A simple spreadsheet can help you easily calculate your LTV once you have all of the above information. I have included a simple template based on a widget that you can use for LTV calculations here. The widget has a one-time revenue stream upon purchase, a recurring revenue stream for consumables, and a service upsell included in the calculations.
A positive LTV means that you are contributing to your gross profit with each additional customer. A negative LTV means that your unit economics aren’t sustainable and you may need to reconsider your offering’s value proposition, pricing, or business model. It could also mean that your offering is not profitable at lower volumes, however, at higher volumes your offering becomes profitable.
Whatever the case, LTV is an important metric to help understand your business’ unit economics and will be a key consideration for potential investors and savvy board members.
OK, so you’ve got the idea and maybe you even have a prototype of the product or service your are planning to offer. How do you determine what the price of your offering should be?
This question is often flummoxing for early stage entrepreneurs. After all, you are running an innovation-driven enterprise — your idea is new and meant to change the way people are currently doing things! How do you price something that has no direct comparison?
The first method of pricing is cost-plus whereby you determine the cost inputs that go into the delivery of your offering and charge a flat markup, say 20%, to come up with the final price. Cost-plus pricing is commonly requested from contractors by military and government agencies.
While cost-plus is the simplest way to determine your pricing — and often a good exercise as it forces the entrepreneur to understand the cost structure of their offering and the lowest price possible to remain profitable — it often leaves a lot of value on the table. In the early stages of your product or service lifecycle there are early adopters who are willing to pay a premium to have access to the product or service before anybody else. Also remember: your costs are irrelevant to your customer. They just care that your product is providing value at an amount they can afford!
Understanding pricing of your offering begins with understanding the Quantifiable Value Proposition (QVP) to your customer. In a B2B setting, the QVP can often be determined as the revenue gains or cost savings the business will obtain through the delivery of your offering. A good rule of thumb is to target your pricing to be about 20% of your customer’s QVP.
Let’s assume that you have done your research and are confident that through the use of your offering a company can reasonably expect to earn an additional $100K in revenues. As a first approximation, an offering price of $20K would be a good place to start — the client obtains plenty of value from having your offering and you extract a modest amount of the benefits. You have set up a win-win for both sides provided your cost structure allows for profitability at that price point.
The 20% figure is just a goal post in determining the pricing of your offering. There are other important factors to consider when you are looking to decide your pricing.
Does your company have a monopoly? If so, you may be able to command higher pricing.
Does the price come within your decision-maker’s budget? If not, your offering may require additional approvals and lengthen your sales cycle.
Does the price exceed the reimbursement the customer receives? Even if your customer receives benefits from your offering outside of reimbursement, it can be difficult to craft an appeasing story to the acquisition committee who may have a few metrics they make decisions on.
There are several other methods for determining pricing that can help you triangulate on your target customer’s willingness to pay. One method is looking at comparables: what are people already paying for similar products and services? If a customer has previously paid for a similar offering then it’s probably already in their budget. The friction to replace an existing offering is often a lot lower than bringing in something completely new. Another method is substitution: if a customer isn’t already using something similar to your offering what are they using instead? Understanding how much a customer is spending on substitutes can often lead to interesting dialogues with the customer about how your offering can better serve their needs and position them for future success.
Different customers will derive different QVPs from your offering so be sure to segment appropriately! Segmenting in this way can help to determine beachhead markets and branding opportunities within your offering. As you scale and are able to lower your cost structure, opportunities may open at the lower ends of the market where you can sell to customers and maintain similar profitability.
Finally, at the early stages of your company it is often necessary to offer a discount to early customers in order to build the customer base and win referrals. While discounts are a great way to drive sales, take care not to erode the perceived value of your offering and make sure there is a timeline on them so that the customer knows they are receiving a discount because they are taking an early risk. Hardware discounts are often much easier to remove than software discounts as people more readily recognize the tangible value of hardware.
Pricing your startup’s offering depends on several levers and requires an in-depth understanding of your customers needs and their willingness to pay. Cost-plus pricing should be avoided if possible as it tends to leave a lot of value on the table and entrepreneurs should focus on delivering and extracting value through their quantitative value proposition. Once you have settled on your business model and pricing you can now look at calculating your customer lifetime value (LTV)!
The Amazon shareholder letters written by Jeff Bezos provide an insightful glimpse into this exceptional organization.
I updated the file originally created by Austen Allred in his helpful post on Medium in 2018. The file now contains every shareholder letter from 1997 to 2018 so you have everything in one place. You can download the file here.