Services’ Value-Price Nash-Equilibrium:

Normative Principles

víctor tang PhD

victang@alum.mit.edu

©©vvtang
tang.
 Services’ macroeconomic value is well established

76 76
74
80 70 76
75
70 66
69
68
60
50 54 57 62
40
22 22
30 24 28 32 42 42
20 21 22 28 28 38 40
10 32 48 45
0

source: world bank data 2012 © v tang.

But what is a service’s microeconomic value?

system of interactions

work product
expectations
money
client provider
objects
Lucas time
production
?
Consulting
Project
value

© v tang.
How heavy is this concrete block ?

How science approaches this question.

Laplace

© v tang.
Service approach

How service approaches this question.

Please check appropriate box

super heavy  10
extremely heavy  9
very heavy  8
heavy  7
somewhat heavy  6
kind of heavy  5
not that heavy  4
not heavy  3
light  2
very light  1
extremely light  0
Laplace

© v tang.
Proposed services’ normative principles

Parity Principles apply to client and provider, albeit differently.

Benefit Benefits are denominated in monetary units.

Value Value = f(benefits’ intensity) and monotone increasing.

Value decelerates Value exhibits diminishing returns.

No-Free-Lunch (NFL) It costs to get value.

Multidisciplinary consistency
Cognitive psychology Fencher’s Law
Behavioral economics Prospect Theory
Game theory Nash Equilibrium
Financial accounting GAAP and DCF

© v tang.
 Example: Caterpillar Tractors
Adapted from Kotler, Anderson, Narus, 1999.

RELATIVE PRICE
$130,000
• Caterpillar
$100,000
• Competitor
$30,000

RELATIVE VALUE
$15,000
• Longer Usage [Durability]
$10,000
• Less Maintenance [Quality]
$10,000
• Less Downtime [Superior Service]
$5,000
• Fewer Replacements [Superior Parts]
$40,000
 Value|client = f(benefits accrued from the service)

services create resulting in measured

for the client… client’s benefits … by …

Competitive new revenues  +$

advantage
“old” revenues  +$
./
Market
expansion cost  |-$| if ↓ ≤0
Gross Profit  -$ if ↓ >0
Effectiveness
expenses  |-$| if ↓ ≤0
Efficiency NEBT  -$ if ↓ >0

Benefitsc $
© v tang.
 ∴ value|c = f(NPV of client’s four benefit streams)

Value|client = value in use

∫tN e i
i
-r ti dt ∫t
+ Rje-r tj dt + Cke-r kt dt + Eme-r mt dt
j
∫t k
∫t m

 NPV(New revenues)c+ NPV(expanded Revenues)c

+ NPV(Cost reductions)c+ NPV(Expense reductions)c

K.N. Otto, V Tang, W,P. Seering. 2004. Chapter 11. Establishing Quantitative Economic Value for Product and Service Features: A Method for Customer Case Studies. In The
PDMA Toolbook for New Product Development. John Wiley and sons. New York. © v tang.
 ∴ value|c = f(NPV of client’s four benefit streams)

Value|client = value in use

Ni Rj Ck Em
i + j + k + m
(1+ri )i (1+rj )j (1+rk )k (1+rm )m

 NPV(New revenues)c+ NPV(expanded Revenues)c

+ NPV(Cost reductions)c+ NPV(Expense reductions)c

K.N. Otto, V Tang, W,P. Seering. 2004. Chapter 11. Establishing Quantitative Economic Value for Product and Service Features: A Method for Customer Case Studies. In The
PDMA Toolbook for New Product Development. John Wiley and sons. New York. © v tang.
 Example of quantified benefits from a case study

Benefit example. Security of transaction approval

This metric quantifies the added revenue a store can expect with
less downtime of the checkout-to-bank approval communication
due to software or hacks.

Added revenue = C*N*f*(r1-r2)

C average customer transaction $ $9.00
N number of customer transactions/year # 600,000
F % of customer paying via e-payment % 40%
r2 sys. x hacker/virus reliability of bank-to-checkout % 99.990%
r1 sys. y hacker/virus reliability of bank-to-checkout % 99.960%
Reduced expenses = R*t
R Labor rate $/hr $60.00
t time reduction hr 10

One-time benefit = $1248.00

K.N. Otto, V Tang, W,P. Seering. 2004. Chapter 11. Establishing Quantitative Economic Value for Product and Service Features: A Method for Customer Case Studies. In The
PDMA Toolbook for New Product Development. John Wiley and sons. New York.
 ∴ value|p = f(NPV of four provider’s benefit streams)

Value|provider = value from use

∫t
Ni e-r it dt +
i
∫t
Rj e-r jt dt +
j
∫t ∫t
Ck e-r kt dt + Em e-r mt dt
k m

 NPV(N ew revenues)p+ NPV(expanded Revenues)p

+ NPV(C ost reductions)p+ NPV(Expense reductions)p

© v tang.
∴ value|p = f(NPV of four provider’s benefit streams)

Value|provider = value from use

Ni Rj Ck Em
i + j + k + m
(1+ri )i (1+rj )j (1+rk )k (1+rm )m

 NPV(N ew revenues)p+ NPV(expanded R evenues)p

+ NPV(C ost reductions)p+ NPV(E xpense reductions)p

© v tang.
Obviously, (value in use) ≠ (value from use)

By inspection of the terms in the provider’s and client’s

benefits equations, it follows that:

NPV(New revenues)c+ NPV(expanded Revenues)c

+ NPV(Cost reductions)c+ NPV(Expense reductions)c
≠ NPV(New revenues)p+ NPV(expanded Revenues)p
+ NPV(Cost reductions)p+ NPV(Expense reductions)p

Therefore, for a given service and a given client, provider’s

benefit stream ≠ client’s benefit stream.
 Value|c = NPV(net cumulative client benefits)

Client value - net worth of the $Vc client

benefits a client receives after value
paying for a service.

client
Therefore, when … incentive to
NPV of buy
benefit
 value ≤ price, $Vc ≤ $Xc, stream
no incentive to buy,
$Xc
 value > price, $Vc > $Xc,
∃ an incentive to buy,
price of
 value does not change, service
when price is raised
or lowered.

source: Anderson, J.C and J.A. Narus. 1999. Business Market Management. Prentice Hall. © v tang.
 Obviously, from client’s perspective …

 Willingness-to-buy for service-a and service-b

(Valueb-Priceb) > (Valuea-Pricea)
indicates which alternative is more attractive.
 Willingness-to-buy increases when value increases, i.e.
(Valueb-Valuea) > (Priceb-Pricea)
 Relative Value > Relative Price
Higher price
Value $Vc’ and
higher value.
Value $Vc
incentive’
Lower price to buy
and incentive
lower value. to buy
Price Pc’
Price Pc

Anderson, J.C and J.A. Narus. 1999. Business Market Management. Prentice Hall. © v tang.
 Value|p = NPV(net-cumulative provider’s benefits)

 Value : net worth of the $$

benefits that a provider value to client
receives after it gets paid. surplus
value to
client

FACTS: transaction price

surplus profit
reservation price
 When Value > Price,
∃ incentive to provider. required
provider profit
 Value does not change, when
price is raised or lowered.
 Transaction price is price of deal. provider
costs
 Reservation price is the lowest
price, which provider will accept.

source: Anderson, J.C and J.A. Narus. 1999. Business Market Management. Prentice Hall. © v tang.
 Value postulates

1. Value,V, is monotone increasing function of net.benefits.

2. There is a threshold net.benefit, s.t. value is zero.
3. “Benefit intensity” is defined as B = f(net.benefits/costs).
4. ΔV is proportional to increase in ΔB/B = “benefit intensity ratio”
i.e. dV=k*dB/B, k=constant.

⇒  dV = k dB/B
⇒ V = k*loge B + c

Fechner’s Law about least discernible difference (LND).

Dehaene, S. 2003. The neural basis of the Weber-Fechner law: a logarithmic mental number line. TRENDS in Cognitive Sciences, 7(4) 145-147.
Dzhafarov, E. and H. Colonius.. 2011. The Fencherian Idea. Summer. American Journal of Psychology, 124(2) 127-140.
Masin, S.C., V. Zudini, and M. Antonelli. 2009. Journal of the History of Behavioral Sciences, 45; 56-65. © v tang.
 Definition and examples of benefit-intensity ratios

• Rp : minimum price a provider will accept for its services.

This is the provider’s reservation price.
costp : providers costs to develop the service
• Benefitsp : discounted value of the provider’s benefit streams.
This is the value from use.
• Provider’s benefit intensity ratio is (Rp+benefitsp)/costp .
• Suppose Rp= $900.00, costp=$50.00 and benefitsp= $800.00
then (benefits intensity ratio)=38

• Rc : maximum price a client will pay the above service.

This is called the client’s reservation price.
costc : providers costs to implement and use the service.
• Benefitsp : discounted value of the client’s benefit streams.
This is the value in use.
• Client’s benefit intensity ratio is (Rc+benefitsc )/costc
• Suppose Rc= $900.00, costp=$40.00 and benefitsp= $2400.00
then (benefits intensity ratio)=37.5

© v tang.
 Vp Measure of value to provider
Value to provider = Vp = ln[α* NPV(Rp+benefitsp )/NPV(costsp )]
= ln [α*(benefit.intensityp ratio)] = ln(α*BIRp)
We call this ratio provider’s valutility.
Rp = provider reservation price
2.0
benefitsp= provider’s benefits stream
costsp = provider’s cost stream
1.0
α >0 is a provider specific multiplier.
0.0
0 10 20 30 40 50
Graphs on right hand side Vp -1.0 BIRp
Vp for:
α =10 -2.0
α =15
α =20 -3.0
α =30.
-4.0

© v tang.
 Vp Measure of value to provider

Value to provider = Vp = ln[α* NPV(Rp+benefitsp )/NPV(costsp )]

= ln [α*(benefit.intensityp ratio)] = ln(α*BIRp)
We call this ratio provider’s valutility.
Rp = provider reservation price
2.0
benefitsp= provider’s benefits stream
costsp = provider’s cost stream
1.0
α >0 is a provider specific multiplier.
0.0
Say α=1/20, 0 10 20 30 40 50
BIRp=20 ⇒ Vp = 0 Vp -1.0 BIRp
<20 ⇒ Vp < 0
>20 ⇒ Vp > 0 -2.0

BIRp=30 ⇒ Vp = 0.41 -3.0

=40 ⇒ Vp = 0.69
=55 ⇒ Vp = 1.0
-4.0
=90 ⇒ Vp = 1.5

© v tang.
Example of provider’s service economics

Value to provider = Vp = ln [α*(value.intensityp ratio)] = ln(α *BIRp )

= ln[α* NPV(price0+benefitsp )/NPV(costsp )]
Rp = provider reservation price
Vp= ln((1/20)*(Rp+180)/5)
benefitsp= provider’s benefits stream Vp= ln((1/20)*(Rp+200)/5)
costsp = provider’s costs to service Vp= ln((1/20)*(Rp+220)/5)

α>0 is a provider specific constant. 1.2

1.1

Example:

valutility
1.0

Provider’s reservation price, Rp 0.9

α =1/20, NPV(benefitsp)=$200K, 0.8

NPV(costsp)=$5K, Vp=1
0.7

1 = ln [(1/20)*(Rp+benefitsp)]/5K]
0.6
∴ Rp ≥ $72K 20 30 40 50 60 70 80 90 100
price

© v tang.
 Vc, Measure of value to client
Value to client = Vc = ln [β* NPV(benefitsc-Rc)]/NPV(costsc )
= ln (β*benefit.intensityc ratio) = ln(β*BIRc)
Rc = client reservation price ln(BIRp/20) ln(BIRp/30) ln(BIRp/15)
benefitsc= client’s benefits stream ln(BIRp/40) ln(BIRp/25)

costsc = client’s costs stream 1.5

β >0 is a client specific multiplier. 1.0
0.5
0.0
Graphs on right hand side, 0 5 10 15 20 25 30 35 40 45 50 55 60
-0.5
Vc for: Vc BIRc
-1.0
β =15
-1.5
β =20
-2.0
β =25
-2.5
β =30
-3.0
β =35
-3.5

© v tang.
Vc, Measure of value to client
Value to client = Vc = ln [β* NPV(benefitsc-Rc)]/NPV(costsc )
= ln (β*benefit.intensityc ratio) = ln(β*BIRc)
Rc = client reservation price ln(BIRp/20) ln(BIRp/30) ln(BIRp/15)
benefitsc= client’s benefits stream ln(BIRp/40) ln(BIRp/25)

costsc = client’s costs stream 1.5

β >0 is a client specific multiplier. 1.0
0.5
Say β=1/25 0.0
0 5 10 15 20 25 30 35 40 45 50 55 60
BIRc=25 ⇒ Vc = 0 -0.5
BIRc<25 ⇒ Vc < 0 Vc BIRc
-1.0
BIRc<25 ⇒ Vc > 0
-1.5

BIRc=40 ⇒ Vc = 0.47 -2.0

=50 ⇒ Vc = 0.69 -2.5
=65 ⇒ Vc = 0.96 -3.0
=80 ⇒ Vc = 1.34
-3.5

© v tang.
 Example of client’s service economics

Value to client = Vc = ln (β*value.intensityc ratio) = ln(β*BIRc )

= ln [β*NPV(benefitsc-Rc )]/NPV(costsc )
Rc = client reservation price
Vc= ln((1/24)*(550-Rc)/7)
benefitsc= client’s benefits stream, Vc= ln((1/25)*(550-Rc)/7)

costsc = client’s costs to service Vc= ln((1/26)*(550-Rc)/7)

β >0 is a client specific constant. 1.15

1.10

1.05
Example:

valutility
1.00
Client’s reservation price, Rcr
0.95
β =1/25, NPV(benefitsc)=$550K ,
costsc=$7K, Vc=1 0.90

0.85
1= ln [(1/25)*(benefitsc-Rcr)]/7K]
0.80
= ln [(1/25)*(550k-Rcr)]/7K] 40 50 60 70 80 90 100 110 120
∴ Rcr ≤ $74K
price

© v tang.
Nash Equilibrium
Vp= ln((1/20)*(Rp+200)/5)
Vc= ln((1/25)*(550-Rc)/7)
1.03

1.01

valutility 1.00

0.99

0.98
68 70 72 74 76 78

provider client
reservation price reservation price
region of
Nash Equilibria for
transaction prices
© v tang.
Services’ Normative Value Principles

Parity Principles apply to client and provider, albeit differently.

Benefit Benefits are denominated in monetary units.

Value Value is monotone increasing = f(benefits’ intensity).

Value decelerates Value exhibits diminishing returns.

There-Is-No-Free-Lunch (TNFL) It costs to get value.

Multidisciplinary consistency and coherence

Cognitive psychology – Fencher’s Law
Behavioral economics - Prospect Theory
Game theory - Nash Equilibrium
Financial accounting - GAAP accounting rules, DCF

© v tang.
OK, but … what is missing?

“… there is no fundamental difference in the

basic principles of measurement in physics,
chemistry, laboratory medicine, or engineering.

Furthermore, an attempt has been made to meet

conceptual needs of measurement in fields such as
biochemistry, food science, forensic science, and
molecular biology”.
2012
International Vocabulary
of Metrology: VIM

(c)©vvtang
tang.
 Call to Action: Services Metrology

metrology  science of measurement and its application.

service metrology  metrology for services.
measurement  process of obtaining quantity values.
measurement output  result of a measurement, a quantity.
measurement standard  used as a reference. Realization of a quantity.

unit  abstract concept, defined either by reference to some

material standard, natural phenomenon, or defined process.

Законодательной основой деятельности по обеспечению единства измерений в

Российской Федерации является Закон РФ “Об обеспечении единства измерений”, принятый в 1993 г.
Деятельность по реализации указанного Закона, выполнение функций и полномочий в области метрологии в соответствии с
Указами Президента РФ от 09.03.2004 г. № 314 и от 20.05.2004 № 649 и постановлением Правительства РФ от 17.06.2004 г.№
294 осуществляются Федеральным Агентством Российской Федерации по техническому регулированию и метрологии
(Ростехрегулирование), которое находится в ведении Федерального Министерства промышленности и энергетики
(Минпромэнерго России).

© v tang.
Call to action

NEED For service science and service engineering to mature and be recognized
as field of academic discipline and professional practice, it needs to be supported by
rigorous measurements, measurement principles, and a body of recognized units.

GAP There is an obvious gap in the metrology of service science, service

engineering, and service management. This gap is particularly challenging because
it is multidisciplinary requiring interdisciplinary skills.

PROBLEM This gap impedes and inhibits the development of service as a science,
academic discipline, and professional practice.

OPPORTUNITY Make a fundamental contribution to service science.

ACTION PLAN Begin immediately …

 Form a working team to develop a strategy for service metrology.
 Write a working paper and circulate for comments.
 Submit paper to NIST and create a formal working relationship with NIST.
 Work to include services in the VIM document for 2015.

(c)©vvtang
tang.
 Service value
 Value normative axioms
Parity principles apply to client & provider, but differently.
Benefit denominated in monetary units.
Value value = f(benefits’ intensity) and ∂v/∂b>0.
Value decelerates value exhibits diminishing returns, ∂2v/∂2b<0.
No-Free-Lunch (NFL) it costs to get value.
Multidisciplinary is required.
consistency

 There is value-in-use and value-from-use; two kinds of service value.

Value to provider = Vp = ln[α* NPV(Rp+benefitsp )/NPV(costsp )]

= ln [α*(benefit.intensityp ratio)] = ln(α*BIRp) = value-from-use

Value to client = Vc = ln [β* NPV(benefitsc-Rc)]/NPV(costsc )

= ln (β*benefit.intensityc ratio) = ln(β*BIRc) = value-in-use

 Price determines the Nash-Equilibrium between client & provider.

© v tang.
© vtang
 references

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confidential
© v tang.
Questions ?

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