How to Make Sure You Get the Price Your New Product Deserves

Article by Alain Meloche, Managing Partner at SPMG
Written for The Toronto Product Management Association

Your company’s President has approached you directly, saying that a new product is being introduced and that it represents the future of the company as he expects great growth potential from this initiative. As the Product Manager, he wants you to find the right price that’s going to capture the value but provide an incentive for the company to capture market quickly, as competitors are very aggressive.

New product pricing, given its sensitivity, highlights overall pricing issues and so is valuable as an example of the issues that need to be considered in the pricing of products.  But overall, it is also becoming a more significant issue for a growing number of firms as product lifecycles shorten and the level of competition increases. As for all products, but especially so for new products, the pricing of these products is especially difficult as there are a number of different and sometimes conflicting, factors at play. Internally, the finance department may want to ensure that development and implementation costs are at least covered and ROI targets met while the marketing group may want to maximize market acceptance and share. Externally, customers may want the benefits that a product provides but may hold back if they perceive risk associated, especially with a new product’s purchase.

How do you balance these various factors and set a price for new products? Our experience has led us to believe that resolving some basic questions provides a roadmap to setting those prices.

1)     What strategic objectives should those prices support?

2)     How does the new product fit within the context of the existing product portfolio?

3)     What benefits would customers receive from the product, actual and perceived?

4)     How could the price level and structure be set to capture all the value offered while taking into account customers’ costs and risks associated with new product adoption and the competitive environment?

1) Strategic Objectives in Setting Price

Whatever the chief strategic concern for a new service or product, price should help address it. This is true no matter what that concern is—whether to achieve rapid penetration of the market, retain customers, or protect margins despite uncertain costs. In each case, the strategy should be reflected in the price.

For example, new long distance providers, with high fixed costs but low variable costs and believing that customers were price sensitive, undercut prices of existing suppliers in order to rapidly gain market share. Everyone is familiar with regular price changes for gasoline based in part on gas companies passing on their feedstock cost uncertainties into the marketplace. “Whole life” insurance is priced highest for wage earners with young families and declines as needs and ability to pay declines- retirees and those on fixed incomes- thereby helping to retain customers for life.

The product lifecycle is a useful framework for thinking about how corporate objectives may change over time and these are shown in Figure 1. below.

Figure 1. Product Lifecycle and Objectives for the product

Companies using pricing strategies in support of those objectives, either explicitly or implicitly balance price with the value provided by their offering as shown in Figure 2.

Figure 2. Price/ Value and Pricing Strategies

There are two basic strategies available for new product release prices.

Premium

·         Demand is likely to be price inelastic

·         There are buyers that have a wide range of acceptable prices

·         Little is known about production and/or marketing prices

Penetration

·         Demand is price elastic

·         Entry barriers are low

·         No separate price-market segments that could accept a wide range of prices

·         Large sales volumes lead to economies of scale

In turn, there are three key elements that determine whether premium or penetration pricing should be used:

·         Nature of the product

o    Revolutionary

o    Evolutionary

o    Me-too

·         The potential competitive response

·         The potential competitive response

·         The existing product portfolio and the resulting company position

The value of new products typically increases directly proportionally to whether the product is me-too, evolutionary, or revolutionary. This in turn, provides guidance relative to the extent that penetration or premium pricing strategy should be pursued. The newer or more revolutionary is the product, with the fewer the comparables, the greater is the opportunity to seek premium pricing. On the other hand, for products that may simply be new to your own company, but not to the market, the opportunity for premium pricing is limited. Penetration pricing is more realistic, but, given existing competitors and their competitive responses, realistically, pricing should occur closer to the price/value equivalency line. Opportunities for penetration pricing occur again at the lower end, with low price/value where the competitive threat presented may not warrant strong competitor response.

2) New product fit within the context of the existing product portfolio

While a new product may represent an entirely new niche or position for your company, its position, to some extent will still be judged in terms of your existing portfolio. Think of the Volkswagen Phaeton. While it represented a completely different product from the existing Golf, Jetta, and Passat lines, the market still judged the new product in light of that existing product line. It was difficult for customers to make the leap from the $15,000- $30,000 price band into products that started at twice that level.

The issue of cannibalization also affects release price. Let’s suppose that Volkswagen had released the Phaeton in the $35,000-$40,000 price range. While it would have been more consistent with Volkswagen’s existing position, the incremental $5,000-$10,000 price over the top end of the Passat may well have led to significant cannibalization of Passat sales. After all, for that relatively minor amount of money, buyers at that range, with somewhat less price sensitivity may have chosen a clearly superior product. The question then became: would a buyer of a brand such as Mercedes or BMW have been willing to switch given the value ascribed to the Mercedes and BMW brands?

The fatal error in VW’s perception was its belief that only performance and other “hard” quality criteria were used by customers to judge the value of the product. The result was a market that perceived an overpriced product while VW was marketing based on the assumption that market was prepared to accept a product in a substantially different position from the rest of its portfolio due to a price/value offering better than its competitors. The approach may have been valid had the market judged value purely on the basis of engineering factors.

Conversely, BMW could choose to launch a cheaper vehicle at a lower price point. While BMW internally, may believe that by pricing to penetrate into a new market segment as shown  in Figure 5, the market may perceive that BMW market strategy is one of pricing generally above the value line so that the quality of the new product may be suspect. The connotation in the market’s mind may then bring the overall perception of BMW market position down the value/price chart. So, it’s important to recognize that price makes a statement about your product. While VW had wanted to make a statement about its”new” product quality, the market viewed that statement as significantly inconsistent with the current position.

3) Actual and perceived benefits from a product

To understand how much of a premium can be charged at the upper limit of the price line requires some understanding of the benefits of the product. Again, this depends on several factors, the most important of which are:

1)     The customer’s industry ( i.e. consumer, business,..)

2)     The product’s life stage: me-too, evolutionary, revolutionary

The degree to which these can be measured with some degree of precision and the extent to which actual to perceived benefits are balanced are represented in Figure 3. As can be seen from that chart, the most readily measured benefits are related to those products that are well established in the marketplace and sold on a B2B basis. Revolutionary products sold to consumers are those the most likely to be sold on the basis of perceived benefits. 

Figure 3: Impact of the Nature of the product and the Customer’s market on Benefits Focus

In the case of a B2B sale, incremental benefits, however, can more easily be quantified through a value chain analysis where the seller can make estimates as to benefits such as supplies, H.R. resources that may be saved through purchase of the new product.

For B2C estimates of the value added, perceptions of the benefits are more likely to lead decision making.

4) Setting Prices

There are two key elements in pricing be it for new or existing products: level and structure.

Level

Release price sends an important message to the market as seen in the automotive case discussed above. Two approaches were highlighted in the automotive case and discussed subsequently;

• Premium
• Penetration

For premium pricing, the question is : what’s the upper limit? Three factors, in turn, are involved in that answer:

1)     Incremental benefits (actual and perceived)

2)     Existing perceptions of the company in the marketpalce

3)    Actual and perceived costs and risks of the purchase by the customer

For penetration pricing, the question is: how low should you go?

1)     At the lower limit, consider cost-plus

2)     Competitive response is a critical factor since too low a price will likely elicit strong competitor response.

3)    Market uptake (volume) needs to be balanced with the potential margins that could be obtained by pricing closer to the benfits actually provided by the product

Structure

Again, it’s critical that the structure be designed so that corporate and customer objectives be supported by the price structure. For example, 25 years ago, few vehicles were leased while today, approximately 20% of vehicles are leased. Through this pricing structure, price was effectively deconstructed, allowing for easier purchases with less money upfront. Also, through the nature of that structure, those leasing cars continue to outlay money to the manufacturers on an ongoing bais as leases expire and consumers typically lease another vehicle.

Key Learnings

The importance of new product pricing lies in its highlighting of issues that are common to pricing generally. In this case, three key points stand out:

1)               Understand what customers will be using to measure value (unlike the engineers at VW)

2)               Understand where your product lies in the spectrum of new products:

a.     If it’s entirely new, with no comparables then more pricing flexibility is possible

b.    For a product with better performance characteristics than existing comparables, the magnitude of incremental pricing can be more easily quantified as the measures/ metrics for the benefits are clearer.

c.     If a product is only new to your company, then pricing needs to be based on competitive factors.

3)               Quantify, quantify, quantify- to the maximum extent possible: BUT, always take into account the broader context and common sense!