New Product Pricing - A Quantitative Approach

“Price Is What You Pay, Value Is What You Get.” - Warren Buffet

In his book, Aïm for life mastery, Raymond Perras describes how peak performance is achieved by applying the right stuff, in the right amount, at the right time (Perras, 2011). Process improvement should be tackled in a manner that is strategic, structured, systematic as these three elements lead to peak results.

In addition, a business should also look for scalability to benefit from economies of scale as production costs get spread across more units, resulting in higher profit margins.

NEW PRODUCT PRICING

Price is the most powerful lever to profitability in the four Ps of the marketing mix: product, price, promotion, and place. A study of S&P 1500 companies performed by McKinsey & Co. suggests that raising the price one percent will improve profitability by over 7%.

Notwithstanding, leadership teams often maintain status quo when it comes to the adoption of new price strategies because price is a double-edged sword that, if set incorrectly, can hurt the business. The fear of breaking the business or facing the possibility of an upset customer is often greater than the desire to gain an uncertain profit. Still, many approaches and tools exist to find the right price to achieve maximum profits using minimum effort and resources.

ADOPT AN APPROACH THAT IS STRUCTURED AND SYSTEMATIC

Product managers are often asked to set new product prices without being provided structure or systems to perform the task. This can lead to an attitude of complacency resulting in conservative price decisions taken to “protect the business” by meeting limited, tepid, expectations instead of targeting for aspirations in a way that inspires the team. The results are often fleeting and reduce the credibility of price as a lever.

The symptoms of a non-systematic approach can be recognized in the following ways: Business leaders unable to explain how the price was set and what benchmarks were used. Teams failing to grasp if they will be leaving money on the table. Launch failures with the market responding negatively to a high price and choosing an alternate solution and/or profits simply failing to meet expectations, and Functional groups pointing fingers at each other without specific examples.

Consider that approaches that are structured, strategic, and systematic will provide a quantitative baseline to enable your team to reproduce successes and/or learn from past failures towards improving performance from one launch to the other. Your product management team will also gain a deeper understanding of how buyers value your product against other solutions in the market.

USE VALUE-BASED PRICING VS. COST-BASED PRICING

We recommend a value-based approach supported with conjoint analysis to evaluate the price of new Instruments against competing solutions. The conjoint analysis is a survey-based statistical technique that is used to determine how people value different attributes that make up an individual product or service.

While cost based pricing may seem to guarantee that you will meet a targeted margin, it doesn’t guarantee that the market will accept your price if your costs are too high in comparison to the industry. You may also be leaving money on the table if you are building a product within your core competencies where you may be a cost leader. A price set too low may not provide a volume uplift if it triggers your competitors to react in a way that leads to a price war where everyone loses.

In addition, consider performing a new product price evaluation early in product development to provide the leadership with an understanding of what the market is willing to pay against alternate solutions. The insights will inform you on whether your costs will allow the business to make the profit margins that it desires or not and focus on a solution that provides the highest rewards for the business. Even if there is not competing product, clients may create their own alternative solution as they are not tied to a single product or company.

DEFINE YOUR PRODUCT UTILITIES

Define the different solutions in the market to ensure that you capture all the product utilities available to your client. The objective is to get to price recommendation(s) for the new product(s) in a way that is strategic, systematic, structured, and scalable.

Clients will compare your new product to other alternative solutions to solve their problem. It is important to broaden your focus to consider what buyers value most from your competitors. Break down each solution into the most important utilities towards creating a product utility/value matrix that is holistic.

IDENTIFY SUBJECT MATTER EXPERTS

We recommend creating a group of up to six subject matter experts (SMEs) based on their knowledge of the product and/or customers. Bring SMEs together to discuss the relative importance of product utilities from a selection of relevant solutions that your client could consider to resolve their problem. We encourage discussions and debate to explore different points of view to get participants to perform pair-wise comparisons that will serve as input in the conjoint analysis.

USE A QUANTITATIVE APPROACH

The pair-wise comparisons can be used as inputs to evaluate the weight of each attribute using a conjoint-analysis. Not everyone is familiar and skilled at translating their thoughts into numbers. It is important to perform a consistency analysis to make sure that the responses are valid and truly convey the thought process of the subject matter expert. A sensitivity analysis is recommended to understand the range of your price as different clients will value your product in different ways.

You should consider an approach that also provides insights on the value of each product utility for your new product as well as for competing solutions. This will help your team understand the differential value of your product against other competitors and how buyers value each product utility in the market.



APPLY STRATEGIC ADJUSTMENTS - (THE ART OF PRICING)

The product management and leadership team are now equipped with a neutral base price that is supported through a quantitative approach. The team can now choose if they want to enter the market with a skimming, neutral, or penetration pricing strategy within boundaries recommended from the analytics. This is where experience can be learned to achieve Peak Performance™ towards pricing, commercial and organizational excellence.



CONCLUSION

We recommend a quantitative value-based approach that is strategic, systematic, structured, and scalable. Post launch analysis comparing results to initial objectives and testing original hypothesis will provide an opportunity to learn, gain deeper understanding of how your buyers value your products, and progress from one new product to another to make the necessary adjustments to reach peak performance.

References

Perras, R. (2011). AïM for Life Mastery: A Process That Will Empower You to Reach Your Chosen Level of Performance While Reducing Stress.