A friend of mine who goes by pen-name of Prodicus and who also has many more years of giving wise advice to all sorts of companies, has recently engaged me into a discourse on how human nature is impacting business decision-making. I decided, with his permission, to publish these thoughts in my blog. The first “unanswered question of marketing” deals with the question of pricing new product. All companies, no matter what size or industry, will deal with this question at least once in their existence. Here are a few insights on how to think about this challenge.
Have we ever underpriced our product?
Product Manager (PM): “I am happy to report that we have wrapped up our market study on the QX product. The research reaffirms our initial analysis that we have a sure-fire winner. The QX far outperforms the competitors’ products currently on the market, and our R&D department seems confident that we will have a defensible patent.”
General Manager (GM): “Finally some good news! You chaps have been working on the QX for a year and a half. Give me a quick snapshot of the market conditions and economics of QX.”
PM: “Well, there are three competitors currently that are producing the incumbent product that QX will take on. All three are comparable products and priced within pennies of each other. One competitor has about 60% market share, and the balance is split between the other two. We estimate the market for QX to be around $65 million, with the current product selling for about $6.15/lb.”
GM: “Sounds like a nice sized market. What is the value proposition for QX?”
PM: “QX can replace the competitive products, and in addition demonstrate two additional benefits to the customer. One, the customer will realize significant fuel savings by switching to QX. We have estimated these savings at $2.88/lb of material used. Two, the customer will no longer need to use an additive that he currently uses. Our research tells us that on the average the customer would save $1.19 in additive costs, per lb of QX used. And to top it off, we see no significant technical impediments for QX to replace the current material being used.”
GM: “And what are you proposing as our introductory price?”
PM: “I am still in discussions with sales, and the folks in production. We seem to be converging on an introductory price of $5.99/lb.”
PM: “Sales thinks staying just under the competitor’s price of $6.15/lb will get the customer’s attention. Our cost figures have come in at $4/lb. At $5.99/lb we clear a tidy 50% gross margin, well above our corporate hurdle rate of 35%.”
GM: “Are we underpricing the QX? It seems capable of creating a great deal of value for the customer.”
PM: “I don’t think so. We are coming in just below the price in the market and we have the cost position to justify it.”
GM: “Still, I feel we are leaving money on the table and will never know how much we could have charged.”
This conversation while hypothetical is not at all uncommon in B2B settings. To better understand the GM’s concern with leaving money on the table put yourself in the role of the PM.
The choice a PM is faced with is to go either for a sure thing, in this case a price below the competitor’s offering coupled with a value proposition that saves the customer $4.07/lb ($2.88+1.19) in other savings. Or, to be more aggressive in pricing by gunning for a higher price to justify the enhanced performance of the QX product, but run the risk that the market may not go for it. What incentive does a PM have to go with the second option? A success is a success, and a smaller success has an equally good personal payoff for the PM without the additional risk. And, who is to know that we could have had a larger (i.e., higher priced) success!
This phenomenon of minimizing personal risk in pricing decision-making is one of the thorniest issues in pricing decisions. Helping PM’s cope with this risk takes a thoughtful GM who is willing to push the PM’s reasoning and justification for a price point. In addition, for a PM to step up to a more aggressive stance on pricing decisions, the GM will need to be more open to sharing some of the risk with the PM.
Some pricing mantra’s to bear in mind:
1. While customers are quick to tell you that your prices are too high, rare is it for a customer to call to inform you that you could have charged more.
2. Increasing a price is a matter of blood, sweat and a lot of tears. So get it right the first time.
3. Post-introduction, the pressure to reduce price is relentless.
4. Your customer is not particularly interested in your costs, only in the price that they expect to pay.
5. Service, even great service, is table stakes. Don’t expect a higher price for your product because of it (at least not for any length of time).
6. Customers will not pay for performance they do not need.
7. If you have a better product, please ask for a price that is worthy of it.