Your R&D has gone well, and you’re approaching commercial introduction soon. You are probably reworking a spreadsheet to put some more detail into revenue models. You might be ready to engage on a trial with a lead customer. Whether a first product, a new member of a portfolio, or the 100th product, setting price is arguably the most fundamental go-to-market decision you’ll make.
When you have existing products with a track-record in the market already, and you are introducing version five, you have a lot of data in hand and the choices are easier. That situation probably warrants a blog entry or two of its own. The discussion below will still have value. Primarily, though, these points are aimed at market entry for a new product in an untested landscape.
Your pricing strategy should consider these six points :
- Discounts and Promos
- Price Evolution (contingencies!)
- Payback and Break-even
- Product Lifetime curve
Each will be discussed briefly below. But let’s preface that by saying that no one approach is going to give you the definitive answer. The best strategy is to work through each approach to see what it gives you, then consider an initial price based on the variables of your specific situation.
Price to Market
This is the dominant strategy used in consumer products and services. Basically this is the process of gathering data on competitive products and prices, and positioning yours within that spectrum based on your assessments (or ideally customer consultations) of quality. Thus if your data suggests your product is in the top 20% of products in the space, you can price within that range as well. One has to turn off their “my-baby” product bias here, and this is where impartial customer testing is very helpful. Given a range of prices for comparable products, tactical decisions can be made about targeting direct competitors with your pricing.
Price to Margin
Even if you feel that the Price-to-Market strategy has given you a concrete answer, you must do this analysis as well. This is where you look at your product cost, and add your desired mark-up, and see where it comes out. Again, you need to look at this in the context of the competition. Even if the product is in a new segment, if your product solves a problem for the customer, you need to consider your pricing against the current way the customer solves the problem.
Bottom line here is that if you cannot make a suitable margin on your product when priced against the alternatives (direct competitors or alternative solutions) you need to either go back to the drawing-board on the product design, or even consider whether this is a market you can viably serve at all.
Margins are a relative thing – industry data shows that a successful restaurant lives on an aggregate 4 or 5% margin, while a successful electronic product manufacturer can manage a 50-60% margin. Hopefully you know what to expect before you embark on addressing your chosen market.
Discounts and Promos
Given a stake in the ground to mark your price, the marketing strategy for the product or service is important as well. There are often product goals beyond selling an individual item (or service) to a customer in a one-time sales event. A successful company builds brand loyalty, develops relationships, and generally tries to add value to a customer’s situation beyond delivering a quality product.
Repeat customers mean long term business success through a lower cost-of-sales, whereas one-off customers mean you have to work just as hard for the first widget you sell as you do for the 1000th. Thus discounts and promotions are often a useful tool.
Your pricing strategy should clearly define where discounts can be applied and where they shouldn’t. It should define discount profiles that don’t decimate your ability to operate. They shouldn’t restrict your ability to make future sales by creating an expectation in the market that everyone gets 50% off all list prices.
Discounts and promos are particularly useful for ‘up-selling’ in encouraging a customer to consider instead of buying widget A at full price, getting widget ‘A’ at 30% off when it is purchased with widget ‘B’ and widget ‘C’ as well. But do the arithmetic to ensure that you do not craft elaborate money losing packages that cripple your business.
Invariably market places evolve. Your product price is unlikely to be a static thing, and you should plan ahead for how it will change. Changes could be required based on general cost-reduction of producers, where competitors are able to reduce their costs and lower prices. Similarly, increased costs in means of production may start to erode margins and required you to raise prices. A new entrant may aggressively attempt to secure market share by undercutting the field.
In all cases, decisions need to be taken in the context of market share, cost, margin and operational complexity. Does the cost of changing your systems negate any improved earnings? Will there be additional frequent changes required as well? Will a price-point war with a competitor bring you both out of business?
By anticipating the road ahead, and sketching your pricing boundaries you can survive surprises. Recognizing that markets evolve is a prudent strategies. Keep in mind, and document your contingencies for responding to unexpected threats. If a new entrant shows up tomorrow with similar features at half the price, what is your response going to be?
Payback or Break-Even
When setting price, it’s important to consider the whole product lifespan. When the development costs, and end-of-life costs are added into your production costs, at which point in your product sales lifespan will you have paid back all costs? When will the product become obsolete, and will the cumulative profits of the product cover the original R&D costs, plus those in getting to market in the first place? Is=n that context is this still a product you want to introduce?
When setting initial price, do the work to model not only the margins you want to achieve on a per-unit basis, but also consider pricing that recovers full development and introduction costs at some number of months or years into the sales projections. A good rule-of-thumb to begin with is to seek payback one third of the way through the product’s market-viability period. Whether you wish to make that a quarter or a tenth will depend on your corporate expectations, and market segment. Expectations when making cell phones are going to be different than making wheel-barrows.
Product Life-time Curve
As a product ages in the market place, a prudent business is consistently researching ways to produce it more efficiently.
The typical approach is to lower costs of components and materials, incrementally improve performance, reduce waste and environmental impact in manufacturing, make processes and procedures cheaper and faster.
At some point, sales begin to wane and decisions are made regarding discontinuation. Pricing can be an effective tool in managing that curve. When margins are sufficiently improved, a product with a diminished customer-value can often take a position in a lower-tier niche. Perhaps as an entry-level product serving as a stepping-stone into your higher-performance products. Or perhaps it can serve a more price-sensitive off-shore market. Sometimes social benefits can be had by donating the now lower-cost model to cash-strapped non-profit businesses. Tax benefits are sometimes possible based on retail-price value, while bottom-line costs to your business for the benefit are minimal, while enhancing goodwill.
A few last thoughts…
Full Product Cost – remember that product costs are more than just the materials that go into individual units, or the cost of the labour and consumables during a service call. There are substantial costs related to the R&D expenses, the selling costs, the advertising and marketing, and even just keeping the lights on in the head-office. Understanding your costs of development, support and overhead are important facets of your pricing decisions.
Customer Cost of Ownership – Remember to look at the customer’s perspective. What are their other costs beyond the simple purchase of your product or service? If you can map out all costs, tangible and intangible, from start-to-finish, you can better understand your pricing options. If your product reduces other costs for the customer, it can allow you to price higher than a competitor if you are able to articulate that value to the customer. You may also be able to ease other elements of the buying decision for the customer, which contributes to a stronger relationship.