The Process for Pricing Innovation
How do you price an innovation? You have been working on a new product or service and getting ready to launch, but what price should you put on it? If there is nothing else like it, how do you price it? What is the process?
As most people have heard: Companies should have started the pricing exercise before building the innovation. Especially if the innovation is designed to drive profits, the value of the innovation should have been quantified, at least at the bracket level. This ensures that the innovation is worth developing. But it is likely your company didn’t do that.
So, now you need to get a price on it and the launch date is coming. What do you do?
The standard consultant answer, “it depends” isn’t good enough. We can do better.
The Innovation Pricing Process can be broken down into three key steps; two are focused on gathering facts, one involves fact-based decision-making:
- Internal Research with Economic Value to Customer
- External Research with Voice of Customer
- Pricing Strategy Decision
Internal Research with Economic Value to Customer (EVC)
Economic Value to Customer (EVC) defines the true value of the innovation for the customer. It looks at the financial impact of your innovation compared to the competitive alternatives or status quo.
In construction, one uses the cost of the alternative that is being displaced as a starting point. Then, one identifies the differential benefits, both positive and negative differentials. For each benefit differential, one attempts to define a model of the economic impact sprung having or not having that benefit. The key in this model is developing rational expressions of how the benefit drives value (or value drivers) that are based on fact, and not conjecture or plug estimates.
For business markets, these value drivers generally translate into monetary value around how the offering drives revenue, reduces costs, or impacts risks. Once all have been quantified, one starts with the cost of the alternative, adds the positive benefits differentials then subtracts the negative benefit differentials.
In essence EVC uses a part-worth utility approach, just like conjoint analysis, when defining the value. Unlike conjoint, it quantifies the true economic value rather than customers price expectations.
Why is EVC necessary? Because the company needs to know the value it creates for customers, and how it creates that value if it wants to be able to either communicate its value proposition or capture its fair share.
EVC can be likened to a value discovery phase in pricing innovation: “How much value are we really creating here? Is this a big deal or a small issue?
With a skilled team, a solid EVC can be done in weeks. Without a skilled team, the results are likely to be poor and the effort to drag on to an ill-defined future.
Once the EVC is complete, or as complete as it is going to get given the facts that can be gathered, it is time for a decision: Abandon the Initiative, Do More Internal Research, Move Forward to External Research, or Go Directly to the Pricing Strategy Decision.
External Research with Voice of Customer (VoC)
Voice of Customer (VoC) reveals customers perceptions of the innovations. One can use this approach to (1) clarify uncertainties in the core facts underlying the EVC, (2) understand how customers perceive the benefits and the offering overall, and (3) reveal customer price expectations.
In execution, one starts with designing the areas of inquiry and sample informant size and target segment requirements. Once well-constructed, interviews are held and information collected. This raw information is then synthesized (analyzed and summarized) for management digestion.
In VoC design for pricing, one will often use Gabor-Granger of Van Westendorp Price Sensitivity Meter techniques. While these have been repeatedly proven to be poor research techniques for estimating willingness-to-pay much less optimal prices, they do reveal customer price expectations. They are also relatively easy to execute and are suitable with smaller samples, such as is common in VoC research.
With a skilled team, a solid VoC effort can be done in weeks. Without a skilled team, the results are likely to be poor, and the effort may appear herculean.
Once the VoC is complete, it is time for a decision: Abandon the Initiative? Do more Internal or External Research? Or Make a Pricing Strategy Decision?
Pricing Strategy Decision
A good pricing decision is two-fold: One defines an aspirational list price and a commercial policy that deducts from this list price known discounts, which lead to the expected target prices by customer segment and perhaps channel.
To drive this decision, one updates the previously constructed EVC with the facts gathered via external research. As necessary, one also calculates the EVC by segment since different customer segments will value the innovation differently.
From the EVC, and informed by the VoC price expectation work, one then defines the capturable value. We suggest starting with the Half-Gains/Double-Losses Rule, then overlay the 50/30/15% Rule as appropriate. From this, one will identify the price by market segment.
Using segment sizes and now knowing the expected capturable price by segment, one can define block demand curves and the expected optimal price.
Again, with a skilled team, the pricing strategy decision can be driven relatively quickly. Without a skilled team, the results are questionable and the decision making will seem highly uncertain—if not mere guesswork.
Once the pricing strategy decision has been formulated, it is time for review. We listed it as CEO review to denote the person accountable for the decision. At that point her/his options are: Abandon the Initiative, Do more Internal or External Research, or Launch with a Price.
Getting Pricing Done Right
Pricing innovation isn’t a mystery, much less should it be a “gut feel.” It is a process. How much of this a company does will depend on the importance of the innovation, the pricing maturity level of the company, and the time and budget restrictions. But, as you can tell from above, it can be done efficiently with a well-defined process.