Pricing New vs. Existing Products
Truth be known, many suppliers guess at the price for their new products. If they guess too high, their customers let them know by refusing to buy. What if they price too low? Well, those customers hate to nitpick: They’ll overlook the mistake and let it go this time. Some suppliers don’t realize how underpriced they are until they try to rationalize products and find customers willing to pay much, much more.
In this issue, we’ll explore how to price new—not existing—products, for three reasons. First, at AIM we focus strictly on new product development; others are more qualified to help you fix existing product pricing. Second, we think it’s a crime to optimize pricing only after years of giving away value. Why not enjoy great margins from the very beginning, for the entire product life?
Once your new product is launched, the pricing insight window usually closes.
Third, customers will help you set prices before—but not after—you launch your new product. Really? Sure, customers want you to develop innovative new products and services that deliver value to them… so they’ll give you insights early on to make this happen. If you’re clever about it, these same insights allow you to establish optimal pricing. But once your new product is launched, the pricing insight window usually closes.
Before we dive into this, let’s be clear we’re talking about customer-focused pricing, not supplier-focused or competitor-focused. Supplier-focused pricing is often called cost-plus pricing. Any correlation between cost-plus pricing and optimal pricing is purely coincidental. It’s like using your birthdate to pick lottery numbers: convenient but rarely correct.
Competitor-focused pricing puts the emphasis on unit pricing—dollars per pound or euros per liter—not on value created. It’s useful only for me-too and incremental new products. Hopefully, your new product will deliver significant new value beyond competitors’ products: If so, competitor-focused pricing is helpful only in understanding customers’ initial price reaction.
Customer-focused pricing is an “outside-in” approach that requires more work by the supplier. It is also the only way to consistently maximize the value you capture with new products… and will be our sole focus in this issue.
Two Ways to Set New Product Pricing
So how do you get customers in your target market segment to help you set optimal new-product pricing? You have two options: 1) Ask customers for pricing decisions. 2) Understand customers’ pricing decision making.
You have two options: 1) Ask for pricing decisions. 2) Understand customers’ pricing decision making.
With the “ask-for-decisions” approach, you would use Van Westendorp, Pairwise Comparison, Conjoint/Trade-off Analysis, etc. Your team would ask prospects to make pricing decisions and analyze these responses to set prices. For the “understand-decision-making” approach, you would use Voice-of-Customer (VOC) and observational methods to essentially “enter the world” of your customers. You’d build an internal capability for replicating customers’ decision making.
Should you use the first method? The second? Both? It really depends on your market. The “more B2B” your market is, the more you should lean toward the second approach—understanding how your customers make decisions. Let me explain.
Some years ago, we developed the B2B Index to measure “how B2B” a supplier’s market is. It measures your customers’ Knowledge, Interest, Objectivity, and Concentration (number of customers in the market). If you sell hydraulic hose to earth-moving equipment producers, your market has a high B2B Index. Those Caterpillar engineers are knowledgeable, interested in your innovations, objective—using economic decision making—and there aren’t many earth-moving equipment makers.
Selling garden hose to homeowners is B2C, representing a very low B2B Index. But what about water hose used by cement companies to clean mixers and other equipment? This is still a B2B market, but with a lower B2B Index than hydraulic hose for earth-moving equipment.
New Product Blueprinting—which is based on the “understand-decision-making” pricing approach—becomes more imperative the higher your B2B Index… for two reasons. First, those Caterpillar engineers are both willing and able to help you design a better product, so you can “enter their world” at astonishing depth (if you know how). Second, there are few customers in the bulldozer market, and each knows their answers to your Van Westendorp survey will haunt them later when you set your price. Good luck getting straight answers out of them.
So here’s what we see in the real world: Our clients—all of whom are B2B—use New Product Blueprinting first to understand their customers’ world. Then if they have a lower B2B index—especially one driven by thousands of customers—they may later use the “ask-for-decisions” approach.
Five Steps to Understand Customers’ Price Decision Making
Let’s now explore this “understand-decision-making” approach. There’s a science to this, which includes five steps.
- Diverge to all outcomes. Independent research by Tony Ulwick (What Customers Want) indicates customers have 50 to 150 outcomes (desired end-results) for every job they hire your product to do. Many suppliers start with their own solutions before understanding the full range of possible outcomes they could address. Big mistake… since this severely limits the value they can deliver. For more on this, please read this free chapter on qualitative Discovery Interviews (See Blueprinting Chapter 11).
- Converge to value-added outcomes. The only outcomes customers might pay more for are those that score high in importance and low in current satisfaction. Anything else you deliver will either cause your customers to yawn, or will give them “me-too” leverage to beat down supplier pricing.
- Use advanced observation. With the right skills, B2B suppliers can use customer tours to a) learn how to create more customer value, and b) gather economic data to quantitatively predict the financial impact on customers. AIM’s AMUSE methodology allows suppliers to find ways to Accelerate activities, Minimize activity input, Upgrade activity output, Simplify transitions between activities, and Eliminate activities altogether.
- Conduct side-by-side testing. Do customers pay more for value? Nope… only for value beyond their next best alternative. Most suppliers do a terrible job of quantitatively understanding what these next best alternatives are. New Product Blueprinting methodology is unique in that it combines external customer interviews with internal side-by-side competitive testing to provide this insight. Please check out pages 7-10 in this complimentary download of Blueprinting Chapter 14.
Your price ceiling isn’t set by the value you deliver. It’s set by your customers’ perception of the value you deliver.
- Create value calculator. Steps 1-4 are necessary—but not sufficient—to setting optimal new product pricing. Now you must pull it all together in a value calculator. AIM’s value calculators are Excel-based instruments that allow you to a) predict and b) communicate the value your new product will deliver. You must do both, because your price ceiling isn’t set by the value you deliver. It’s set by your customers’ perception of the value you deliver.
A word of caution: If you find it helpful to perform Van Westendorp or Trade-off Analysis, be sure to complete steps 1 through 5 above first. The supplier that understands why customers make decisions—pricing or otherwise—has an important competitive advantage. If you’re going to design a new car engine, it’s not enough to understand all those lights and dials on the dashboard. You’ve got to get under the hood.
Finally, remember you may need to come at pricing several times in your product development process. You’ll need increasingly accurate pricing estimates as you move through your stage-and-gate process… “perfecting” your pricing prior to launch.
There’s so much more we don’t have space to cover here: dealing with non-economic elements of decision making, such as switching effort and risk… suppressing next-best-alternatives through intellectual property… identifying when further outcome improvement will increase only costs, not value… dealing with purchasing agents incented solely by unit pricing… and so on. Feel free to contact us directly if you’d like to discuss this further.. For general information on Blueprinting, please visit www.theaiminstitute.com.
If you are an existing Blueprinting client, you’ve got three job aids (in addition to your Blueprinter software) to help you set new product pricing: AMUSE Customer Tour Checklist, Customer Tour Log, and Value Calculator Examples. If you need fresh copies, please use the above email to request them.