Pricing New Products

Companies habitually charge less than they could for new offerings. It's a terrible habit.

Exploring the Full Range of Pricing Options

For products that replicate others on the market (“me-too” products) or that offer small improvements (evolutionary products), the room to maneuver is relatively narrow, and incremental approaches may come close to the optimal price (see “Launch Position,” at the end of this article). Even then, however, a lot of money can be left on the table. Charging just 1 percent less than the optimal price for a product can mean forfeiting about 8 percent of its potential operating profit. (This analysis is based on average economics for S&P 1500 companies. See Michael V. Marn, Eric V. Roegner, and Craig C. Zawada, “The Power of Pricing,” The McKinsey Quarterly, 2003 Number 1, pp. 26—39.) And the more novel a product may be, the more important it is for companies to take a broader view of the pricing possibilities.

The highest price. Since incremental approaches tend to focus on the lower end of the price range, companies should start by defining the opposite end of the spectrum. Such a price ceiling, based on a product’s benefits, may ultimately prove to be unrealistic: there may not be a sufficient market at that level, it may leave too much room for competitors, or customers may be strong enough to demand a greater share of the value the product creates. (See Ralf Leszinski and Michael V. Marn, “Setting Value, Not Price,” The McKinsey Quarterly, 1997 Number 1, pp. 98—115.) But establishing this ceiling will ensure that each and every potential price point is brought up for discussion.

To establish a price ceiling, a clear understanding of a product’s benefits for its customers is essential. The value of some benefits, such as savings on raw materials, can be measured easily. But others, particularly process and relationship benefits such as on-line purchasing options or brand reputation, must be evaluated through market research.

Advanced marketing tools — for instance, conjoint analysis and perceptual mapping — can assess how much value each benefit offers to customers. (Conjoint analysis examines the direct trade-offs among competing products. Perceptual mapping, which assesses the benefits of different products that may not be direct substitutes for one another, seeks to identify the benefits that no other product offers.) But companies must see to it that their research does more than make comparisons with known reference points. Many suppliers rely too heavily on their internal perceptions, which sometimes unintentionally skew their efforts to probe the market. While formulating the research and writing the questions for a market test, a company should therefore ensure that they cover a broad range of possibilities; otherwise the work may serve merely to confirm the benefits claimed by the product’s developers or anecdotal information brought back by the sales force.

To take an accurate measure of the benefits a product offers — and thereby find its true price ceiling — market research must be designed to elicit more open-ended feedback than can usually be acquired through multiple-choice questionnaires or trade-off techniques, both of which can limit responses. For example, a controls maker’s revolutionary high-pressure steam valve for nuclear power plants significantly increased the reliability and reduced the complexity of their water-management systems. At first, trade-off techniques were used to research the market: the company described the technical benefits of the new valve and tried to find out how much customers would pay by comparing it with a valve for another application. Most of them felt that a 20 to 25 percent premium was justified.

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