In my recent blogpost on the demise of a breakthrough, reader Paul posted the interesting question: “It is getting harder and harder to keep up with all changes. Especially in technology. I wonder how much of this is transferred in prices we pay for products like this.”
To be honest: I’m really not a pricing expert, but I do know pricing is one of the most difficult aspects of any new market introduction: how to ensure a competitive price positioning that satisfies maximum demand and yields a decent margin?
In case of an incremental product improvement or line extension it’s relatively straightforward: you’ve got your current product’s sales figures and competitor’s prices. These will help in determining the ideal price positioning that matches your brand value. For real and potentially disruptive innovations however, current figures are just meaningless. If your innovation offers fundamentally new benefits, there is really nothing to compare it with, right?
In this case you’ll need to understand what the true value of your product or solution is in the eyes of the customer. As I’ve stated before, at the heart of any successful innovation is its value proposition. A value proposition that answers the consumer’s ultimate questions: what’s in it for me?
According to Atkinson, Kaplan and Young[i], a value proposition details what customers can expect to receive in exchange for their money. It comprises the following 4 elements:
- Price: to be paid by the customer given the product attributes
- Quality: conformity between what has been promised and what has been delivered
- Functionality and features: the performance of the product
- Service: including after sales
Two aspects in this definition are of particular interest for our discussion:
The first is “the price to be paid (…) given the product attributes”. In most cases the price level depends largely on the cost to develop and produce the product, the Cost per unit of Product. The more features built into your product, the more it will cost to produce, and the higher it has to be priced to be profitable. This also implies that the total quality has to be superior to justify that high price. A tough challenge to meet
But the definition also explicitly mentions “the performance of the product”. And here lies the key to value based pricing. Defining your offerings in terms of its performance will direct the customer focus to your proposition’s value rather than its price aspect. If differentiation in your offering is possible, you should strive to create an offering with a lower cost per unit of performance rather than per unit of product to control the overall solution cost. This doesn’t just create huge value for your customers, it’s also much more difficult for others to copy.
Lower cost per unit of performance delivers longer term competitive advantage and better position to retain the aspired pricing position. Choosing to compete on price per unit means you’re eventually doomed to rely on process innovation to achieve lowest cost per unit of product – and thus step into the commodity trap.
So let’s get back to the question: How much of the (new) technology is transferred in the prices we pay for products like this? Well, if you focus your development efforts on the unit of performance, you will refrain from stuffing your innovation with a plethora of features and functionalities that just drive up the cost per unit of product. Adding functions creates complexity. There is good complexity – the kind of complexity costumers are willing to pay for; but there is there is also poor complexity, the kinds of that no customer values.
This means that it is essential to find out what functionality or new technology is critical to quality. Only by understanding your real customer needs, you’ll be able to develop highly differentiated solutions with a level of performance that customers will highly value. This requires you to do your upfront homework well – discovering consumer insights at the very start of the innovation process, well before any significant investment decision are made – when the cost per unit of consumer product is still under control, and when you can assess without risk what it will be worth to the consumer.
Atkinson, Kaplan en Young, Management Accounting,
Pearson Prentice Hall, 2006