Goldilocks and the Three Prices
I wrote recently about how to price innovation and offered advice to make a risk-mitigated, educated guess based on customer-driven, value-based inquiry, further narrowed by complementary, competitive, and alternative offerings.
Yes, at the center of that long, smart-sounding sentence is a scary word: guess. I also said that you will guess wrong because it’s practically impossible to perfectly predict exactly how the market will respond and value a brand-new offering that has never existed before. So not only do you have to guess about one of the most important decisions you’ll make about your new offering, but you will do it wrong.
Which Wrong Guess?
The question is whether you would rather guess wrong by setting the price too high or guess wrong by setting the price too low? Both missteps carry a cost. Price too low, and you will sacrifice the incremental profit you could have made from those customers who would have paid you more. Price too high, and you will sacrifice the incremental profit you could have made from the lost sales from customers who walked away because of price.
So, how do we solve this challenge? When clients bring this thorny conundrum to us, I love to tell the story of Goldilocks and the Three Prices.
For anyone who doesn’t know the story, Goldilocks and the Three Bears is a fairy tale in which Goldilocks prefers the bed of Baby Bear because it’s neither too hard (Papa Bear’s bed), nor too soft (Mama Bear’s bed), but just right. She prefers Baby Bear’s porridge because it’s neither too hot (Papa Bear’s porridge), nor too cold (Mama Bear’s porridge), but just right.
When setting pricing, everyone would love to set the perfect “Baby Bear” price. Not too high (Papa Bear), not too low (Mama Bear), but just right. But I’ve already shared the virtual impossibility of guessing innovation pricing exactly right.
So, which is the greater mistake: Papa Bear pricing or Mama Bear pricing? We recommend Papa Bear pricing for innovation. Problems with Mama Bear pricing are significant:
- Low prices = low margin. Enough said.
- Companies tell themselves that acquiring customers and inducing trial for the new solution are most important. “Once customers fall in love with our solution, we can raise prices!” In reality, this is incredibly difficult to execute because today’s experience is tomorrow’s expectation. Customers become accustomed and even entitled to that initial low pricing and will strongly resist price increase. Furthermore, customers hate this tactic, creating a terrible customer experience and risking churn.
- Because of the price-quality effect, low prices signal low quality and low value. This is incredibly problematic with innovative solutions for which customers are not well equipped to judge value. When a brand-new solution is launched, there is a unique (like, once-ever, truly unique) opportunity to fix a value in the mind of the customer. If you fix a low value in their mind, it’s an arduous effort to overcome. Although this is related to #2 above, in many ways it’s more damaging. #2 limits pricing and profitability, which is bad enough. The implication of this more harmful point: your innovation is not valuable, and the quality is low. Ouch.
If we agree Mama Bear pricing is a bad idea, is Papa Bear pricing any better? What about that lost revenue and margin when customers walk away from too-high prices?
Why Papa Bear Pricing?
In our experience helping companies develop pricing for innovation launches, we’ve seen repeatedly that organizations routinely undervalue and underprice innovation out of the gate. What you might initially believe is Papa Bear pricing is, in reality, Baby Bear pricing, or even worse, Mama Bear pricing.
As Baker, Marn, & Zawada wrote in The Price Advantage, “A whole host of forces – internal, customer-based, and competitor-based – conspire to cause business after business to misprice – usually underprice – innovative new products. And the more innovative and revolutionary the product, the greater the risk of severe underpricing. Mistakes made in new product pricing can condemn even the most groundbreaking new product to a lifetime of mediocre performance and profitability.”
Damning words, those: condemned to mediocrity. Condemned. Not temporarily detained. Condemned!
Consider how unmovable Mama Bear pricing is: adversity to raising prices after launch, fixing (low) value in the minds of customers, and setting expectations and entitlements create a nearly permanent problem once customers are introduced to Mama Bear pricing.
Papa Bear pricing comes with challenges, surely, but adjusting prices down as necessary, utilizing promotional pricing tools such as free trials and introductory discounts, etc. gives an organization the flexibility it needs to iterate to Baby Bear pricing: just right.