How to Price Innovation
A common question from our clients and keynote audience members is: “How do we price brand new products and services? What do we do about pricing if we have no idea what something is worth?” This simple question is challenging to answer. The short, honest answer is, “it depends.” A complete answer would take a book. What follows is the incomplete, intermediate version.
The Surprising Place to Start
How should a smart, strategic leader set pricing for the revolutionary products and services for which no pricing or value trail has been blazed? Guess. Yep, you read it right. Guess.
Not like flip a coin or roll dice kind of guess. Nothing so random as that. Smart, educated guessing based on your overall business strategy coupled with complements, alternatives, value created for customers, etc.
Start with the knowledge that the price will certainly fall between $0 and $infinity and start narrowing from there based on what you know about how your product or service will add value for customers:
- What pain point does it address?
- What time and money does it save them?
- What goal does it help them achieve?
- What risk does it mitigate?
- How does it help their brand and help them attract more customers?
- How does it help them teach better and provide a better student experience?
- How does it help them do better medicine and serve patients better?
- How does it address internal challenges for them around employee engagement, safety, legal liability, customer experience, or A or B or C?
- How does it help them save for their daughter’s college tuition, enjoy their life, learn piano faster, have a more pleasant commute, or X or Y or Z?
Think about every advantage of your solution, how a customer might value it, what is the bare minimum they would pay to solve it and what is the absolute maximum they would pay to solve it?
Keep on Questioning
Critical questions to ask to narrow initial market pricing include: What else they might buy to address those same needs, and how much do those alternatives cost? Consider complementary and competitive solutions that might inform your price narrowing efforts.
A few other strategic questions to consider before setting your initial go-to-market price after narrowing your educated guess based on value:
- Likely Frequency / Repetition of Purchase: Will customers buy once and never buy again or will the same customers return over and over to buy from you? If they will be repeat customers, how frequently will they repeat their purchase? The answers to these questions will inform how dynamic you can be with your pricing without the penalty of customer pushback and the likelihood of creating customer entitlements around certain price points. Understanding these realities will inform the risk-reward calculus of how bullish you can be with your initial market price.
- Velocity of Sales Opportunities / Number of Customers in Market: If you have only a small number of “at-bats” because there are a limited number of customers, projects, or opportunities to sell in a given time period, the risk of being overpriced carries a very large consequence. Marketplaces with many customers and/or a high number of opportunities annually lessen the consequence of guessing wrong in either direction. Understanding the impact of pricing missteps based on your particular situation is critical to setting the right initial market price.
- Cost and Capacity Analysis: It’s important to check initial market price against costs and capacity to make sure it works for business. To be clear, this should be a final check to ensure pricing derived based on value is in fact profitable, rather than using a cost-plus pricing approach to set pricing. Cost doesn’t drive price, only value drives price. Almost universally, when cost-plus methodology is used to set pricing for innovation, groundbreaking solutions are relegated to mediocre financial performance.
- Segmentation: Is it just one price that you should go to market with for this product or several? Should you create tiers for this service based on segmentation criteria, or will every customer pay the same price? Give some thought to how to use segmentation as a tool to learn how your market values your innovation and how much they will pay for it.
Ok, so you’ve done the work to generate an initial guess and narrowed it based on customer-driven value-based inquiry. You’ve considered complementary, competitive, and alternative offerings to further narrow your pricing. You’ve asked yourself a set of strategic questions about your business to make sure you’re not overlooking something. Now what?
Fire Bullets, Then Cannonballs
Remember that you are guessing. You will guess wrong. It’s practically impossible to perfectly predict exactly how the market will respond and correctly value a brand-new offering that has never existed before. You will be wrong. Take a deep breath and let yourself off the hook for trying to figure out the perfectly right price. The key is to be wrong in the lowest-cost, risk-mitigated way.
In Great by Choice, Jim Collins shares the concept of firing bullets before cannonballs. Take small shots to calibrate line of sight so you can conserve gunpowder for cannonballs, only once your line of sight is calibrated.
In pricing innovation, this means being smart about how to launch, test, and iterate. Validate your initial market pricing by testing it in the market in low-risk ways. Make early unvalidated moves in low-risk areas so that your validated pricing can be rolled out to higher-stakes opportunities. Repeat. Gather feedback (including sales and profitability results). Improve pricing. Repeat. If this sounds imprecise, it is.
My apologies to those who were hoping for a formula. It’s far grayer. However, I invite you to see that as an opportunity rather than a challenge. And if you would like our help to address your pricing strategy for new products and services, please contact us.