Pricing Process for Innovations - MaCoCoPri
Again and again, we hear from product managers that pricing is lengthy and difficult, prices are set by management or a profit margin is added to the costs and voilà: Done is the new price.
However, with innovations that solve market problems, customers are willing to pay more for the product. So why waste margins, when within a few weeks and a structured pricing process, selling prices can be found that are accepted by customers, generate more profit for the company, and thus secure further investments and jobs?
The systematic pricing process in four steps
Finding the right selling price MaCoCoPri:
- Market participants analysis
- Cost calculation
- Conditions definition
- Prices determination
1. Market participants analysis
The market includes the customers and the competition, if any. In customer interviews, product managers learn what pains customers have and what values are behind them, e.g., reduce costs, save time, reduce, or eliminate risks, reduce waste, make more profits. These problems can be quantified and converted into a monetary amount. Replacement costs can serve as an example. If a customer changes a razor blade 12 times a year and a blade costs 8 EUR, then no competitor who brings a new technology to the market and whose blades are changed only 2 times a year will charge 48 EURO for his blade.
In the competitive analysis, the competitors, and their price lists and also customer reviews of the competition are analyzed. Together this gives a good fact base about current prices in the market. In addition, customers can also tell what is good or not so good about the competition, which is important for pricing innovations. Customers are happy to pay more if existing product solutions are improved, if the current ones in the market are annoying, time consuming or waste money.
In the case of prices, which have been determined by the market analyses and in the case of qualitative needs, such as more recognition, avoidance of pain, long-lasting beauty, save the environment, feeling good or similar, conjoint analyses help to determine the price acceptance of customers.
By means of price sensitivity analyses, such as the vanWestendorp analysis, customers can be asked what the product is worth to them without specifying a price. Here, the customer expresses his concrete ideas about the amount.
In addition to knowing what the solution is worth to a customer, the market potential is used to estimate whether the calculated sales prices can generate the necessary profits.
2. Cost calculation
Costs and profits are essential for the profitability of a company. Therefore, the manufacturing costs as well as sales and overhead costs and service costs during the life cycle have to be determined and how much profit is necessary to cover further expenses. The calculated cost per unit sold should be available prior to pricing. Management's expectation of when an innovation should pay for itself should also be considered. Whether it will pay for itself in 6 months, 1 year, or 3 years depends on the market potential and profit margin. If the entrepreneurial goal is not reached, the production costs, the product concept and the pricing have to be examined again./
With the market potential, the cost per unit can be calculated, which in turn is used for the break-even calculation. This calculation is well suited to determine at what point the number of units sold will generate a profit. If this number of units is higher than the market potential, more homework needs to be done with regard to the product concept.
3. Conditions definition
Pricing is based on gross prices, which may differ from the communicated market prices. However, the buyer is only interested in the net prices, what he actually has to spend for the product. For a market launch or growth increase, it is possible to give quantity discounts or price reductions for a certain period of time. These so-called sales deductions can have various causes, such as warranties, exchange rate changes, volume discounts or commissions for distributors, etc., which have to be taken into account in the pricing process. These have to be taken into account in the pricing in order to realize the required profits.
However, price surcharges are better than revenue reductions. Where are these opportunities to charge extra through additional services? The most common are packaging and transport costs, short-quantity surcharges, VIP services, surcharges for customization or rush orders. If the additional services offer real added value for the customer, then they are happy to pay for that added value. For many customers who purchase machines, the lifetime value is important. This consideration includes costs for spare parts over the lifetime of a product, such as warranty services and maintenance. These conditions must be defined when setting prices to avoid unpleasant surprises later, i.e. negative contribution margins.
4. Price definition
With the knowledge from step 1- 3, the sales prices can now be defined. Since there can be several market segments and also different market segments in the countries, the sales prices have to be created for each country and each market segment.
And how can you determine if the sales prices meet the expectations of the customers and the management?
- using the market fact-based market potential, sales price and costs, margins and ROI can be calculated.
- using the Gabor-Granger method, the possible sales prices can be tested for acceptance by the customer. This can be done very quickly with e.g. the software from quantilope or conjointly.
If you as a product manager would like to carry out future pricing more systematically in order to recommend a realistic market price to the management, try these four steps. The four steps can be done in a few weeks, and the time can be shortened (about 3 weeks) if the tasks are done in parallel. Certainly, colleagues in sales, production and finance will assist in making this process as efficient as possible.
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About the author
Ulrike Laubner-Kelleher is a passionate product manager. For more than 20 years she has been involved with innovative products and the optimization of development processes. For many years, she has managed and trained the product portfolios in international product management. She has held leading positions in product development, strategic and operational product management.