Dec 14, 2010
A few years ago, I worked with a product manager for a medical device company who had a burning question for me. His game-changing product was ready to go, the sales force was lined up and beginning to make contacts with customers, and his CEO was expecting this to be a $100 M product. He now just needed to slap a price on it, and wanted to know what I thought. My response: you should have been thinking about this a long time ago.
Pricing is an incredibly important aspect in the success of nearly every business. Yet somewhere in the commotion of building their enterprise, an entrepreneur often lets it slip through the cracks. Sooner or later (usually later, unfortunately) my medical device client’s question will pop up: “When should I start to think about price?” The answer is that if you have a business plan, a potential customer, a prototype, or anything beyond an idea on a napkin, you should already be thinking a lot about price. Generally speaking, if you find yourself asking that question, you are probably already late and need to start catching up.
Over the next few months, we will dig into best practices and useful techniques to drive more profitable revenue in your business. However, we need to first examine the urgency of thinking about price early and often.
For starters, price is one of the most effective levers a manager can pull to drive profits. But to effectively do so over the long-term, it cannot be a one-time decision. Pricing is a mindset that needs to be integrated throughout the entire lifecycle of your product and must infiltrate every functional area of your business. Effective pricing is driven by the value you are able to deliver to your customers. Managers must constantly assess this value and look for ways to increase it. In many cases, it is an economic value (e.g., labor savings, access to a new customer segment). This is most common in B2B markets. Sometimes there is a psychological value delivered (e.g. a “coolness” factor of a new gadget), which is often a factor in consumer markets. But to capture this value, to truly monetize your new business, you need to be thinking about price at all stages of the game.
Launching Your Business:
This mindset is particularly necessary for entrepreneurs. When developing a business model or drafting your business plan, price (and accordingly, value) needs to be at the top of your mind. Why would anyone pay me for this? What are they getting? How will this specifically help to improve a company’s financial position? What are my customers using now (the next best competitive alternative, to be discussed more in a future article on quantifying value) and how is my solution better? Thinking about these questions from the moment of your business’s inception will ensure you are driving toward a profitable outcome – one where you are going to truly deliver value that the market will pay for.
Remember that you are starting the business to make money, not to make stuff. The challenge for entrepreneurs is to succeed in this task by doing more with less. But the “less” comes through higher efficiency – a greater degree of focus in your actions – not through simply doing fewer things (or worse, just doing everything 50% of the way). Focusing on price starting at the planning stage and throughout the company’s lifecycle will help you keep your eye on the prize, and ensure you are spending your limited resources in the right areas – the ones that return the most money. So when you think about launching a new business, think about price.
Launching New Products and Services
All too often, the end goal of driving value is forgotten in the chase to make stuff. As the product begins to take shape, new features are added daily. Wouldn’t it be cool if we had an extra flashing light? It wouldn’t be hard to make the product function as a toaster, too, so let’s add that. The result of this product-centric process is a lot of time and money spent developing a more costly product that doesn’t deliver any more value to the market. When the product launches with the inevitably higher price required to cover the additional features, no one buys it, as the value delivered does not merit the high price.
The product development and launch processes need to be done with price at the forefront. Will adding this feature allow us to capture higher profitability? Why? What is the value that the new feature delivers – is it a totally new value driver, or does it just increase the impact of the original value driver? Is this the most important value driver to my customer, or the 10th most important? Are the same customers interested in both of these value drivers? As an entrepreneur, your time and resources are stretched thin. Focus on developing your products in a way that creates the biggest impact on the most important value drivers. When you think about developing and launching your product, think about price.
Finding and Meeting Customers
Have you ever met with a potential customer, even just in exploratory conversations, having not given serious consideration to price? If so, fear not; you are not alone. Entrepreneurs can easily get caught up with other aspects of the business and think that it’s not the “right time” to think about price. But what happens? A potential customer eventually asks, and you don’t have the answer. Do you throw out a number? Marginal cost plus 10 points?
The first price mentioned to a customer, even if informally, creates a very powerful reference point. What you do today affects what your world looks like tomorrow. Pricing decisions are not made in a vacuum, and will not magically reset a year down the road when you’re ready to get into the black. Once a reference price is set, you have given customers an anchor that they will not quickly forget. Dramatic moves away from this initial price will not lead to pleasant conversations. What would your best customer say when you tell him or her that the price is about to double? And if you cut price in half, customers may wonder if you were being “fair” initially, or perhaps that price is falling because no one is buying (and they can therefore get even further discounts).
Instead, use these early conversations as a source of information to further develop your pricing decisions and understand how you can deliver value. Before you show up, do your research. Read a 10-K and find a line where you think you can have impact. Are you trying to impact a $1MM cost bucket, or a $500 MM cost bucket? If a customer is focused on reducing costs, realize that a revenue driver may not be as attractive to them. Is there a better way to frame your value story? Talk specifically about how they would use the product in their company – what processes, divisions, people and financial line items would be affected. What are the most attractive aspects of this product and why? Don’t assume you know the answer – ask the question. Ask what could be done to improve the value of the product. When you are talking with customers, you need to be thinking about price.
The “Right Time” for Pricing
Thinking back to my medical device client and his innovative $100M product, a major opportunity to drive profitability was lost by waiting until the 11th hour to think about price. After a few months of hard work using some of the strategies and tactics that we will discuss here in the coming months, the product launched at a price over ten times that of the current market leader and has been very successful. Even so, money was lost by not infusing price into the development process. For example, early stage consideration may have led him to developing studies to validate his performance claims, increasing the speed of revenue growth and perhaps opening additional segments in the short term. Who is to say it couldn’t have been a $500M product?
For all the reasons discussed here, the right time to think about pricing is now. Companies are by and large rational decision makers. They will buy when they get something in return that is greater than the opportunity cost. Understand why buying your product is a good decision, and use that information to become an even better supplier. In doing so, stay focused on monetizing your value at all stages of the game. Remember: you’re here to make profit, not to make products.
Special thanks go out to my friends and former colleagues on the Monitor Group’s pricing team, especially Georg, without whose support over the years, I would not have much to write about.