Pricing new products is one of the most important things a marketer does. Afterall, its one of the four Ps of marketing (product, pricing, promotion, place/distribution). Unfortunately, I find marketers spend either far too much time or far too little time on pricing. During every product development cycle the inevitable question arises: “So, how should we price it?” An awkward silence fills the room. Someone speaks up and throws out a number. Someone else suggests you hire a consulting firm to do a comprehensive pricing analysis. The team defers the question and kicks the can down the road for a future meeting. Pricing is important and everyone wants to get it right. After all, if your price your product too high it may never gain market traction. On the other hand, if you price it too low you’ll end up leaving money on the table. Here is a pragmatic approach to pricing strategy which I adapted from my days on Wall Street and have applied to launching products. I think its a Goldilocks approach which provides an appropriate level of analysis while still leaving room for intuition.
Here is the outline of a pricing analysis which you can do in-house in a couple weeks. I have found that this analysis makes pricing discussions much more productive. I hope it will save you hours of unproductive team meetings and thousands of dollars in consulting fees. Note all numbers in this analysis are made up and are for illustrative purposes only.
The Money Slides:
The primary output of your analysis is two money slides: an executive summary and a floating bar chart. The executive summary should highlight your interpretation of the analyses and provide rationale for your recommendations. The floating bar chart shows the suggested price points of your product based on several different analyses.
The Underlying Analyses:
I like to use four different types of analyses:
- Comparable product analysis
- Bottoms up margin analysis
- Van Westendorp analysis (proxy for value-based pricing)
- Cost of substitutes analysis
Obviously, one could do a lot more work (which may be appropriate in certain scenarios) but I find that these four analyses provide great reference points to further hone your intuition. Let’s discuss each analysis:
Comparable Product Analysis:
For established product categories, comparable product analysis is an extremely useful analysis. Look at the range of price points for existing products in the marketplace. It's important to categorize products by comparable feature set as products often have “basic” or “pro” feature sets which may straddle the perceived value of your product.
Bottoms Up Margin Analysis:
The bottoms up margin analysis gives you an idea of where your floor is for your pricing analysis. In this analysis you need to evaluate the unit cost of goods sold for each product. For cloud software this may be quite small (although be sure to factor in the cost of bandwidth, storage, infrastructure management etc.) and for physical products this can be quite significant. Then use a sensitivity table to determine the price points you need to hit your margin requirements. While I always recommend pricing based on value instead of cost, it is important to understand your cost structure – particularly if you are going to pursue a freemium strategy.
Cost of Substitutes:
Substitutes are anything a customer can use to solve their problem instead of using your product. Every product has a substitute. With new product categories the substitute is typically the status quo. Two examples of substitutes for in-room video conferencing are i) the speakerphone and ii) Skype running on a Mac Mini with a webcam.
The Van Westendorp analysis provides a decent proxy for the customer's willingness to pay. Van Westendorp requires asking customers (via survey or a series of focus groups) three questions:
- What price would you expect to pay for this product?
- At what price would this product be too expensive that you wouldn’t consider buying it?
- At what price would this product be so cheap that you’d question its quality?
Voila. There is your Goldilocks pricing analysis. Not too much, not too little. It should include the two money slides plus a couple slides for each analysis. The whole thing should take only a couple weeks which leaves plenty of time to test your pricing with real customers.
Remember that unless you are selling a commodity product, your customers' perceptions are far more important than the academic “correctness” of your pricing model. That’s why its important to get out of the office and refine your intuition by pre-selling your product. I like to try to get pre-orders at a couple different price points and with a couple different terms. You may find, for example, that your buyer cares more about not paying for inactive users than they care about the product’s actual price point (in which case active-user pricing may be appropriate). Your buyer’s body language and objections will help you arrive at the perfect pricing model.
I hope that helps. How do you price products? Any interesting tips?