5. MARKETING OF NEW PRODUCTS
5.7 P RICE - SETTING NEW PRODUCTS
Every entrepreneur and company leader must strive as quickly as possible to achieve an aggregate income that exceeds aggregate expenses in the business. Thereby money is achieved for development, investment and accumulation of reserves for future economic strain or future needs. Income or revenue, to use another term, is often directly dependent on the price-setting and the discounts offered. However, the classical view of pricing is under a change as we in the Internet world see many products that are given away free of charge meaning that the users will pay for secondary products instead of primary products or for extensions of the primary products and/or services. Here we mainly will discuss the pricing of primary products in the classical view as the new view means no pricing at all for the primary products.
For industrial products and many consumer products still the traditional pricing is
relevant and will so be even in the future.
Price-setting new products is difficult to carry out at the same time as a price-setting strategy is strongly affecting the company’s profit margins. Some reasons for this are that there is no generally accepted price level to relate the price to, there is no information available concerning price-sensitivity, there is no information available concerning competitor reactions before the new product has been launched, there is no knowledge concerning customer reactions to the new products before they have been introduced to the market, and that therefore there is a lack of knowledge about which marketing and sales arguments give the best effect, until a few new products have been sold.
When price-setting a groundbreaking new product the first thing to do is to gain an impression of the usefulness the product will have to the customer/user. Then through practical tests one must investigate which price is the highest that can be set without making the product impossible to sell to the buyer category ‘pioneers’. This is done mainly through actual attempts to sell to some selected customers. If the customer buys direct without discussing the price, then the price is probably too low. If the reaction is favorable to the product but not to the price, then this can always be adjusted downwards so that a price level acceptable to the customer is reached. If it is difficult to sell the product at the set price, introductory offers can be made. An alternative is to reduce the price. Note however that the method of asking a possible customer to suggest a price seldom gives a correct price indication unless one has first indicated a price. This applies especially if the customer is hesitant about buying the product.
There is no right price for a groundbreaking new product, since the product value will vary for each buyer/user. The price to be determined then is the price that corresponds to the usefulness that the product has to a sufficiently large number of users. The manufacturing cost has little or nothing to do with the usefulness a product has to a user. Unfortunately many engineers see it as almost immoral to set prices in any other way than in proportion to the manufacturing cost. This attitude is regrettable. The conceptual difference between engineering setting and market-oriented price-setting may be illustrated by the two following models:
Engineering price-setting: Market-oriented price-setting:
Costs + margin = price Price – costs = margin
The biggest cost is often the manufacturing cost of the product if the product comprises a good deal of hardware. For software-based products the manufacturing cost is always low or insignificant. If the price that can be set for the next stage in the sales chain for a hardware-based product is lower than three to four times the manufacturing price, one should as a rule not begin to manufacture and sell the product. The mark-up factor however is not a fixed factor and varies by product and
sector. In pharmaceuticals with a long development period, the factor needs to be very high to cover future R&D. For extremely expensive products like aircraft, boats, nuclear plants etc., it is often not possible to have a factor exceeding 1,5 while for products with low prices one needs a mark-up factor in the region of 5 - 10. Price-setting of software-based products cannot be compared with the manufacturing price at all, but must be based on the use of the product and the number of potential buyers.
When price-setting a new product it is important to remember that once the product has been launched on the market, it is extremely difficult to raise an initial price that was too low. Instead of a large price rise, one must make small rises (e.g. 5 – 10 %) over a long period. This to avoid too raucous protests from sellers and customers. If on the other hand the initial price is set too high, there is always a possibility to reduce the price, at the same time as a price reduction is always greeted positively by the market – which is never the case with a price rise. Experience shows, above all, that sales personnel often side with their customers every time the company introduces major price rises. Thereby the company encounters an internal conflict with the sales personnel and an external conflict with the customers when prices are increased.
If a number of units have been sold at a high price and the company nevertheless wants to reduce the price, for example owing to the appearance of a competitor with lower prices, it is important not to irritate or disappoint the first buyers by suddenly offering the same product at a lower price. The ambassadors for the product, which the first pleased buyers are, will no longer benefit the company in such a case, since they feel cheated. This is serious, since the “jungle telegraph” information on the market is very important for all new products. When reducing the price the product must be modified somewhat so that the market perceives the new version as a somewhat cheaper product sold at a lower price, at the same time as the first version should remain on the market mainly in its original design at the same price or a price close to it or even maybe higher.
For substitute products, which are intended for sale on an existing market, there is relatively little scope for free price-setting. In this case it is usual to assume that the competitors’ price level is the starting-point for one’s own price-setting. A small price rise of, for example 10-20 %, can often be justified by product and/or user advantages. If this tactic is used, it is more difficult for competitors to take countermeasures. They can scarcely raise their prices because a competitor has entered the market at a higher price! If on the other hand one enters the market at a lower price, there is a great risk that this measure will start a local price war which can be pursued successfully only by a player with plenty of money or one that has accumulated reserves for a long time.
By and large before the launch of a new product it is always crucial to consider what the competitors will do when they suddenly discover the new player. A new competitor is never welcome on the market by them and in order to spotlight the competitors’ potential, one can have some colleagues or friends pretend to be competitors in an imaginary market strategy game. A “war game” of this type leads to
the unconscious and conscious formation of an action plan to be used when the real market game starts, i.e. when the product is launched on the market.
Personal experience of the introduction of groundbreaking new products shows that the remarkable situation often arises where pioneer buyers are not interested to buy the products if their price is set too low, whereas a high price often increases interest in the products. Pioneers, then, seldom wish to buy a product because it is cheap, but rather because it satisfies a personal want for something unique, or a wish to be noticed, etc. Too low price-setting therefore seems even to be able to produce a repellent effect on the pioneers, both in a market perspective and the point of view of coverage. The principles of this situation can be illustrated as in figure 5-6.
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Figure 5-6: Number of buyers as a function of the price-setting upon introduction of a groundbreaking new product
When the pioneers have been provided with the new products, then product differentiation is required (i.e. user adaptation) to reach the so-called early majority group. Product differentiation is done above all in order that the more sophisticated pioneer version is upgraded for the pioneer group’s repeat purchase at the same time as the simpler, cheaper version should be launched, which is adapted to the early majority group. For these two groups it is suitable to implement a stepped price-setting as shown in figure 5-7. If one does not make such a product and price differentiation, the number of buyers can diminish in an unfavorable way.
Figure 5-7: Number of buyers as a function of the price-setting when the so-called early majority group is to be reached
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Number of buyers When the late majority group is eventually to be targeted, the usual procedure is to issue an even cheaper version of the product. At the same time one must also reduce prices in the rest of the range so as not to lose market shares. At this stage the price-setting can be as in figure 5-8.
Figure 5-8: Number of buyers as a function of price-setting when the so-called majority group is to be reached
Price-setting when the latecomers are due to be targeted may be characterized by the asymptotic curve commonly used to illustrate how price-setting influences sales volume. This curve, which is shown in figure 5-9, is often appropriate for mature products and sectors.
Sales price
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Figure 5-9: Number of buyers as a function of price-setting for a mature product Investigations have shown that costs and selling prices usually drop by 70-80 % for each doubling of the cumulative sales volume of an article when it is established and accepted by the market (e.g. Utterback 1994). Gordon Moore – former chairman of the board of Intel – suggested that every 18 months the number of transistors is doubled in computer memories without price increases for the customers. His assumptions held for 30 years why one talks about Moore’s law. These experiences are important to bear in mind, and emphasizes the importance that initial price-setting should be at a sufficiently high level to allow establishing business operations with long-term profitability.
When a mature level has been reached for the products, many large companies tend to measure their progress in market shares. They then pay careful attention to how their market shares change over time. Through temporary price cuts or other marketing activities a competitor can for example temporarily win market shares on a local market unless the company quickly responds to the challenge. If a competitor is permitted to operate for a long period at a lower price level, thereby gaining a larger share of the market, then customer loyalty towards this company will increase at the same time. If the competitor then raises its prices to the normal level, it will as a rule retain a larger market share than before the price reduction. The term hysteres (meaning lasting) has been borrowed from physics to denote this effect. The retained higher market share is correspondingly called the remanence (Simon 1997).
If the company does not itself sell the product to the end customers, it is important when price-setting to ensure that sufficient scope is left for the retailers’ mark-up. It is usual for prices to double at each middle step between the manufacturer and the customer. Since one cannot generally have one price locally and higher prices on other markets, since there are contacts between both buyers and retailers on different markets and web technology is pushing this development forwards, an end price must be applied that is fairly uniform on all markets. Upon launch on the home market therefore, one must use the price that the planned retailers should use. Thereby much-needed margins for the business operation are created in the initial phase.
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