Determining how to price a new product or service is one of the most critical decisions a business can make. Unfortunately, companies often make at least one of two critical mistakes. First, they often don’t consider the perceived value of the product or service to the consumer as the primary basis for the pricing decision. Second, they don’t conduct any research to understand consumer segmentation and differences of willingness to pay by different target groups.
When a new product or service fails to meet initial sales projections, it can have serious business implications. Let’s look at a couple of examples.
Cost-plus pricing of a kids’ entertainment platform leads to lackluster sales
Many companies adopt cost-plus pricing model, which is essentially adding a specific amount of markup to a product’s unit cost. It’s transparent and simple in that a company can simply mark up each of its products by xx percent. However, this method can be dangerously simple in that it doesn’t really take into account the value consumers attribute to the product. The problem with this method is that consumers may be willing to pay a very different amount than what it is offered. Therefore, on one hand, companies may be leaving money on the table if people value the product more than its price. Perhaps no less detrimental, sales may suffer if consumers undervalue the product or service compared to the price.
An illustration of this latter point is the case of an international digital media and entertainment company that wanted to expand to the U.S. with a new kids’ platform service offering cartoons, games, books, and activities for kids aged 2 to 8. When they first started offering the service in the U.S., they didn’t do any consumer research and set their prices too high based on margins they were seeking to obtain. The price for the service was close to Netflix. When initial sales were lacking, they quickly embraced the idea of doing research to optimize their price based on what consumers were willing to pay, otherwise referred to as value-based pricing. We conducted pricing research and after we understood consumers’ willingness to pay for the service, we recommended an optimal price that was $4 lower than the original launch price. The results were really positive and with the right price, the service soon became one of the top downloaded apps from Apple store with over 5 million active users per month. Ideally, the research would’ve been done on the front-end, giving the company time to go-to-market and build its base more quickly while potentially exploring add-on products to drive the additional revenue they initially sought.
Sizing up the audience to fit desired pricing for a new beverage
Consumer segmentation and pricing with specific target groups in mind are also very important to consider. I recently worked with a CPG client to price a new beverage product. The company’s executives already had set a price range for the product to be between $20-$28 and established they could not make a profit if priced lower than $20. Their desire was to price the product at a premium price point. To conduct a study like this, it was clear we needed to understand consumer segmentation and the price specific consumer target groups were willing to pay for the product. We tested a range of price points and determined the willingness to pay individual consumers across various products to illuminate the optimal price points for different consumer targets. The results indicated that the ideal consumer target (those willing to pay for the product at a premium price) comprised 30% of all consumers. This helped our CPG client develop the optimal go-to-market strategy for the new product.
Consumer segmentation can also lead to the implementation of pricing “tiers”. Media companies for example offer different tiering packages knowing that different consumers have different needs and price points. Meeting the needs of different consumers at the prices they are willing to pay is an important strategy that enhances the chances of new products and services succeeding.