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McKinsey: Don't undercharge for new products Are your company's new products making as much profit for you as they could? Probably not, according to a new report from McKinsey that indicates 90% of all pricing mistakes involve pricing a new product too low. (9/24/2003) That can be disastrous, McKinsey warns, because it's virtually impossible to raise the price on a product that has been introduced too low. No one complains, however, when a manufacturer cuts a product's price. The reasons new products may be priced improperly are many and complicated, McKinsey reports. Some are underpriced on purpose in a quick grab for market share. Some are underpriced accidentally because the maker underestimates its potential. Most, however, are underpriced because the methodologies used to establish the price aren't sophisticated enough or appropriate to the product category. For example, McKinsey says that most new products are priced based on the costs of old ones. If a product costs 15% more to make than the product it is replacing, for example, the manufacturer will automatically set the price 15% higher without any particular regard for the true value delivered by the new product. McKinsey cites the example of one of the first makers of portable bar code readers. The company based the price on the value of stationary readers without properly evaluating the additional value delivered by portability. "Portability and instant access to information prepared the way for real-time inventory control, vastly improved logistics planning and just-in-time deliveries, thus eliminating the need for large inventories. Buyers quickly recognized a bargain and flocked to the low-priced product. The company, which couldn't keep up with demand, not only failed to capture the full value of its reader but also set the market's price expectations at a very low level. A single bad decision easily erased $1 billion or more in potential profits for the industry." A related story shows how valuable the right market research can be. A maker of plant controls created a new high-pressure steam value for nuclear power plants that significantly reduced the complexity of the plants' water-management systems. When the company first took the new valve to test markets, it asked potential customers how much more they would pay for the valve than for existing valves on the market, based on its technical merits. "Most of them felt that a 20 to 25 percent premium was justified." In a second round of tests, the company did not phrase its questions in terms of currently available valves. Instead, it asked prospects "to evaluate the cost of planned maintenance shutdowns and the role the new valve could play in reducing their number … This time the customers gave a figure that was several times the price of the existing valve." Clearly, if the maker had marketed the valve simply on the basis of the first round of research, it would have significantly under-priced it. McKinsey also warns product makers to beware of cost-plus pricing, pointing out that few companies have a good handle on their real costs. For example, companies typically overlook research and development expenses associated with an entire product category (especially costs for abandoned projects) and the goodwill costs of acquisitions that lead to new products. Also, "overly optimistic market projections can create false estimates of costs, particularly fixed ones." Companies also should resist the urge to offer discounts to help a new product get established, according to McKinsey. "Discounting, which could be routine for continuing product lines, might sabotage a new product's reference price. Free samples and free trials are better options because they don't affect potential buyers' perception of the product's value. Finally, McKinsey urges that product pricing decisions start early, while a new product is still in development. "At present, companies routinely overlook the higher reaches of their pricing potential," the company reports. "Basing release prices on credible market research and cost analysis can give managers the confidence to ride out the initial turbulence that usually surrounds new products and to claim their true value." Author:Benoit Tuerlinkx, Solvay |
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