Far too many companies fail to develop a long-term life cycle pricing strategy that is continuously adjusted across the product life cycle (PLC). Typically, the savvy company will conduct extensive pricing research to find the a launch price that is aligned with their target group’s willingness-to-pay, but then fails to re-evaluate the pricing continuously. This is problematic in two ways: Firstly, you will either be losing out on revenue or leaving money on the table as you fail to take into account the changes in the customer’s willingness-to-pay, and secondly, it will most likely deteriorate the returns on other products in your portfolio. Proper life cycle pricing across both the early, mid- and late-stage of the PLC is absolutely crucial to reap the rewards from the R&D investment.
It is important to note that early-stage pricing cannot be done in a vacuum. In fact, the most important aspect of early-stage life cycle pricing is not pricing the new product - it’s pricing the existing portfolio products and optimize the context in which your new product's price is set. The willingness-to-pay for a recently launched product will be very sensitive to anchoring effects from existing products, especially if your product is merely a newer version of an existing portfolio product. The customer will compare the two products and look at how much additional value the new product offers, and then compare the two price points. Upon launching a new version of a product, many companies heavily discount the older product version to get rid of the remaining inventory, and make room for newer, improved product version. However, this approach creates a much lower value reference for the new product and so, when the customer evaluates the incremental value offered by the newer version, it will seem much too expensive.
Imagine if Apple were to start selling iPhone 6s at $300 just before launching the new iPhone 7.
Of course, the customer will not make her decision in a vacuum. She will compare the two models and decide whether she wants to pay $349 for a slightly better camera, an updated operating system and an additional gigabyte of RAM. The iPhone 7 may very well be worth $649 to her, but this is not the valuation she bases her purchase decision on - it’s her valuation of the additional value offered by the newer version.
When launching a new product version, it is probably a reaction to the fact that the demand for your older version is declining and producing it is not very cost-efficient. However, there may still be customers out there willing to pay a high price for it because they know what they get, or simply grew accustomed to it. Consequently, in many cases it can make sense to price the older version even higher than the newer version: in that way, the price will reflect the cost-inefficiency of producing the older version, provide a strong value reference point for the newer product (now your customer is getting more value at a lower price!), and simultaneously incentivize all your customers to buy the new, improved product version and grow accustomed to that instead.
Once the optimal context is created, you can set a high price for the new product that reflects the value this product provides to the customer.
At this stage, the product has gained a foothold in the market and generates satisfactory profits. However, this is also where competitors will start noticing the success of your product and launch similar products, or reduce the prices of existing ones to compete on price. A common reaction by companies is to systemically reduce prices, however, this will only leave you with tighter margins, unnecessarily increase price competition in the market, and essentially not gain any market share, either.
Discounts can, indeed, be a good idea. However, they should be based on market conditions. I.e. declining sales due to a new product launch or a competitor’s price change. Market monitoring is a crucial component in mid-stage pricing so that pricing decisions (typically discounts) are based on competitive behaviour and sales trends rather than a fixed price decrease. The mid-stage of the product’s life cycle is where companies generate the majority of their profits, and so, fine-tuning your pricing will greatly impact the bottom line. Frequency is key: testing your prices once every two weeks would be ideal for the average company, so no unnecessary (or even damaging discounts) are granted.
At this stage, sales are declining and most customers have moved on to a newer version of the product. However, those customers that remain will typically exhibit very high loyalty and thus, have a high willingness-to-pay. They know the product and feel comfortable with it, and don’t want to take the risk that comes with trying a newer version. And so, it can often be a good idea to set a high price for products in this stage, also to minimize the competition with the new product version that you will be launching sooner or later and avoid cannibalizing the product version next in line.
Eventually, you want to take the product off the market, however. Not only will it be expensive to keep it in production, given the low demand, but it will also create undesirable product proliferation and increase choice difficulty for your customers. Ultimately, by keeping the product on the market, you are further complicating your customer’s purchase decision as they will have to make the comparison of two largely similar products. It’s time to let go, and make room for your next product.
If you are interested in more in-depth papers on pricing, you can download several PriceBeam resources for free.