Pricing to Create and Dominate New Markets for Across the Board

Published by the Conference Board, Spring 2000.

Creating and dominating new markets is hard. Many top executives want to do it to get away from highly competitive markets, but building and commanding them puts great stress on your business’ resources.

When you decide to invest time, people, and money in an existing competitive market, you are competing with others who have their own advantages. To succeed you will have to execute with great skill and in precise time frames. Your business will need money, people, and especially the ability to manage time. If you can’t beat others to market acceptance, you will find yourself in a price war and then your ability to manage costs will be a key differentiator. In competitive markets, operational excellence is required for sustained success.

For some executives the strongest lure to new markets is the lack of competition. In new markets you can set your own ground rules. Operational excellence is less important than attracting customers. Being the only supplier allows you to make mistakes and still sustain great margins.

When you decide to grow by creating and dominating a market, pricing becomes one of your key tools. For many growing businesses, pricing is a mathematical decision - price equals costs plus overhead plus profit. But, it can also help your business create new markets that you can then dominate. When you do this, pricing becomes much more important than merely covering your costs. Pricing helps define new markets.

Pricing for New Markets--Internal and External Views

When you plan to define the market from scratch, you have two price views to consider--one internal, the other external. In the internal view of pricing, you price to cover fixed and variable costs. Ideally, you price so that you achieve a profit without sacrificing volumes. This process is internally focused, defined by the needs of your business and your strategies.

In the external view, your price is a tool to define your market. When you price at one point, you may find that you will compete in the existing market. Setting your price at a significantly higher or lower level may create a market where none existed before. As paradoxical as it may seem, a higher price may increase your volumes. Let's explore the internal versus external drivers for pricing.

Looking internally, when you decide to compete in an existing market, your costs are a key component of your plan. You will need operational excellence to keep costs low and margins acceptable. For example, if you choose to enter the market for over-the-counter painkillers, your ability to stay within a certain price range is critical to working with distributors.

The good news is that you know the price point before you start. The expectations are set. In existing markets, you can know and then balance the expectations, the cost of doing business, and your forecast for volumes. That balance gives you stability and allows you to identify a break-even point.

The balance fails when you want to create and dominate a new market. In an unknown market, you can't price by expectations. You have no knowledge of a working price point. Volume forecasts resemble fiction more than fact and without dependable volume forecasts, you can't even determine the costs of doing business.

When you decide to develop that over-the-counter medication to create a new market, you know that your costs will be substantial. What you do not know is whether anyone will buy your product. If you decide to offer a new kind of service as a consultant, you can put your costs in a spreadsheet. However, you can't know whether the service will sell. Volume forecasting is futile. Your internal view of pricing is so incomplete that it will be of little value.

So for creating and dominating a new market, look externally. In the external view, price depends on larger goals. These might include creating stock value, attracting a certain market, or making it easy for customers to acquire your first product so you can sell a second.

Internal vs. External View of Pricing

Internal View External View - Price to Profit - Price to Market - Cost Based Pricing - Price to Market - Explicit Expectations Are Set - No Known Expectations - Forecasting volumes is important - Forecasting volumes is ineffective - Stock Market Value is Important - Stock Market Value is Important - Goal is to Build a Profit - Profit May Be Sacrificed to Stock Market Value

If your goal is to increase stock value, you might price to create a new market without regard to costs. This has certainly worked for others. In the 1990s, the market values of Amazon.com and America Online didn't seem related to their operating margins. Instead, the valuations seemed to relate to how much these market creators and dominators can grow.

If your goal is to find a new market to enter, it may be tempting to rely on marketing studies in choosing that market. Remember, however, that market research is most useful when you are looking at existing markets. It is clear that you would want to know the market perception of a new air freight product before you launch, but what would the surveys have told Federal Express before the company created a new market in expensive, overnight delivery services? The demand simply did not show up in the minds of consumers - they did not ask for what they could not envision. The decision to offer guaranteed overnight delivery had to be a gut call.

Marketing data for product line extensions is important. However, if you wait for the marketing data to support a new market, you may be waiting for another vendor to define and create the demand in that market. Unfortunately for you, that vendor may use the opportunity to dominate the market. The first company to attract the right customers is often the winner.

When it is important to attract the right customers in the new market, your price can be a very useful tool. The key to success is knowing your target customers. If your target market is likely to respond at a set price point, your best chance of success comes when you meet that point.

If that point is lower than your costs, you have an operational challenge, the same one many dot-com companies face; you have to deliver something at that price point and still have money to operate. But what if the best buying response comes at a higher price point? Should you reduce your ability to reach the market so that you can lower the price and make less money? Perhaps you would be better off making more money and attracting exactly the customers you wish even if your profit feels too high. Prospects in a new market may drive you to enter at a higher price point than you had planned.

Pricing as a Marketing Tool

Many people are slow to buy a superior product at a very low price. The buyer of a notebook computer enters the market with a preconceived idea of what he or she will spend. A client will have a clear idea of what professional services are worth per hour--no matter who provides it. When a family decides to buy a luxury car, they expect a certain price range.

Moving outside these ranges can create discomfort. In a known market with known products, discomfort is tempered with familiarity. The price may seem odd, but if the product is a known quantity paying that price is a more comfortable decision. In a new market, with unknown products, creating discomfort can kill sales. For instance, Amazon.com’s signature product was not books, the company’s product was a new process for delivering books without going to stores or using catalogues. If Amazon had made that process uncomfortable at the beginning, the business might never have attracted enough customers to survive. Their emphasis on secure ordering and one click shopping was a comfort to buyers.

A price point also creates, or curbs, comfort. Customers will compare it with the results they expect from the product or service. If it is in line with the result that they expect, it is more comfortable. This makes comfort a part of the sales and pricing strategy.

That comfort is even more important in a new market. With no habit or social guidelines to follow, a customer will be more likely to say no to something vaguely disquieting. It's easier to sell something at a comfortable price, even if that price is higher.

A price point also represents an image that the customer may wish to project. It feeds into the self-image that every company, client, and customer has. There is status in buying and then displaying an expensive product.

Beyond image, customers also link pricing to the perceived economic value of the problem they want solved. The more serious the issue, the more people expect to pay for a solution. It's a rational response. If you have a business problem that keeps you up at night, you want to believe that the vendor helping you will understand how difficult or important the problem is.

What Higher Price in a New Market Can Suggest

  • Comfort
  • Prestige
  • Exclusivity
  • Higher-quality solutions

 

Pricing to Market–Some Applications

Consider the cost of replacing your existing computers with an entirely new concept such as network computers. You get substantial value from your installed technology, so you'd want to make sure that any new solution would offer results that are at least as good, if not better. Most customers expect to pay accordingly. If someone offered you a new concept priced at around $3,000 per workstation, you would probably consider it. If someone else came to you and offered you the same results for $300 or $500, would you wonder what the catch is? This is the offer that several vendors have made, including well established suppliers such as Oracle.

For many customers, it all sounds too good to be true. Internal studies at one vendor of network computers concluded that the lack of comfort was a key factor in losing sales for that product. “Too good to be true” killed deals. People expect to pay for quality and look askance at something that seems too inexpensive. Network computing is a new market that has not taken off.

Merck had a similar issue to consider when it discovered that Finasteride not only reduced the size of some enlarged prostates; it reversed male-pattern baldness in many men.[1] Merck was already selling the compound as Proscar for approximately $65 per month to insurers and health-care providers. The patient paid $13 to $16 a month.

In 1998, no real market for pharmaceutical baldness pills existed. Merck looked at the products available and decided, “You will find all kinds of schlock, potions, and lotions that cost $50, $60, $70 a month that don't do anything.[2]” Merck could have entered the market at the same price per gram as Proscar, $13 to $16 per month to the patient. Instead, the company chose to define a new market--customers who would buy pill treatments for male-pattern baldness with the imprint of a major pharmaceutical company. Merck offered the same compound under the name Propecia and at a substantially higher price: approximately $45 to $50. This helps differentiate Propecia from over the counter remedies.

Baldness is an issue many men take seriously. It would be fair to assume that they are willing to pay an accordingly serious amount for an effective solution. Would they put the same faith in a $10 treatment as they would put in a treatment five times as expensive? Would they be as likely to use it religiously if it were the same price as a fast-food meal? Merck bet that the answer is “no.”[3]

The more common pricing strategies emulate network computers. They try to enter at the lowest possible price point, hoping to capture as many buyers as they can. Many entrepreneurs imagine that since giving the product away helped create a new market for Netscape, it can do the same for anyone. Building a plan on that assumption would be a mistake.

Pricing, New Markets, and the Internet

A common Internet strategy has been to identify a new market, enter, and grab as many customers as you can before competition moves in. Many companies give “product” away or sell below cost to gain share. Sometimes it works, but is it the best strategy?

The market creators in new Internet businesses do not represent the cadre of price leaders. Amazon.com leads its category in sales, but has never consistently offered the lowest prices. Pointcast gave its push technology away at no cost, but the company has not been able to establish a consistent market presence. An informal study of Webvan users indicates that the grocery service is not winning on price, but on service. The users surveyed did not know whether they were paying more or less than grocery chains for food, and did not care as long as the prices stayed “reasonable.”[4] The number of companies that offer free personal computers over the net has dropped, and many of the high value rebates have been allowed to expire.

On the other hand, high price does not guarantee success. Despite a head start of several years, CompuServe was unable to make a higher priced, less user friendly service competitive with America Online.

What is the best role for price in opening a new Internet market? Based on recent data, the best policy may be to make price comfortable and focus corporate resources on other issues. In a recent study, customers were asked what draws them to return to sites to do business.[5] The customers responded that pricing was the draw one time in six. Ease of site use was more than three times as important.

User friendly and easy to navigate - 54%
Good previous experience - 36%
Fast response time - 36%
Relevant and updated content - 27%
Competitive Pricing - 15%

On the flip side, what drives customers away? Here are the factors that customers say are most likely to cause them to take their online business elsewhere.

Outdated/stale content - 28%
Slow response time - 24%
Downtime and technical problems - 22%
Navigation becomes difficult- 17%
Bad customer service - 16%

The lesson is that comfort may be more important than bargains for establishing a new market on the Net. If your team is looking to establish a new market there, ask them to question any plans to lead with price instead of ease of use and great content.

Can a Low Price Put You at Risk?

Setting a high price can produce three counterintuitive effects in the market:

1 - A higher price may be more attractive. This might seem odd, but consider the case of Larry K., an entrepreneur in Virginia. Opening a new seminars market, he priced his programs very attractively. Even so, attendance was below breakeven. Then he tripled his price for the same offering. Attendance increased by 250 percent. Buyers saw more value at that higher price and responded accordingly. The product did not change, just the price and his profit.

2 - Some customers want to be sure you understand. At a higher price, you may appeal to the customer who wants you to understand how difficult or important the problem is. If you charge $100,000 for a problem that he or she thinks is going to cost $250,000 to fix, the customer may wonder whether you have underestimated the issues. One experience of direct marketing is that volumes may go up when you raise a price. Your price can be too low and cost you sales because your customer is not comfortable that the product or service will really deliver the full results.

3 - Usage is linked to price. When people or companies pay a substantial amount for something, they are more likely to use it. Correctly or not, customers equate value with price. If the price is low, usage can suffer. You might wind up shipping large volumes without getting the usage you want. When usage drops, so does word of mouth advertising. Repeat sales dry up. A low price can put you at risk in new markets.

A Pricing Process for Creating New Markets

Let's examine a process that you can use to set a price that will help you create and dominate a new market. First, we'll look at the steps in the process and then consider an example of how to use it. To start, reverse your normal inclinations regarding pricing. Instead of pricing to cost and pricing as low as possible, follow these steps:

  1. Decide who makes up your market. The key is to narrow the definition of your primary target customers.
  2. Estimate how much economic value they will get from your product.
  3. Estimate what that set of customers would regard as a comfortable price.
  4. Guess where the breakeven would be at that price. Use that to define your exit strategy.

As an example, you might apply the four steps in the following way to create a new market for a painkiller:

1 - If your market includes patients who suffer from migraine headaches, that eliminates the traditional pain market. Normal headaches, sprains, even broken bones are outside your market. Focus only on the people who have migraines. Migraines are a problem that sufferers feel deeply and will pay dearly to solve. You can also quickly see that your market is individuals, not HMOs or health plans. Migraines are a pain that people will pay out of their own pockets to alleviate.

2 - The economic value of your solution is high. It would not take long to determine that migraines cost hundreds of thousands or even millions of workdays per year. On an individual level, you can survey migraine sufferers to decide how much impact the pain has on their ability to earn money.

3 - Surveys and conversations can also tell you where a comfortable price would be for that set of customers. You would quickly find out that the price has a floor and a ceiling. A person suffering from a migraine headache may be willing to pay $10.00 to $15.00 per incident to relieve that pain. Would he or she trust a pill that claimed to provide pain relief for less than $2.50 per incident? Remember that surveys tend to measure what already exists. The newer your market, the less you can rely on customers to guide you on price. It may become a matter of intuition. In many cases, fear overrides that intuition and prices are set low “just to be sure.”

4 - After the cost of patents, development, licensing, and approval, you may have invested millions of dollars to get to the point of being able to manufacture the drug. Even then, you may not know the drug's real market potential. However, you can build a formula that will show you how many prescriptions you need to sell at $120 per package of ten to break even. As you enter the market and it responds, revisit your calculations. You can decide when to consider scaling the price down to raise the barrier to competition, as Hewlett-Packard has done with printers. There are other exit strategies. Choose one early.

Price setting can be either an art or a science. Although you can jump in and start setting prices without thinking about your market, your chances of success increase when you use price to choose your customers. Not only will you increase volumes; you may also increase the usage of the product. Do I mean to suggest that you should always enter a new market with a high price? Not at all. You should always use price to help define your market.

When creating a new market with the hope of dominating it, keep your pricing externally focused. Price early to define that market. New markets require new thinking in pricing as well as products. Pricing is never just a function of costs. Instead, it helps you define which customers you attract. That also tells you where not to invest resources. When you only invest resources in the right market, you dramatically increase your chances of sustainable growth.

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Questions to Help Build a Pricing Process for New Markets

  • Whom do you want to use the product or service?
  • Who has a problem that must be solved?
  • Is your offering a solution to a must-solve problem?
  • Will the customer be able to enter new markets by using your product?
  • If your price were higher, would it be a source of pride or pain?
  • If your price were lower, would it be a source of pride or pain?

Three Advantages to Pricing High

  1. A higher price may be more attractive
  2. It may show that you understand how serious the issues are
  3. People are more likely to use something when they pay more for it.

 

[1] For more details on Proscar and Propecia, see Nancy Ann Jeffrey’s article - Drug Shuffle for Balding Men in the Wall Street Journal, April 13, 1999, Page B1 in the Western Edition.

[2] Paul Howes, a Vice President sales and marketing for Merck. Ibid

[3] Merck is gambling that patients will not ask for the prostate medicine and cut the pills to use for hair growth. There are rules against doing so, and the company is apparently discouraging doctors from selling Proscar off label. Nonetheless, Merck captures the revenue for sales made either way.

[4] Informal study done in the SF Bay area, performed in December, 1999 by the Meyer Group. The numbers involved do not represent a statistically significant sample.

[5] From Building, Maintaining, and Repairing Web Brand Loyalty in Pulse of the Customer, published by Cognitiative, Inc in October of 1999.

Copr. 2000, all rights reserved