Price too high and you'll get too many competitors at lower prices. Price too low and you'll expand the market faster than you can serve it, and even more competitors will pummel you. So what's the right price?
If you are like most executives, you are trying to create the proverbial better mouse trap. A lot of companies succeed in designing the mousetrap, but don't catch too many mice. Somebody else usually moves the mice first. How can pricing be used to control that situation better?
In Silicon Valley and in technical companies everywhere, you hear stories about how Apple and Microsoft "borrowed" from the Xerox Palo Alto Research Center. I remember that period well because our company was a beta test site for the first Xerox in-office computer networks.
The sales people kept asking us nervously about whether or not we minded paying the very high prices that Xerox was asking for the STAR system. We kept saying that the quoted price was no limitation, as long as the technology worked. The sales people looked at us incredulously.
But we were serious. When the system became to crash whenever it rained (and it rains a lot in Boston), the price suddenly became much too high for us. The equipment was thoughtfully taken back by our Xerox representative.
Extremely attractive new technologies that can be the basis of improved business models usually turn out to be very price sensitive. When new technologies are first available, often the only people who can afford them are customers for whom a revolutionary way of operating is now possible for the first time.
As others see the technical promise being fulfilled, it simply becomes a substitution pricing decision. Customers prefer the new technology when its price becomes enough lower.
A good example of this can be seen in the transitions from one generation of microprocessors to the next. When brand new, the faster chip will often sell for as much as $200 while the chip that is two generations old may have dropped to $30. Yet the old chip also used to sell for $200 -- just about three years before.
Most new technologies are about as price elastic as the old technologies that they replace. But occasionally, a new one comes along that is more price elastic. Then, pricing becomes helpful for controlling the pace of market development.
If prices are kept too high, the market growth declines. If prices are too low, the market explodes, demand cannot be fulfilled, and competitors enter by the dozens. Market share is dramatically lost under such conditions by the current suppliers.
On the other hand, by controlling the rate of price change along with one's own capacity, a far-sighted competitor may be able to seize vast quantities of market share. Although product innovation is clearly part of its success, Nokia appears to have used this pricing approach in part to manage the demand for its products and its rapidly increasing market share in digital cellular handsets during the 1990s.
Be sure you always know what value you are delivering and how your pricing will affect consumption of a new technology. You will probably have to be fast on your feet with those prices. At a low-enough price, that Xerox network would have stayed with us despite its water problems. How might the world have turned out differently if the price had been a lot lower and the reliability a lot higher?
What are the right prices for your better mousetraps?
Copyright 2008 Donald W. Mitchell, All Rights Reserved
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