Innovation & pricing – Part 1 – incremental innovation
In this series of articles I want to share my thoughts on bringing innovation to the market. Often, the price of an innovation is not addressed with sufficient time and resources. Yet companies generally have a “long time” to prepare the future offer (with the exception of innovations created in an emergency context) and they invest substantial and well-suited resources for R&D and industrialization. The pricing of an innovation must be prepared seriously in the business plan, from the pre-project phase and be reexamined once the first representative prototypes are available.
We usually classify innovation into 4 categories: incremental, adjacent, disruptive and radical.
In this first article we will discuss the first category of innovations: so-called incremental innovation.
What is it about ?
Incremental innovation is by far the most common form of innovation observed in many fields. Quite often these are relatively minor innovations for constantly improving what already exists. The risk-taking is usually quite low and the payoffs are attractive, especially since earlier versions have already been put on the market. Incremental innovation tends to lengthen the life of a pre-existing offer. It also allows to expand the range and optimize production, at limited costs and investments. From a marketing point of view, this allows to rejuvenate or refresh the offer at a lower cost. It is easier for the company to stand out from the competition in the selling arguments.
But this also creates a tendency to offer ever more sophisticated products / services / processes. The resulting technological inflation is not always based on a proven customer need or demand. Some incremental innovations even make products too complex for the end user (this is very clear in consumer appliances). Sometimes we just test customer reactions to our creations rather than listen to them. It is complicated to try to value innovations to customers that they do not need. In my opinion, innovation therefore requires a segmentation or re-segmentation exercise.
What methods to set the price?
Incremental innovation, of course, offers to companies the opportunity to raise prices. Some companies try to do it, others do another calculation and give it up. This calculation is perfectly respectable if the idea is to create a competitive advantage to significantly increase the market share. But if you are a monopoly, not valuing innovation is more difficult to understand…
Companies that want to increase the price of incremental innovation are generally satisfied with the traditional method known as “cost plus” (or fixing of the price based on the costs) which consists in adding the costs then adding their margin objective, without any validation through market research. Some executives find marketing research expensive and unnecessary. It’s easier. It’s like pricing by decree. Then they launch, hoping that it will go well!
For small and agile companies in the digital world this does not have too many consequences because they quickly correct things. For example, they practice “A / B testing”. They are able to test quickly on a large scale and adapt almost instantly to the test results. Simple and efficient. For large industrial multinationals, which sometimes take years to prepare their marketing and train their subsidiaries, it is risky: the inertia of the “system” is considerable, both in reporting market information and then taking a new decision and changing course …
Fewer are companies that use pricing methods based on customer studies or competition. Incremental innovation is, however, the simplest category to study because both customers and salespeople know existing products and generally those of competitors: they have a baseline that allows innovation to be valued differentially.
The price study must begin with a customer value study, which quantifies the relative share of the 5 fundamental components of value and collects highly valuable verbatims. The study should also make it possible to understand purchasing behavior and to quantify the proportion of customers interested in innovation in general. There are many areas where the clientele is overwhelmingly conservative or primarily seeks a low price, with those seeking innovation remaining very few. Behavioral studies should help understand customer buying cycles: it is complicated to sell an innovation to customers who renew equipment every 5, 10 or even 15 years, as with capital goods. In the long run, the innovative character is lost and the competitors catch up with you.
Then we have to study the “propensity to pay” (or willingness to pay). There are different methods from the traditional declarative method developed in the 1970s to more modern, non-declarative approaches, especially the more recent ones which use the input of applied neuroscience. These have the advantage of avoiding the many biases inherent to declarative methods but are still reserved to large groups with substantial resources.
The propensity to pay should if possible be analyzed by strata, depending on the criticality and the temporal urgency to acquire the innovation. Indeed, I suggest segmenting the study of the price of innovation according to the criticality / time ratio. The timescale ends with the estimated arrival of competing solutions on the market. A customer for whom the acquisition of an innovation is critical and urgent must honestly agree to pay a significantly higher price to get it. For several years now, we have become accustomed to paying far more expensive transport tickets under certain conditions (dates with high demand, lack of anticipation, cancellation conditions, etc.) or a high additional cost to have accelerated delivery on e -commerce, then why should we freeze the price of an incremental innovation? This idea scares traditional companies, both for customer relations and for the technicality that this requires.
We should take advantage of the customer study to collect indications on the imminent release or not of solutions competing with our innovation.
The propensity to pay is a particularly difficult element to tackle in B2B sales to large accounts. In fact, the size of private or public clients and their limited number create a very particular situation of balance of power. Their huge size creates inertia in decision-making and sometimes a problem of acceptability to pay a higher price for an innovation, especially for an incremental innovation where the reference price constitutes a very powerful anchor. Some large structures even have expert resources capable of estimating the cost of purchases and will impose a price on their supplier (estimated by costs). Negotiators then have an overly financial approach bias, to the detriment of other aspects such as the added value of innovation for the end customer, exclusivity as a competitive advantage or even the speed of access to production capacities more limited at the beginning. In this case, I advise the parties to negotiate a “win-win” agreement of strong temporal price degression to trigger a price-volume dynamic that will be linked to the increase in production capacities and the resulting productivity gains. Tactically, the supplier does not necessarily have an interest in granting exclusivity of the innovation to one of its customers, especially if the propensity to pay is low and a majority of customers show their interest in the short term.
After estimating the propensity to pay we must add making sure that the sales force is also trained and that it adheres to sell innovation at its price. In the field, you may find that not all salespeople are ambassadors of innovation. So you have to test the price of the innovation with your sales force and verify before launch that it is part of their written business objectives.
For these client studies it is recommended to use specialized professionals who are experts in these methodologies and their application to the sector and who have access to representative panels. While some companies have internal resources for this, they may lack methodologies and sometimes do not have access to representative samples of the market, especially customers of their competitors. Customers of the brand are often easier to contact. Loyal customers, who are close to the brand, when questioned directly by the brand will not necessarily dare to speak their minds or upset a friendly marketing interlocutor. It is a mistake to interview such a biased sample, although it is always better than doing nothing.
Competitive intelligence should not be neglected either: some companies believe that they will release an innovation when this is not true. Many companies still have a very narrow view of their competitive environment which they mistakenly think they know well. Imagine you are in this situation. You were preparing your innovation launch and even doing customer and sales force research to set the price. But the competition was not asleep and it “unsheathed” its innovation a few months before you, you discover in dismay the innovation in the media thus taking your organization completely by surprise. Your competitor has just set a first market price for the innovation for you. When several competitors offer a very similar innovation almost at the same time, your competitive advantage is reduced but you stay in the race…
Add to that the sometimes overwhelming ignorance of the competitive field. Even world leaders underestimate the real number of their competitors (in one case studied in BtoB services, they were 3 times more numerous than what the company knew).
There are special cases where innovation price studies are particularly difficult to conduct.
This is the case with BtoBtoC. A supplier develops an innovation and seeks to sell it to another company which will distribute it or integrate it into its offer to make it more attractive to end customers. Innovation price testing with this reseller / integrator is not representative of the end market as it is a discussion between a seller and a professional buyer who is first and foremost a negotiator and not necessarily an end user of the innovation. In this case, if the supplier does not have access to end customers or does not conduct end customer studies, there is a high risk of ceding most of the benefit of its innovation to its reseller / integrator. This is not a very fair sharing of value because it is the supplier who invented, invested and who takes most of the risks (for example the warranty costs in case of quality problem).
Another special case is innovation “invisible” to the end customer. Its valuation is delicate and must be the subject of further marketing reflection, in particular jointly and upstream with business customers, resellers / integrators if this is the case.
A third difficult situation concerns the offers of “complex” products or services. The launch of a new product or service will generate packages or bouquets made up of a mixture of real innovations and simple novelties that are not innovations at all (options, aesthetic modifications, etc.). This is the case with car manufacturers who, at the launch of new models, will offer different levels of “finishes” (generally from the most basic and stripped down to the luxury version, including all kinds of intermediate finishes according to customer styles). Options, equipment, customer customization and services will be added to these finishes. There are actually quite a few real innovations and very few that other competitors do not already have. True innovation is found buried in a great deal of other information and its specific price does not necessarily appear. What do the customers think if they are specifically interested in this innovation? And what about when they no longer pay a purchase price but a leasing or a rental where the rents are pure marketing constructions to display an attractive monthly fee?
Finally, a last special case concerns products with short development cycles where reactivity is paramount and where there is not enough time to carry out conventional studies. This is the case, for example, with sporting goods which follow the waves of prototypes on a weekly basis and which are able to validate products in just 3 months. In this emergency they may think that it is not possible to conduct studies. But if they have studied the market further upstream (price positioning, market share, image, segmentation) they can nevertheless carry out price tests quickly, ideally with ad hoc panels offered by service providers or else they will have themselves made up taking care not to limit themselves to customers of their brand. There are fast and affordable online research solutions for SMEs (especially in BtoC).
What price strategy?
Some companies want their incremental innovation to be highly valued in the price. This may be part of the recipe for success for some brands that started with a successful product base. Over time, they build their image and customer loyalty because over the years or decades they have become accustomed to developing their offer by small touches. They seem to have an approach to innovation that is well mastered, organized, communicated and properly valued, taking care not to outdate the previous generations. In certain areas where the new product does not erase the previous one, the brands decide to continue to market a few earlier versions for the part of the clientele that does not seek innovation at a high price but a lower price or a feature / price ratio more suited to their needs and their budget. You will find many examples of brands in the world of high-end automobiles, specialized sports equipment or even tech** that follow this strategy. They have a customer base that is very attracted by innovation and willing to pay for it to own it before others.
Other companies focus on maintaining sales volumes or market share. This can lead to not wanting to take risks and not significantly (if at all) valuing the incremental innovation in the price. They therefore have little interest in maintaining the old offers, except in drastically lowering the price to satisfy some of the customers who are looking for a low price and a proven product *. But by having prices too close between the new and the old, they accelerate the obsolescence of old products sold just before, whether they have been discontinued or not. In markets with regular renewal, old products bought at a price close to new innovative products will be perceived as much less attractive, which will devalue them if there is a second-hand market. We will recognize here the companies which seek above all to maintain or increase their position in market share in very competitive environments and where the customer base is mainly conservative or focused on the price. This is common in B2B.
There is a third option which consists in introducing an incremental innovation at a lower price than the previous product. The question of profitability is even raised. This is a perilous strategy for the company and even for the market. It can be explained in very specific cases: either Dantesque / crash market conditions (where the company would play its last card), or very dynamic markets in which the company wants to take the leadership (situations where it would be possible to acquire very quickly simultaneously notoriety, new customers and a lot of market share), or still in the idea of blocking new entrants (be careful, dumping is an illegal practice in many countries!).
Between these 3 models, there are probably companies that hesitate. The decision must first be consistent with the overall marketing strategy and more particularly the product or service offering strategy. Many companies offer a diverse product line within a product line: they may have different pricing strategies for the products in a line and even change them over time (see “textbook case”**). The orientation of the pricing strategy also depends on the level of confidence of business decision-makers in taking risks on innovation in relation to the pricing power of the brand (ability to increase the price without significant impact on demand). This can create disagreements between a project management “proactive” on the objectives and a more “cautious” operational sales management.
Brands with a dominant market share (in a given segment and market) a priori have the potential to strongly promote their innovation, unlike those with a low market share. As the market share is rarely homogeneous from one country to another, the price increase linked to innovation deserves to be carefully assessed by segment and by country. This is interesting in BtoB where the final prices are often invisible. But on the contrary in BtoC where online sales and price transparency on the internet tend to homogenize prices in the same monetary zone (such as the Euro zone), it will be much more difficult to adapt the valuation to each country. .
Whenever possible, marketing should identify and then target customer sub-segments who expect innovation and are willing to pay the price *. If the proportion of these customers (“tech fans”, “early adopters” …) is in the minority, you have to think twice before deciding to put the innovation as an option or as a base in the product / service offer.
A final fundamental element to take into account is the brand and more precisely its image ranking * and the perception or not of the innovative character of the brand by customers *. A leading brand with a strong image in a segment probably has a pricing power that will allow it to aim for a double-digit increase for its incremental innovation. A non-leader brand but strongly renowned for its innovative character logically also has great potential if its customer base is more attracted to innovation than the customer base of another competing brand which would be of the same image level but deemed to be conservative. A multi-brand group that has both characteristics in its brand portfolio (1 leading image brand + 1 reputedly innovative brand) will have to be very careful about the timing of the introduction of innovation and also on the consistency of the innovation price between its brands.
Finally, the room for maneuver on the price of an incremental innovation will be much lower for a brand with low pricing power, not known for its innovative / pioneering character and without a customer base with a strong interest in innovation.
Incremental innovation is the most common form of innovation and consists in improving what already exists. Its interest is to rejuvenate and increase the lifespan of the offer, boost the attractiveness of the brand while moderating the cost and risk taking compared to other forms of innovation.
The price of an innovation and the sales volumes are the top 2 lines of the business plan that make up the turnover. Volumes will depend in part on pricing. The marketing mix of an innovation project should in principle reserve a balanced budget for pricing compared to other components (product, promotion, distribution). The classic “cost + margin” approach is necessary but not sufficient in innovation pricing. Many companies are focused on the technical and project launching aspects, thinking that they will see the price later because it is a business of salespeople. However, the price is the responsibility of marketing and must be seriously approached very early on with adequate research resources and gradually refined until market launch when the development cycle is long. For companies with short development cycles (3-6 months) it is different because the competition and the market go fast, time is running out and you have to aim straight away.
The specific situation of the brand in terms of image, market share and customer base in its segment will be decisive in considering the possibility of strong valuation or not of an incremental innovation. But it is worth remembering that price is only one important factor among many in the success of an innovation in the market.
* this information is accessible thanks to ad hoc customer study
**A textbook case : the Iphone.
Publishing author: Pascal Doreau
First publishing: February 9th 2021 (french version)