Pricing Innovative Products, Part I

So you’ve listened diligently to your customers and identified a new product or feature that you believe brings real value. Now, as you ready to take the product to market, you face the inevitable question of how to price it. Undoubtedly, no matter how innovative, unique, or original your product/feature, a market standard exists. Your customers are using something to attempt to solve the problem or bring the value you hope to bring. (And if not, you better reconsider whether you’re solving a real pain point.) The pricing question, then, becomes what is the economic value of your solution over the existing products? We call this the Premium of Innovation. Any product that brings greater value commands some premium pricing. We break down pricing methodologies into two parts, quantitative and qualitative.

Quantitative Pricing Methods

A number of articles consider the premium of innovation as it relates to new companies, but little exists on the matter of pricing innovation into individual products. Truth be told, the premium when observed at a corporate level is usually measured ex post facto: the value existing companies (stock price multiplied by number of shares or some similar variation) subtracted from the free-market price of the new venture (again, sum of stock outstanding). Not a lot of use for us.

Let’s look at two models applied to pricing innovation at the product level: Cost+Margin and B.I.B. Heavy private equity influences on the start-up sphere may be to blame for the overutilization of the Cost+Margin model. PE typically invests in new projects with a strict timeline and expected ROI. Often, when the ROI metric is hit, the equity holder will sell out to the next seed round, regardless of the adjusted potential of the matured venture. Aligned in construct, entrepreneurs and PMs too often reduce the pricing equation to cost plus desired return. Too often, this leaves money on the table, especially with SaaS products, where fixed costs per unit vary wildly with sales volume.

An alternative awaits. The B.I.B.: Base + Innovation Premium + Brand

We start with a “comp base” or market gut check weighted by similarity. Start with pricing for however many competitor products it takes to reach a 75% share of the existing market. Some modifications will be necessary here to account for disparate business models. Monthly vs. annual. Sale vs. subscription. The razor blade model. Etc. A n elemental version just assigns three classes to competitors: low, mid, or high similarity. Under that model, low prices are multiplied by 0.5; mid by 1.0; and high by 1.5. Those prices are averaged to arrive at your base. To this we add our premium of innovation. Where do we get this. Often an easy approximation is to look at how the market priced the same/similar feature in a different product line. Is your new feature an ergonomic adaptation to child safety scissors? Look at the premium assigned to ergonomic pens, chairs, or utensils. Is your new feature an anti-scratch coating to Covid face shields? Look to the premium associated with scratch-free eyeglasses, hockey face visors, and watch faces. Finally, we add any value brought by association with our brand. This may be negligible, except in cases where the new product/feature is introduced by company whose existing product prices are not included in the 75% of market share (above).

The Base + Innovation Premium + Brand model rewards companies for innovation without limiting it to capturing a pre-determined margin.