Monetizing Innovation

One of the biggest issues with innovation is the failure to put customers’ willingness to pay (WTP) at the centre of product activities. The most successful innovators determine what customer values and what they are willing to pay for it and then design products based on those inputs.

Lack of understanding of customer’s WTP often results in one of four innovation failures:

Feature Shocks

Adding too many features to the product, most of which customers are not willing to pay for. Not only does it make the value proposition harder to notice, but also increases the price. As a result, even if a customer is willing to pay a lot for certain features, the total price is often too high.

Minivatons

Creating a breakthrough innovation and pricing it too low, leaving massive profits on the table. It happens when we don’t realise that our customers are willing to pay a lot for our invention and decide to play it safe.

Hidden gems

A breakthrough innovation that lies hidden. The company either doesn’t recognise the hidden gem’s value or lacks the competencies to bring it to the market. Researching customers’ WTP helps us spot those gems and motivates us to learn how to monetise them.

Undead

They happen when we overstate the customer appeal and chase inventions that, in the end, the customers are not willing to pay for.

Pricing strategy is our short- and long-term monetisation plan.

High-level pricing strategy

Quick overview of overarching strategy. It should have clear intent, quantifiable goals and a time frame for execution.

A common approach is to set one core objective and establish core principles that should guide us towards that strategy.

Price-setting principles

Price-setting principles are the tactics that help us realise our strategy, and they serve as a guardrail from making emotional knee-jerk decisions. They include

1. Monetisation model: How will we charge our customers?
2. Price differentiation: Will we have different price points? If yes, how do we differentiate? By channel? Region? Industry vertical? etc.).
3. Price floors: What is the floor below which we’ll never price? What’s the maximum discount we will grant?
4. Price endings: Should our prices end at x.0, x.50, x.95, x.98?
5. Prince increases: Will we increase the price over time? How much and how often?

Principles for reaction

If we don’t plan ahead on how we’ll react to market shifts, then there’s a high chance our reactions will be emotional and spontaneous. Reaction principles come in two varieties:

1. Promotional reactions: Whether and how to promote and who will receive these promotions and when. Also, what promotion we’ll not resort to.
2. Competitive reactions: Countermoves on potential rivals’ reactions.

Example

High-level strategy

Over the next two years, we plan to increase revenue by 40%. We will accomplish this by establishing a premium price versus the market leader in core consumer segments and discounting the price in growth consumer segments. This is because we believe in the following opportunities:

1. We can’t make drastic price moves: The market leader sets pricing expectations for our consumers.
2. We won’t lose many core consumers: These consumers are relatively price insensitive and brand-loyal, even if we charge a slight premium.
3. We can communicate our price advantage in growth segments: Consumers in our growth segments are more price sensitive and try to directly compare prices to those of our competitors.

Price-setting principles

1. We will adopt a profit maximisation strategy.
2. We will price on a subscription basis.
3. We will differentiate pricing by industry vertical and vector.
4. We will never discount beyond 50%, we will never price below $25/month.
5. We will end our prices in x.99.
6. We will increase prices over time using annual escalators, and the size should be around 3% beyond the inflation rate.

Principles for reaction

1. We will offer promotions only to new customers. The duration of promotional pricing will not exceed one month and will never be >25%.
2. We will add value to preserve the price as long as the price cut from the competition is less than 20%. We will only start a price reaction if the price difference gets beyond 20%.

A short library of methods to research WTP early.

Technique 1: Price-points

• After demonstrating the product, ask potential customers what they think is an acceptable/expensive/outrageous price.
• Acceptable usually means ‘cheap’, expensive usually means ‘willing to pay for’, and outrageous usually means ‘too expensive.’

Technique 2: Direct question

• Directly ask the customer if they are willing to pay X for the product.
• Based on the outcomes, on the next interview, increase/decrease the number.
• Always ask ‘why?’

Technique 3: Probability questions

• Show the product, tell the price, and ask the customer to rate on a scale of 1–5 how likely they would buy it.
• If the result is 1–3, then lower the price. 4–5 is good.
• Data shows that if customers say 5/5, there’s a 50% probability they would actually purchase it.

Technique 4: Indexing

• You can compare your offering to some well-known market leaders, say you build competition for Salesforce.
• Ask, “if Salesforce indexed at 100 points in terms of value, how would you rate our product?”
• Ask, “if Salesforce indexed at 100 points in terms of price, how would you rate our product?”.

Technique 5: Build your own

• First, you have to have a general idea of what your customer’s overall WTP and per feature WTP is.
• Show them the list of features with an adequate price tag for each feature, and ask them to build their own product/bundle.
• You’ll see what combination resonates the most, which features are rarely picked, and in what price-range do customers end after creating the bundle.

Technique 6: Most-least questions

• List out product features (say, 10)
• Create a few bundles with a limited number of features (say, 6 out of 10)
• Show each bundle to the potential customer and ask them to sort the features from most valuable to least valuable.

Technique 7: Purchase simulations

• Usually done after the main research has been already done.
• Create a few potential product configurations with price-tag on them.
• Show the configuration and price to the customer and ask them if they would buy it. Go through every bundle.
• It’s closest to the real-world sales simulation, but to be truly useful, the options and price points should be based on realistic research, not just random brainstorming.

• Don’t confuse ‘price’ with ‘price point’. Price is a value perceived by the customer. Price point is the actual dollar amount you are charging.
• Counterintuitive as it might sound, reducing the number of features often allow companies to increase the price. Feature shock can often hide the true potential of the product from the customers.
• Avoid the ‘average trap’. If half of your customer’s WTP is $20 and the other half is $100, then create two product configurations. Pricing it at $60 would exclude the profit from the first half and under-price the second half.
• When it comes to innovation, there’s only one way to segment — by needs, value, and WTP.
• Don’t have too many segmentation schemes (different segmentation for product/sales/marketing, etc.), preferably you should have only one.
• The golden rule of segmentation: segment in a way which allows you to act differently based on segment.
• Limit the number of segments on your radar to reduce complexity, and don’t try to serve every segment.
• Product configuration means you design a product option for a particular segment with features that the segment has a high willingness to pay for. It creates a unique value proposition for that particular segment.
• To maximise monetisation potential, we should curb our instinct to give too much value-added functionality or free. Proper configuration requires the guts to take away features.
• When configuring a product using good/better/best technique, the ‘golden ratio’ is to provide 30%/70%/100% of the value.
• To decide whether to bundle or not, analyse if bundling allows you to increase revenue. McDonald's is a great example — if they didn’t bundle burgers with fries and coke, many people would buy just burgers, and McDonald's would be leaving money on the table.
• Sometimes unbundling is the right answer. Ryanair unbundled almost every part of their service, making the price flight a mere 9.99. Not only it allowed customers to pay for what they actually needed, but even though the price increased noticeably when you added luggage, seat selection, etc., 9.99 is what stuck in customers' minds.
• Auction-based pricing allows you to withdraw from the act of price-setting and let the market figure out how much it wants to pay.
• WTP should be the core element of every business case, and the business case should not be a static document — it should be updated and reviewed regularly as more is learned.
• Marketing and sales teams are often brought too late and are too detached from the value of the product. They should be included as early as possible.
• Communication differs per segmentatiom. Different segments are offered a different value proposition.
• In communication, focus not only on your competitive advantage but also think through what is your competitive disadvantage — and plan to defend against it.
• For B2B customers, communicating value through money saved is one of the most efficient tools.
• There will always be a few customers willing to pay the most premium price for the tier offering the most functionality, no matter what. They believe you get what you pay for, and they deserve the best. This as a fact of life.
• Make decisions easier for people who can’t choose by offering 3 price tiers. Low/medium/high.
• It’s usually better to offer a cheaper product to get the foot in the door and the more expensive sub-product to monetize it later. Most customers are more willing to pay $200 for a coffee machine with $5 coffee capsules than $500 for a machine with $3 coffee capsules. Cost upfront is usually more psychologically painful than recurring costs.
• Reducing the price just before the sales didn’t take off can damage the brand and sends a message “we made a mistake, our value/quality is lower than we promised”. It also erodes profits and customer lifetime value. Holding onto the price is especially important in the first few months — it’s a narrative we create around the product.
• Before reducing the price, come up with at least three non-pricing actions before approving the decrease, and even when we decrease the price, we should ask customers for something in return (longer commitment, greater volume, endorsement, reference, etc.)
• If sales are higher than expected, scrutinize them the same way you would approach underperforming sales. It’s a sign you might have a minivation.
• Some companies made the biggest innovation leaps through pricing innovation.

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