Nice overview of pricing methodology from Jim Schuchart on the MIT Entreprenurship Review.
1. Identify Alternatives: What is the next best competititive alternatiive? Sometimes the compeition is not making any investment in this issue.
2. Quantify Your Superiority: Use simple math. (the simpler the better) Apply basic, but conservative assumptions that are easy to understand and difficult to refute. Don’t worry too much about perfecting the numbers, just be conservative. Roughly right is better than precisely wrong. As you move forward, customer conversations, annual reports, pilot programs, and field tests will help refine the inputs. The important thing is to understand how we are driving value, and roughly how much it is worth.
3. Acknowledge Your Deficiencies: Your story must be fair and believable to gain traction, and a key step is to acknowledge that the next best competitive alternative may have some advantages. The analysis looses credibility if the audience thinks we didn’t look at the entire picture. Consider the cost of switching from the incumbent solution as a deficiency.
4. Put it Together and Capture Your Value: In most cases, you’ll have multiple positive and negative drivers to consider, but for now we’re keeping it simple. So now what?
If we are more valuable than the competitive offer, their price is a hard floor for our offer. Anything below this number leaves money on the table and can lead to dangerous price wars. Our ceiling is that differentiation plus the price of the next best competitive offer. Above this price you are asking your customer to make an economically irrational decision.
This approach creates a pricing band – from floor to the ceiling, and the range may be quite large. Decisions on how to share that value creation band with your customers (e.g. where to set your price) depend on company strategy, industry dynamics, and degree of innovation. In mature and highly competitive markets where innovation happens on the fringes, companies typically capture 10% of the differential value. More aggressive companies who focus on profit or operate in younger markets often captured roughly 30% of the net differential value. In some cases, such as highly innovative products where psychological drivers are in play or unquantifiable pain points exist, nearly 100% of that value can be captured.