Feature

For years, the culture among companies which bought Respironics' home care therapy products included the expectation that certain features, especially software, would be thrown in free of charge.  Those were also the expectations of Respironics' own sales staff.  So when the company decided to start charging for its new software feature, it had to tread carefully.  In a Product Strategy Network Forum, Philips-Respironics Global Product Manager Bob Barker described how he helped facilitate that transition.  In this follow-up article, Barker describes how a market price was determined for the company's new software.

By Peter Longini, Managing Editor

Not long ago, airlines used to include beverages, snacks, two checked bags, and a choice of seating as part of their basic coach fare.  Now, at least some of them are trying to introduce those same services as premium items, for an extra charge.  And travelers are fuming. 

Coaxing people to pay for services they used to get for free is a very hard sell.  But with costs going up and income falling, lots of industries are finding themselves in the same dilemma: a valuable service component of their product which was formerly provided without charge, now becomes a candidate for generating new revenue.  In the case of Philips-Respironics, a maker of professional devices for home health care, many of whose customers had been feeling the squeeze of falling insurance reimbursements, it happened when a new Web-friendly application was added that improved the administration of treatment, although not the therapy itself. 

Deer in the headlights

Bob Barker, global products manager for the company, was confronted with that challenge almost from Day One.  By the time he arrived at the company in 2007, EncoreAnywhere - the name of the Internet software enhancement - had already been under development for several years.  One of Barker's first assignments was to price it.  "I stood there like a deer in headlights, because I had no idea of how to price it," he recalled.  "Respironics is a device manufacturer first and foremost.  It's easy to price a box because you give the box to a home care provider and they give you money.  But software was something entirely new."

Complicating the issue was the fact that Encore Pro - an earlier generation smart card used for data-gathering applications with the company's devices - had already been given away free for years.  And Respironics' customers - the home care providers who used that system - were accustomed to receiving those benefits without charge.  "We had conditioned our customers, our sales force, and everybody else to say that this functionality is free," he said.  "That was a really big hurdle to overcome.  And to make matters worse, our competitors were giving away their desktop applications for free as well." 

Beyond that, the business was operating in a culture where customers were trained to haggle, negotiate, and resist payment.  "We, as marketers, essentially vary the pricing to match their willingness to pay," he said.  "Over the years we've entrenched in the customers' minds that if they become unwilling to pay, they pay less.  And we reward our best, most loyal customers with higher prices than the ones who either threaten to defect or actually go ahead and start buying from the competitor.  We've conditioned them to negotiate on price and to leave value out of the equation."

But with EncoreAnywhere, Respironics realized that there was a business opportunity, as well as a legal need, to charge for it.  For one thing, there was real value in the software.  And in the case of therapeutic devices where third-party payments are involved, giving away something of value could appear to be an inducement.  And that impression, in turn, could lead to all sorts of unhappy regulatory consequences. 

"So we realized that success was going to require changing a lot of people's expectations," Barker recalled.  "There was a lot of skepticism.  The sales force didn't believe that our customers were going to pay for it.  Sales management didn't want the sales organization spending time trying to convince them to pay for this when they had a big quota of therapy devices they had to sell.  We didn't have the processes in place.  So it was a big challenge."

In focus

To help get that process underway, Barker organized a lavish focus group for some of its big Encore Pro users - set in Las Vegas.  "We wined them, dined them, and basically heard their thoughts about the software idea.  They loved the product.  But they didn't think they should have to pay for it," he said.  "We were trying to figure out how we're going to charge for this, and what the customer value was, and then panic set in." 

For starters, they began to examine its potential economic benefits.  "We began a time and motion study," Barker said.  "We asked what's the cost of handling this Encore Pro card data and how much could the modem save them?  The results gave us a good feel for what they're actually spending time doing.  And it turns out that sharing that data back and forth is a big pain for them." 

So instead of pricing based on a customer's willingness to pay, Barker followed an approach called ‘value pricing,' a strategy based on understanding the real economic benefits to the customer.  "Not just in a theoretical way, but in dollars and cents," he said.  "What you do then is go to them and say, ‘Here's why you should pay.  Here's how it's going to be profitable for you to use my product instead of the competitor's, and here's by how much.'  So it really is a proactive and strategic approach."

Pricing models

However before settling on a specific price, Barker examined a series of possible price levels to evaluate how they would likely affect different customer segments.  "The point was to get down to a net economic value so we could think about the possible range we could charge for each of those metrics.  But would it give them sticker shock?  Would it cause them to pass out on the spot?  Ultimately we decided to go with per location pricing; one to three locations is a fixed price.  Each additional location is an extra amount, and it's going to be billed monthly as an ongoing service." 

The goal of a value pricing scheme is to capture some of the economic value that the software delivers to its customers.  But, Barker cautions, you can't capture everything and different customer segments value different things.  "There's resistance, there's disbelief.  There's a lot of things that affect their willingness to pay that will prevent you from getting 100 percent of the economic value you deliver.  But you're ideally going to get somewhere in there.  And the more you push to the top, the better off you are."

Paradigm shift

So where did Respironics end up?  "Ultimately our strategic mandate to drive market penetration, the price sensitivity, and the competitive intensity got us down to the low end of that price range," Barker admitted.  "Not to zero; we actually do charge.  But that's an astronomical, extraordinary change for home care providers.  Instead of our saying, ‘Would you like more of that?' we've actually said, ‘You want it, you pay for it.' 

"We wanted a nice, clean, simple pricing model that would be easy for our sales force to understand, and easy for them to explain to the customer.  Because, let's face it, they're already swallowing a big change, which is going from not paying to paying.  Making it complicated for them is just going to make them dig their heels in." 

Did it work?  "We succeeded in moving the state of the art, the thinking, the mindset, the expectations of these customers away from ‘This is a free thing that we get,'" Barker pointed out.  "Early on, we had customers beta test it, and they said, ‘We think we should be getting this for free.'  Today, a lot of these same customers are happily paying the monthly fee.  So in that sense, we think this was very successful.  We've signed up a number of customers in a fairly short time, because we're targeting at some very select regions.  We're expanding our rollout.  And we've developed a very strong partnership with our sales force." 

More about product pricing

Bob Barker's presentation at a recent PSN Forum event showed how they went about setting the price for their software product.

Feature: The right price. Finding the right price for a technology product is part art, part science, part strategy

Presentation slides: The slides from Bob's presentation are available to PSN Members in the PSN Member Exchange. Download presentation slides (PSN Members need to login first.)

About the Author:

Peter Longini is the Managing Editor for Inside Product Strategy™. He can be reached at   .