Finding the right price for a technology product is part art, part science, part strategy

Feature 

A company's pricing strategy is strongly influenced by its larger market strategy.  But for a new type of administrative software, Philips Respironics Global Product Manager Bob Barker found that it can also be determined, as well as supported on the sales side, by figuring out the actual dollar value it brings to the paying customer. 

By Peter Longini, Managing Editor

There are lots of ways to price an item.  In Middle Eastern bazaars, for example, it's determined through animated bargaining.  So, for example, when a tourist arrives, the vendor will typically ask ten times the item's actual retail value.  Then, after a certain amount of ritualized haggling, posturing, pleading and feigning rejection, a price agreement will be reached.  Or then again, it may not.

Commercial products in the western world, on the other hand, don't lend themselves quite as readily to wide-open wrangling.  At the same time, however, there's no uniform way of pricing them.  And with a product as ethereal as software, the basis for determining a transaction price is often, to put it politely, inexact.  It's frequently done late in the product development process and typically by people who were never involved in its creation.  Beside that, the customers who decide to buy aren't necessarily the people who pay.  As a result, there are distortions in the market where the value concepts of different stakeholders are misaligned. 

At a recent Product Strategy Network forum dealing with pricing, Bob Barker, the Global Product Manager at Philips-Respironics, talked about how his company set the price for an online add-on to a home care device that treats patients with sleep apnea.  And while a number of approaches were available for establishing product prices, the company opted for a strategic one. 

Customer value

Particularly in the case of healthcare products, where the end user is not necessarily the paying customer, the link to customer satisfaction is more roundabout than for most other types of products.  But the goals are the same.  "Product management is all about figuring out how you deliver value, what value to deliver to the customer and how you make money doing that," he said. 

For Respironics, the test case came with a Web-friendly software product called EncoreAnywhere.  It built on an earlier product, Encore Pro, which is Respironics' brand name for a smart-card product which takes data from the therapy device to generate reports that tell how the patient is doing, whether they're using it, and if it's making them any better.  Insurers, understandably, don't want to pay for therapies that aren't helping or aren't being used. 

At the same time, though, Respironics' customers weren't accustomed to paying anything for the data-management accessories to their device.  And neither were their competitors' customers.  But EncoreAnywhere, if it were used properly, could have real value to the paying customers - the health care agencies.  And Respironics felt that the market should pay for receiving that extra value.  The question was: how much value did those customers actually receive and what would be an appropriate price for delivering that value?

Value pricing

So to find out, Barker employed a methodology known as ‘value pricing' - a strategic, rather than reactive approach to setting a product or service price.  "Value pricing methodology involves understanding what economic benefit the customer is going to get from using the product," he explained.  "It's an end-to-end process that looks at the features customers value.  How do they get the value out of them?  What business process, what functions, what rewards or satisfaction are they going to get out of it?  And how do different customers react to different features or aspects of the product?  Not every customer is going to assess the value of different product parts the same way.  So that becomes the natural basis for a really useful customer segmentation."

But should you structure a different offering for each segment?  "We offer pretty much the same thing, with minor bells and whistles, to different segments," he said.  "But in this methodology, you really think about it from the top down.  You ask, how am I going to price it?  What am I going to charge for?  And how much am I going to charge for those things?" 

Value definition

"By the end, you've done this exhaustive exploration of what's valuable to the customer.  And that informs your whole marketing and sales process.  It becomes the basis for communicating the value, raising the willingness to pay on the part of your customer by explaining to them how they're going to get value, and by how much.

"Then, using the tools you create in the marketing communications side, you can go out and do value selling.  You negotiate with the customer, you manage the tradeoffs when customers push back.  And the whole approach gives your sales force a bit of backbone," he said. 

"Value definition is the linchpin of this method," he continued.  "It's the idea of total economic value to the customer.  And it's not just their idea of the value, but the price they already pay for the next best competitive alternative to your product.  It's the product they would use if yours didn't exist.  That sets the baseline.  The total economic value tells you the maximum price a fully informed economic buyer, who's looking to maximize their benefits, should pay.  And it's more than the product itself; it's all the things around it - service, support, financing - everything that allows them to benefit from the product. 

"Figure out which ones are delivering the biggest bang for the buck," he said.  "Focus on those features that give the most differentiation.  Add them up.  Get down to a dollar value for each customer for these features and you get the total economic value, which is the reference price plus all your positive differentiation minus your negative differentiation." 

Unequal value

"Do that for each segment, because the value to customers in different segments is going to vary because they have different business models, different practices.  And so they're going to value things differently.  Then, once you've clustered your customers into groups, you have to repeat the exercise with different customer segments to make sure that you understand the value to that group.

"Not all aspects are equally valuable to everybody.  So what you do is to say you're going to build an offering for this particular segment.  You take all the features and services and everything that gets bundled into the thing you deliver, and you split it out.  Unbundle it, figure out who values it, apply those determinations, and bundle them back together into an offering.  Then you repackage it into an offering for each segment and allow the price to scale with the value they receive," he said. 

"Find a metric that scales with the value they receive; they should share with you some of that surplus you're product is generating," Barker claimed.  "And it's got to be easily measurable; ideally something the customer already measures.

"Make sure you're legal, and make sure you can count it, manage it, track it and bill for it.  If you're selling hard physical goods, you want it to be aligned with your cost.  But in this case, because it's a software product, our margins were a little bit vague.  So we looked at how we could charge for EncoreAnywhere.  We could charge a single flat annual fee, a site license, or maybe a tiered fee somehow based on their size.  So we took a bunch of alternatives we thought were pretty good and asked "is it going to be a barrier to adoption?  Can we measure it?  Can we control it?  Is it going to drive our customers away from putting patients in EncoreAnywhere?"

Paying for value

"Different companies employ different pricing strategies, like pricing low for more penetration.  Or going as a premium product, with high margins at the expense of high volume.  Then there's neutral pricing where you're not really pricing to go after market share.  We looked at all of those and said we have a strategic objective to get good penetration of this product.  So that weighed towards pricing it towards the lower end," he said.  "But by and large, we've managed to start getting people trained to the idea that there's going to be a bill coming every month for the software."

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: You mean to tell me that I have to pay for that...? Going from free to pay is a huge step for both sides of a transaction 

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   .