Marketing of High-Technology Products and Innovations Pricing Considerations in High-Tech Markets

Key Points Customers evaluate transactions based on Cost/Benefit analysis Therefore products should be priced according to perceived values from customers

Main Concepts Main Concepts To Be Understood –Moore’s LawMoore’s Law –Network ExternalityNetwork Externality –Unit-one CostUnit-one Cost –3Cs of Pricing3Cs of Pricing –Monetary Cost/Nonmonetary Cost –Total Cost of Ownership (Life Cycle Costing)Total Cost of Ownership –Customer Oriented PricingCustomer Oriented Pricing –Customer Classification Matrix (in terms of price paid and cost to serve)Customer Classification Matrix

Main Concepts Cont Main Concepts To Be Understood –Technology ParadoxTechnology Paradox –Captive Product PricingCaptive Product Pricing –Cost TransparencyCost Transparency –Reverse Auction –Pricing LiningPricing Lining –Outright SaleOutright Sale –Pay-Per-UsePay-Per-Use –LicensingLicensing –Micropayment

Chapter Agenda The High-Tech Pricing Environment The “ 3 Cs ” of Pricing Customer-Oriented Publishing The Technology Paradox The Effect of the Internet on Pricing Decisions Additional Pricing Considerations

The High-Tech Pricing Environment Need to re-coup R&D investments in light of: –Rapid pace of change –Short, volatile product life cycles –Price/performance pressures Moore ’ s law –Network externalities –Unit-one costs –Customer perceptions of costs/benefits

The High-Tech Pricing Environment –Customer perceptions of costs/benefits Anxiety “ Balky ” Upgrade considerations –Competition –The Internet –Backward compatability, Derivatives

The 3 Cs of Pricing

Customer Perceptions of Benefits/Costs Benefits: –Functional –Operational –Financial –Personal Costs: –Monetary –Nonmonetary

Additional Customer Considerations Total Cost of Ownership –Ex: Lifetime cost of owning a corporate PC is $42,000 (in 1995) Purchase price accounts for only 10% of total cost Implication: –Show total cost of ownership lower than competitor ’ s, despite higher initial outlay

Customer-Oriented Pricing How will the customer use the product? What are the benefits the customer will receive from using the product? Calculate customer costs and understand customer ’ s trade-off between costs and benefits.

View from IBM ’ s Technology Expert One way to help customer manage risks is through financing and leasing –Assist with upgrades and replacement flexibility –Creates stepped payment streams allowing customer to match results to cash outflow –Way to capitalize or manage assets –Allows for scalability.

View from IBM ’ s Technology Expert Advantages: –Forms long-term relationship –Avoids commodity trap Caveat: –Must understand customer risks and value components

Implications of Customer- Oriented Pricing Pricing decisions are part of product design decisions Different segments value the product differently Therefore, different customers yield differential profitability And different segments may be priced differently –Ex: Microsoft Full Version/Education Version

Analyzing customers for profitability

Carriage Trade: Pay top dollar; require much service –i.e., customers with customized products and high service level; willing to pay –Cost-plus pricing may a simple solution for these customers

Analyzing customers for profitability (Cont.) Bargain Basement: price sensitive; don ’ t require many services Aggressive: demand high services and low prices simultaneously –Might be large and important to firm; and powerful Aggressive and Bargain Basement customers should be screened through central office to ensure profitability

Analyzing customers for profitability (Cont.) Passive Customers: accept high prices, don ’ t require much service –Product might be crucial to operations –Customer might face high switching costs –Very profitable if price based on value

Analyzing customers for profitability (Cont.) Implications: –Must track costs on a per customer, or per segment basis via accounting –Might decide NOT to serve some customers.

Technology Paradox Rapid pace of price declines At the extreme, technology is “ free ” and companies literally give products away. How can businesses thrive when their prices are falling? –Requires exponential growth of market to be faster than the exponential decline of prices –Requires new skills: ingenuity, agility, and speed

Possible Solutions to the Technology Paradox Keep costs falling faster than prices Innovate? –Make products easy to use, exciting, or both Two extremes: –Market domination: own the standards and charge a premium for them Intel and Microsoft –Sell a commodity and hope for volume Middle-of-the-road: Learn new tricks

“ Middle of the Road ” Solutions to the Technology Paradox Try to avoid making commodity goods –Provide value beyond competition –Mass Customize Agility and Speed –Focus on “ best possible solution ” (vs. best solution possible) Find new uses for products –Collaborate with complementary providers –Expand to other segments

“ Middle of the Road ” Solutions to the Technology Paradox Develop long-term relationships with customers with low/free pricing –Goal is life-time value rather than margin –Establish a market-hold to grab “ mind share ” (eyeballs; personalized customer knowledge) Behavior -> Brand Loyalty (Attitude) (ex., free ISP, mailbox) Capitalize on that knowledge as a form of switching cost –Establish an installed customer base to sell ancillary products and services “ Captive product pricing ” (Free PC w/on-line fee, Printer, Satellite TV) Offer complete solution ( “ end-to-end; ” whole product) Rely on advertising and marketing revenue

Drawbacks to Low-Price Strategies Devalues brand equity/perceived value Antitrust considerations: –Line between predatory pricing and effective pricing? Infer “ intent ” and examine impact on prices Large firms scrutinized more carefully because of their greater market power.

Effect of Internet on Pricing Cost Transparency –Solutions: Pricing lining/versioning Innovate

Additional Pricing Considerations from Embedded Nature of Know-How Outright Sale of Knowledge vs. Licensing –With high levels of technological uncertainty, easier to valuate know-how in the short-term Leads to more licensing rather than outright sale One-time/single Use vs. Multiple Users –Depends on customer ’ s cost of sharing the product relative to the manufacturer ’ s cost If easy for customer, then price (higher) for site licenses (multiple users) If difficult, then price (lower) for individual use

Additional Pricing Considerations Pay-Per-Use vs. Subscription Pricing –Network externalities favor subscription pricing Generate more users to increase the value of the network –Technological uncertainty favors subscription pricing Risk averse customers prefer flat rates to avoid uncertainty

More on Leasing to Finance Purchase of Technology Infrastructure Can generate savings through tax benefits Can minimize balance sheet impacts Can maintain operating flexibility with respect to equipment Can attract investors with residual value of leased assets

Discussion Questions –How would characteristics of the high-tech industries influence the pricing decision on high-tech innovations/products? Please specify those characteristics and then discuss the corresponding pricing decisions. –When your competitors provide a low price and low quality product to your customers, what can you do?

Discussion Questions Cont Discussion Questions –For the same product, can the price be different for different market segments? If yes, what would be the major considerations to set up different prices? –What is “Technology Paradox”? Can you give an example of why and how a company can still make money when the commodity price is close to zero (or when the commodity is almost free)? –How can a company deal with cost transparency?