Monetizing Innovation

1. Design products around price, not the other way around

"How you charge trumps what you charge."

Flip the traditional process. Most companies develop products, then try to figure out how to price them. This leads to a 72% failure rate for new products. Instead, determine what customers value and are willing to pay for before designing the product. This approach:

• Increases chances of market success
• Ensures features align with customer needs
• Avoids overengineering or underpricing
• Allows for more accurate revenue projections

Examples of success with this approach:

• Porsche Cayenne SUV
• LinkedIn's InMail and Talent Solutions
• Michelin's pay-per-kilometer tire service

2. Have the "willingness-to-pay" talk early in product development

"If you don't do it early, you won't be able to prioritize the product features you develop, and you won't know whether you're building something customers will pay for until it's in the marketplace."

Gather crucial customer insights. Early willingness-to-pay (WTP) conversations provide:

1. Validation of market opportunity
2. Guidance for feature prioritization
3. Prevention of the four types of monetization failures:
   • Feature shocks (overloaded products)
   • Minivations (underpriced innovations)
   • Hidden gems (overlooked potential)
   • Undeads (products nobody wants)

Methods for WTP conversations:

• Direct questioning
• Purchase probability scenarios
• Most-least preference analysis
• Build-your-own product exercises
• Purchase simulations

Key tips:

• Frame as "value talks," not pricing discussions
• Ask "why" frequently to uncover deeper insights
• Analyze distribution of responses, not just averages
• Combine qualitative and quantitative research

3. Segment customers based on needs, value, and willingness to pay

"Like it or not, your customers are different."

Avoid one-size-fits-all solutions. Effective segmentation:

• Guides product development for specific customer groups
• Enables tailored value propositions and pricing
• Maximizes revenue potential across segments

Steps for effective segmentation:

1. Analyze customer WTP data
2. Identify distinct needs and value perceptions
3. Group customers with similar characteristics
4. Validate segments with sales team input

Segmentation pitfalls to avoid:

• Segmenting too late in the process
• Relying solely on observable characteristics (e.g., demographics)
• Creating too many segmentation schemes

Example: A paper company identified four distinct segments based on customer needs and WTP, leading to targeted product offerings and improved profitability.

4. Configure products and bundles strategically for each segment

"Bundling helps you determine whether your products and/or services should be sold together or separately."

Optimize feature sets and combinations. Strategic product configuration and bundling:

• Aligns offerings with segment needs and WTP
• Maximizes value capture across customer groups
• Simplifies decision-making for customers

Key principles:

1. Leaders, Fillers, and Killers

   • Leaders: Must-have features driving purchase decisions
   • Fillers: Nice-to-have features with moderate importance
   • Killers: Features that may deter purchase if forced upon customers

2. Good, Better, Best (G/B/B) options

   • Creates clear value differentiation
   • Appeals to price-conscious, quality-conscious, and compromise-seeking customers
   • Ideal distribution: 30% good, 70% better/best (with at least 10% best)

Tips for effective configuration and bundling:

• Align with customer segments
• Limit complexity (max 9 benefits or 4 products)
• Ensure mutual benefit for company and customers
• Avoid giving away too much in entry-level offerings
• Consider unbundling when appropriate (e.g., Ryanair's à la carte model)

5. Choose the right monetization model for your innovation

"Establishing a favorable monetization model can be as important as the new product itself and the price you charge for it."

Go beyond simple pricing. Innovative monetization models can:

• Differentiate your offering in the market
• Capture value more effectively
• Align pricing with customer perception of value

Five powerful monetization models:

1. Subscription: Recurring revenue, increased customer lifetime value
2. Dynamic Pricing: Adjusts based on demand, supply, or other factors
3. Market-Based Pricing (Auctions): Let market determine value
4. Alternative Metric Pricing: Align charges with customer-perceived value drivers
5. Freemium: Attract users with free offering, convert to paid

Factors to consider when choosing a model:

• Customer acceptance and preferences
• Future industry trends and developments
• Company life cycle stage and competitive position
• Implementation feasibility and scalability

Example: Michelin's pay-per-kilometer model for truck tires aligns pricing with customer value and differentiates from competitors.

6. Develop a comprehensive pricing strategy

"Without a clear goal, you won't have an effective pricing strategy."

Plan your short and long-term monetization approach. A well-defined pricing strategy:

• Aligns organizational goals and actions
• Provides guidance for pricing decisions
• Increases likelihood of realizing monetization potential

Four building blocks of an effective pricing strategy:

1. Set clear goals: Prioritize revenue, market share, profit, or other objectives
2. Choose strategy type: Maximization, penetration, or skimming
3. Develop price-setting principles: Monetization models, differentiation, floors, endings, increases
4. Create reaction principles: Promotional and competitive response guidelines

Key tools:

• Price elasticity curve: Shows relationship between price and demand
• War-gaming sessions: Anticipate and plan for competitive reactions

Companies with well-defined pricing strategies are 40% more likely to realize their monetization potential.

7. Build a robust, data-driven business case

"If you don't know how much customers might pay for your proposed product, how much they value it, how demand (that is, volume) will likely change based on its price, then how can you trust your business case?"

Create a living document. A strong business case:

• Integrates customer WTP data
• Models linkages between price, value, volume, and cost
• Evolves throughout the product development process

Nine steps to build an effective business case:

1. Forget traditional static approaches
2. Assemble basic ingredients (market size, segments, costs, etc.)
3. Include price elasticity analysis
4. Apply data-verified facts
5. Add risk assumptions
6. Be realistic about goal trade-offs
7. Consider competitive reactions
8. Assess overall company impact
9. Continually update and refine

Benefits:

• Increased confidence in market potential
• Better-informed decision-making
• Ability to adapt to changing conditions

Example: Manheim's DealShield product launch success based on robust business case incorporating customer WTP and market simulations.

8. Communicate your product's value effectively

"If you can't clearly communicate that value, how can you expect customers to understand why they need your new offering and why they should pay for it?"

Articulate benefits, not features. Effective value communication:

• Resonates with customer needs and pain points
• Justifies pricing based on delivered value
• Increases likelihood of purchase and adoption

Three steps to create great value communications:

1. Develop crystal-clear benefit statements

   • Focus on customer outcomes, not product features
   • Quantify relative value compared to alternatives
   • Use Matrix of Competitive Advantages (MOCA) framework

2. Make benefit statements segment-specific

   • Tailor messages to each customer group's needs and values
   • Highlight relevant differentiators for each segment

3. Measure impact and refine messages

   • Regularly assess customer perceptions of communicated value
   • Update messaging based on feedback and market changes

Tips:

• Involve marketing and sales teams early in product development
• Use simple, concise language focused on customer outcomes
• Test messages with customers before finalizing

Example: SmugMug's revamped product lineup with clear, benefit-focused messaging led to significant revenue increase.

9. Use behavioral pricing tactics to boost sales

"Sometimes, that data only makes deciding harder. Behavioral pricing is the magic that happens when value pricing meets irrational customer psychology."

Leverage consumer psychology. Behavioral pricing tactics:

• Make it easier for customers to compare, decide, and purchase
• Increase perceived value and willingness to pay
• Boost sales and revenue without changing core product

Six powerful behavioral pricing tactics:

1. Compromise effect: Offer a middle option to simplify decisions
2. Anchoring: Set context for value perception
3. Price as quality signal: Higher prices can reinforce quality perception
4. Razor/razor blades: Low upfront cost, higher ongoing fees
5. Pennies-a-day pricing: Break down costs to reduce sticker shock
6. Psychological price thresholds: Avoid falling off price "cliffs"

Implementation tips:

• Test tactics through focus groups, A/B tests, and large-scale experiments
• Combine rational and behavioral approaches for maximum impact
• Avoid overwhelming customers with too many tactics

Example: An Internet startup increased average revenue per user by 36% using behavioral pricing tactics.

10. Maintain price integrity after launch

"Reducing your price so soon sends an unintended message: that your new offering has less value than you initially communicated."

Resist pressure to cut prices. Maintaining price integrity:

• Preserves profit margins
• Protects brand perception and product value
• Avoids setting dangerous precedents

Strategies for post-launch pricing discipline:

1. Be patient in addressing sales issues
2. Track diverse key performance indicators (KPIs)
3. Conduct regular deal "deconstructions"
4. Advocate for pricing patience within the organization
5. War-game potential competitive responses
6. Address unusually high sales (potential underpricing)

Tips for maintaining price integrity:

• Identify root causes of sales issues before considering price cuts
• Develop non-pricing alternatives to boost sales
• If price cuts are necessary, get something in return (e.g., longer commitment)
• Avoid reactionary price wars

Example: Apple maintained price integrity for the Apple Watch despite initial negative press and rumors of lagging sales, resulting in a $2.8 billion product in its first six months.

Last updated: December 19, 2024