Chapter 5

Pick the Positioning of Your New Product

In-a-Rush Tip

This chapter is critical. You need to read it all!

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There Are Only 3 Choices!

There are only three positioning strategies for your prices—but enormous complexities within each.

Your options are only:

How do you determine the best price for your new offering? You must first understand the psychology of your price positioning.

Warning

Sometimes the best position is simply the one that is open. For example, if you’re planning to launch a new barbeque sauce and the competitors are all priced about the same, that tells you the best position for your new product may be premium priced. If lots of people are buying barbeque sauce, some of them are likely to pay an extra dollar for a better sauce. That extra dollar will cover your extra costs and give you a nicer profit margin. Plus when you launch, your unique selling proposition (USP) is easy and compelling: “Treat yourself to the BEST!”

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The Psychology of Price Positioning

It is critical to understand what a price conveys to consumers about your product. One of the biggest mistakes you see with new marketers is a disconnect between the product positioning and the price.

If you want your product to be perceived as one of the best quality choices among your competitors, you can’t have the lowest price. Period! By the same token, if you have the lowest price (or one of the lowest prices), consumers will refuse to believe your product is high quality. Yes, if you have a well-known, quality brand name and then have a low price, consumers will not infer low quality. (Although if the price is low enough, they may suspect it’s a knockoff.) But especially for new brands or moderately known brand names, the price you put on your product is a key indicator to consumers of its quality.

The consumer doesn’t know your brand. (Even if you’ve been around for a while, many to most won’t know what your brand stands for.) They don’t know what quality standards you have or haven’t implemented.

But they know that you know. You know better than anyone the quality of your product. So if you put a low price on it, the consumer will believe you know that a low price is all it’s worth. If you put a higher price on it, the consumer will believe you know that a high price is what it’s worth.

But . . . keep in mind that the consumer is not an idiot. If you price high but the consumer can tell (either before or after purchase) that your materials are substandard, you will pay a steep price for your deception. That price could be low sales, high returns (if the quality is evident only after purchase), and/or a high trashing of your product on Internet review sites.

I have conducted research on the pricing of a new HDTV brand, where I found that good consumer reviews were every bit as valuable to a new product as a good brand name. They have become the new gold standard for quality assurance!

Penetration Price Positioning

Most new business owners default to penetration price positioning (pricing lower than their competitors) because they are afraid nobody will buy their product otherwise.

Let’s be clear about this. You will likely (but certainly not always!) have a lot more sales if you select this option. The question is: Will you be more profitable—or a lot less profitable?

And also, this is the most dangerous price positioning you can assume, and in a minute I’ll show you why.

But first . . .

Two Situations that Call for Penetration Pricing

Who should use penetration pricing? Anyone in one of these two situations:

Two Reasons to Not Use Penetration Pricing

There are a lot of negatives when it comes to penetration pricing. For example, in a NewProd model developed by Cooper (1985), the results imply that penetration pricing is a fallback option that is inferior to product superiority and to be used only if the company can’t obtain superiority and have it fit within the company. He found lower pricing than competitors to be fourth in economic advantage to the company, behind:

I believe there are two major reasons not to use penetration pricing, which are detailed here.

Reason #1: To Avoid a Perception of Poor Quality

If you see a very low price on a pair of Nikes, what do you think? If it’s low but possible, you probably think “Great deal!” and want to buy them. If the price is unreasonably low, you probably think “Bet they’re poor-quality knockoffs.” Same with any well-known and respected brand name.

But when you launch a new product or service or when you have a brand that doesn’t have millions of dollars spent promoting the name, you don’t get the “Great deal!” benefit of the doubt. A low price on an unknown brand is almost always perceived as being due to a lower quality.

For example, I was shocked to find I got 11 percent more orders for my business newsletter at $127 than I got at $97. But upon further reflection, it’s perfectly logical. Most business newsletters (although none of them were direct competitors) were priced at $150–$399 when I launched. My price of $97 looked surprisingly low. Surprisingly low equals poor quality perception. Once I raised my price to a more “normal” amount, the low-quality-perception-due-to-price stopped being a factor.

This quality perception is a much bigger problem in some categories than in others.

• Example #1: Suppose you see lots of laundry detergent products at $2.99, and one in a comparable size at $2.25. Would you buy the $2.25 brand? Maybe. Maybe not.
• Example #2: Suppose you are on trial for a murder you didn’t commit. Most of the attorneys you contact charge $450/hour. One attorney wants $199/hour. They all have good recommendations. Would you hire the $199/hour attorney? Not if there was any way in hell you could find the money for one of the others!
• Example #3: Suppose you want to get a face lift. You get quotes from plastic surgeons with good credentials and recommendations of $10,000, $9,500, $11,000, and $6,999. Again, there’s little likelihood of you selecting the $6,999 surgeon if there’s any way you can afford one of the others.

What will happen to your customers if your product turns out to be poor quality? A bad box of detergent? So what? A bad criminal attorney? A death sentence. If the risk is great, the likelihood of a successful low pricing strategy is lower. If the risk is minimal, the quality perceptions can be managed with ads and/or product packaging that stress quality.

Reason #2: To Prevent a Price War

If you under-price the current products in your marketplace, you will likely start a price war with your competitors. Starting a price war is another junior-marketer mistake. It comes from planning your own strategy without considering what reactions your competitors will have to your pricing. If those competitors think you have a chance of success, you can bet the farm they will respond in some manner.

Price War Example

Suppose you plan to enter a competitive marketplace, and the current prices of your soon-to-be competitors are:

• $35
• $31
• $29
• $27

Your costs are $20, so you decide to enter the market with a price of $26. What do you think the competitors will do?

Consider your competitor at $27. The market positioning of that competitor is “lowest price.” That’s what that company is known for—how customers see it. If you take away that “lowest-price” position from that competitor, what does it have left? Probably nothing. It certainly wasn’t competing on quality, so you’ve left it probably with no positioning.

Think of your lowest-price competitor as if it were the Wal-Mart of your industry. The only reason you buy at Wal-Mart is to get lower prices (and sometimes convenience and one-stop shopping). If you opened a store that competed with Wal-Mart by offering lower prices, what do you think Wal-Mart would do?

That $27 competitor is most likely to drop its price to $25 in order to remain the lowest-priced competitor. What is your response? If you want to be the lowest-priced option, you’ll drop your price to $24. Then it will drop to $23, then you drop to $22, then it drops to $21.

Now you have a terrible problem. You can’t lower your price anymore and still make any profit at all. So you’re stuck at a $22 price—and you are not the lowest-priced offering.

The hard truth is that the $27 competitor could probably go lower than you and still have a profit because it already has economies of scale. If you’re making $2 profit at a $22 price, it will probably be making more than that at a $21 price. But that’s not the biggest problem.

After this price war, you are not the lowest-priced product—and you’re making only $2 per unit sold. If you had been smart and entered the market at $28, one dollar above the lowest-priced competitor, you’d still not be the lowest-priced product—but you’d be making $8 profit per unit sold.

If you’re not going to end up being the low-cost competitor, it’s better to be second lowest at a higher price than second lowest at a rock-bottom price.

If you can’t win a price war, don’t start one!

How to Avoid a Price War—If You Really Do Have 30 Percent Lower Costs

One of the smartest moves Wal-Mart ever made was at its launch. Wal-Mart had invested millions of dollars in automated warehousing and in a whole just-in-time inventory system where vendors have to ship small amounts frequently (costing the vendors more money, but saving money for Wal-Mart). In addition, Wal-Mart didn’t “buy” from many vendors until the product was sold in their stores. Those vendors have to ship product which Wal-Mart will either buy from them as it sells, or return to them if it doesn’t.

In other words, Wal-Mart’s costs were at least 30 percent lower than its potential competitors, and those competitors couldn’t easily match Wal-Mart’s costs without huge investments.

But what if the competitors didn’t realize this? What if, when Wal-Mart launched, its competitors started a price war with Wal-Mart? Yes, Wal-Mart could have “won” the war—but at the end of it, prices would have been much lower than those Wal-Mart could charge without a price war.

Remember, no company really “wins” a price war. One company will emerge from such a war holding the low-price position, but its profits will be greatly reduced. Because once you’ve lowered your prices for a product, it’s very, very hard (often impossible) to raise them back up when the war is over. If consumers have learned that you can buy product X for $15, then you raise it back to $21, you’ll find your sales will disappear!

So how did Wal-Mart avoid a ruinous price war when it launched? Remember, it’s illegal to talk to your competitors about pricing!

Instead, Wal-Mart gave lots of interviews to the business magazines. Those interviews talked about Wal-Mart’s state-of-the-art equipment and systems—that other companies don’t have. Wal-Mart let its competitors know just how much lower its costs were, so the competitors would not start a price war. The hidden message of those interviews was this:

“Don’t even think about starting a price war with us because our costs are so much lower than yours that we’ll be dancing on your graves!”

Skimming (or Premium) Price Positioning

Companies that have the highest price positions in a marketplace are usually smaller, with less sales than companies that price lower. But they are usually some of the most profitable companies. Example: Timex sells more watches and probably has higher dollar sales, but for profits we’d both have more cash if we owned Rolex!

There is a lot of research on a higher price equaling higher quality in buyers’ minds (which you’ll see in Chapter 14).

Here it’s worth noting that buyers see a quality difference—even if it doesn’t exist! Here are three studies where a higher price all by itself makes the product more attractive.

Beer Study

Beer drinkers prefer the taste of beers that are priced higher—even if the blind taste test uses the same beer! McConnell (1968) did blind taste tests using the same beer and got these results.

• He was especially impressed with the anger and hostility beer taste-testers showed when told there was no difference in the beers they tasted. He sees this as proof that they did indeed perceive quality differences in the beers that were due entirely to and positively correlated with the price.

Carpet Study

• Carpet buyers can be repelled by low prices—even if their senses should be telling them the quality is good. Gabor and Granger (1966) found that even consumers handed a carpet sample, so they could ascertain the quality for themselves, were uninterested in buying it if the price was low.
• They handed buyers a sample of a quality carpet that normally sold at 72 shillings per square yard. Here’s how likely they were to buy when given an artificially low price:
  • 60 percent likely when told the price was 40–60 shillings
  • 30 percent likely, when told the price was 20–40 shillings

Wine Study

• Neuroeconomists at Caltech conducted a very revealing study about wines. They revealed that our brains themselves tell us an expensive wine tastes better than a cheap wine, even if—unknown to us—the two wines are the same!
• They hooked up wine tasters to equipment showing brain activity. When tasters were told the wine was $45, one additional area of the brain was stimulated—the orbitofrontal cortex—and the tasters reported a better taste. When told the same wine was $5, that portion of the brain was not excited, and tasters reported a much poorer taste.

Net Result

Tasters actually—physically as well as mentally!—got more pleasure from drinking an expensive wine than from a cheaper wine—even though they were both the same. The premium-price position in most (not all) industries is the most profitable.

There are two types of skimming pricing:

Temporary Premium Pricing

A temporary skimming/premium price strategy works best for unique products, or those with a clear (usually technological) benefit over the competitors. The price is set high at the launch, because either the product has no competitors or it is demonstrably better.

But you do expect competitors to arrive and/or improve their products to become comparable to yours. Once competitors catch up, it is expected that your price will be lowered to end up in the same ballpark as your competitors.

Why is this done? For three reasons:

Prestige Pricing

A prestige pricing strategy is where you decide to have the best quality and highest (or one of the highest) priced products in a market. A luxury product.

What’s a luxury product? It isn’t determined by the actual dollar price of the product; it’s the price relative to your competitors. There’s a luxury brand of bubble bath and luxury cookies. It’s all relative.

Look at your industry. If all your competitors are priced about the same, there may be a position open for a “luxury” brand in your marketplace—one that justifies its higher price through better quality ingredients, “green” ingredients, “natural” ingredients, classier packaging, etc.

This is a great, highly profitable strategy—unless there’s already a brand in your market that “owns” the prestige position. For example, Sony used to own the prestige position in consumer electronics products—and still does with some consumers although their problems have eroded this perception.

However, there could be a prestige position that is even higher than the one owned by a brand. Example: Rolex is the prestige brand for most of us when considering a watch to buy. However, there are some brands much more expensive for a different target group of customers—those who think a Rolex is too ordinary.

We’ll cover pricing psychology in detail in Chapter 11, but I want to make sure you note here that prestige products typically are not priced in pennies. For example, a $14.99 price makes a product look “ordinary” or discounted, whereas a price of $14 or $15 conveys high-quality.

For example, there are a lot of consumer health newsletters, most priced around $19.99, some at $29.99. The point is, they all have pennies in their prices. Harvard publishes a number of consumer health newsletters itself. Their prices are $22, $24, or $28. No pennies.

I have seen “luxury” brands include pennies in their prices (especially electronics), but I strongly recommend you test a price without them. Luxury is part image, after all, and pennies don’t fit the image.

Warning

There is a limit to how high a quality you can deliver and still reap the rewards in pricing. A friend of mine makes luxury bed linens sold in upscale department stores. She buys gazillion-thread-count luxury cloth to make the linens, but she doesn’t buy the best cloth possible. She would like to go with the absolute best, but she’s found there’s an upper limit to what people will pay for bed linens—even very rich people.

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Competitive Price Positioning

The third price positioning option is competitive. That means you price in the ballpark of your competitors.

This strategy hasn’t received much attention/respect from pricing researchers due to it being confused with a “match-competitor-pricing” strategy, which is actually quite different

• “Match-competitor prices” is a strategy that requires no investigation of the best price. You just pick a price similar to competitors and run with it. It is substantially better than a cost-plus pricing strategy, but that’s like saying a punch in the face is better than getting maimed. Yeah, it is. But why would you want either?
• A competitive pricing strategy is the end result of an analysis of your competitors and their products’ benefits and negatives, as well as an analysis of what customers want from products in your category.

Among companies that do not use cost-plus as their pricing strategy, competitive price positioning is the next most utilized, probably because it requires the least amount of time investment.

Reasons to Use a Competitive Price Positioning Strategy

There are a number of reasons for selecting this strategy over a premium/prestige-position or a penetration/low-positioning strategy. Some are:

• Because the high priced position(s) is/are already owned by strong competitor(s)
• Because you don’t have the lower costs necessary for a successful low-price positioning
• Because customers in your category don’t care for a luxury version (e.g., it’s detergent and the market for luxury detergent is too small or nonexistent)
• Because customers in your category care much more about some other factor than price (e.g., convenience, terms, celebrity endorsement, etc.)

It is important to note that companies who successfully use a competitive price positioning will find themselves competing on something other than price.

The Lazy Person’s Guide to Pricing Strategy

1 Most popular: cost-plus pricing. Calculate costs, then slap a profit margin on top of it. (See Chapter 2 for all the ways this hurts marketers.)

2 Second most popular: match-competitors pricing. Pick a price similar to competitors and run with it. (See earlier in this chapter for how this differs from a more optimal competitive pricing strategy.)

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Learning More about Competitive Pricing

Is competitor benchmarking more critical for retail-sold products, which are displayed close to competitive products? One indication this may be true is the price differential between books sold in retail stores (including online stores) and e-books sold individually online. Individually sold e-books carry disproportionately higher prices per page than do printed books, even though pricing on a cost-plus basis would produce the opposite result.

In studying successful new-product pricing practices, Ingenbleek et al. (2003) found competition-informed (or based) pricing was:

• Successful in highly competitive markets when relative product advantage is low
• Unsuccessful in highly competitive markets when you have a high relative product advantage
  • That’s because companies in their study appeared to underestimate the value of their innovative products.
• They also found competitive-based pricing to be of less value when competition is strong. They postulate it is due to quick competitive matching of any innovative differences, causing a downward spiral in pricing. In such a situation, companies that do not pay attention to their cost floors may find themselves making unprofitable pricing decisions.

Exporters in the United Kingdom were surveyed by Tzokas et al. (2000), who found prices were set by these exporters based primarily upon production costs, foreign customer needs, and then competitive price levels.

Noble and Gruca (1999):

• Classified competitive pricing (including leader, parity, and low-price positions) as appropriate only for mature products. They did, however, note a Harvard Business School case (Shapiro, 1977) where the optimal pricing for a new product required competitive and product line pricing considerations.
• Found that parity pricing was most used by firms with high costs, low market shares, low product differentiation, and high levels of capacity utilization and brand elasticity.
• Found that unlike any of the other pricing strategies, the importance weight given for this strategy by those using it was split. While the median was 50 percent, almost half of the managers rated it much higher or lower—outside the middle of the scale (30 percent–80 percent).
  • This may be reflecting two different kinds of companies using this strategy: those that considered competitive prices only in passing, and those for which a competitive price positioning was an essential part of their pricing and marketing strategy.

Cannon and Morgan (1990) considered “going-rate” pricing inappropriate if there are not a number of close substitute products on the market.

Zais (1977) found competitive pricing was the most used pricing strategy for information centers and libraries when initiating user fees. He found it ideal for centers that had insufficient cost data with which to price their services and that also had little information on demand.