Pricing Policies for New Products

Pricing Policies for New Products by Joel Dean Harvard Business Review Reprint 76604 NOVEMBER–DECEMBERHBR 1976 Pricing Policies for New Products by Joel Dean ow to price a new product is a top manage- 1. Technical maturity, indicated by declining rate ment puzzle that is too often solved by cost- of product development, increasing standard- Htheology and hunch. This article suggests a ization among brands, and increasing stability of pricing policy geared to the dynamic nature of a new manufacturing processes and knowledge about them. product’s competitive status. Today’s high rate of 2. Market maturity, indicated by consumer accep- innovation makes the economic evolution of a new tance of the basic service idea, by widespread product a strategic guide to practical pricing. belief that the products of most manufacturers New products have a protected distinctiveness which will perform satisfactorily, and by enough fa- is doomed to progressive degeneration from competi- miliarity and sophistication to permit consum- tive inroads. The invention of a new marketable spe- ers to compare brands competently. cialty is usually followed by a period of patent protec- tion when markets are still hesitant and unexplored HBR first published this article in November 1950 as a and when product design is fluid. Then comes a practical guide to the problems involved in pricing new period of rapid expansion of sales as market accep- products. Particularly in the early stages of competition, it tance is gained. is necessary to estimate demand, anticipate the effect of Next the product becomes a target for competitive various possible combinations of prices, and choose the most suitable promotion policy. Then as the product’s encroachment. New competitors enter the field, and market status matures, policy revisions become necessary. innovations narrow the gap of distinctiveness be- Joel Dean outlines the possible price strategies for each tween the product and its substitutes. The seller’s stage of a product’s market evolution and the various zone of pricing discretion narrows as his or her dis- grounds for making a choice. To update his original state- tinctive “specialty” fades into a pedestrian “comment, Mr. Dean has written a retrospective comment, modity” which is so little differentiated from other which appears at the end of this article. He amplifies his products that the seller has limited independence in earlier article with insights from intervening years and in pricing, even if rivals are few. light of such developments as inflation. Throughout the cycle, continual changes occur in Now president of Joel Dean Associates and professor of promotional and price elasticity and in costs of pro- business economics at Columbia University, Mr. Dean duction and distribution. These changes call for ad- was formerly on the faculty of the University of Chicago. During World War II, he was head of machinery price justments in price policy. control and later of fuel rationing. Books he has written Appropriate pricing over the cycle depends on the include Managerial Economics (Prentice-Hall, 1951), Capi- development of three different aspects of maturity, tal Budgeting (Columbia University Press, 1951) and Sta- which usually move in almost parallel time paths: tistical Cost Estimation (Indiana University Press, 1976). Copyright © 1976 by the President and Fellows of Harvard College. All rights reserved. 3. Competitive maturity, indicated by increasing novelty to a 49-cent “price football,” partly because stability of market shares and price structures. entry barriers of patents and techniques were ineffec- tive. Frozen orange juice, which started as a protected Of course, interaction among these components specialty of Minute Maid, sped through its competi- tends to make them move together. That is, intrusion tive cycle, with competing brands crowding into the by new competitors helps to develop the market, but market. entrance is most tempting when the new product At the outset innovators can control the rate of appears to be establishing market acceptance. competitive deterioration to an important degree by The rate at which the cycle of degeneration pro- nonprice as well as by price strategies. Through suc- gresses varies widely among products. What are the cessful research in product improvement innovators factors that set its pace? An overriding determinant can protect their specialty position both by extending is technical—the extent to which the economic en- the life of their basic patents and by keeping ahead of vironment must be reorganized to use the innovation competitors in product development. The record of effectively. The scale of plant investment and techni- IBM punch-card equipment is one illustration. Ease cal research called forth by the telephone, electric of entry is also affected by a policy of stay-out pricing power, the automobile, or air transport makes for a (so low as to make the prospects look uninviting), long gestation period, as compared with even such which under some circumstances may slow down the major innovations as cellophane or frozen foods. process of competitive encroachment. Development comes fastest when the new gadget fills a new vacuum made to order for it. Electric stoves, as one example, rose to 50% market satura- STEPS IN PIONEER PRICING tion in the fast-growing Pacific Northwest, where electric power had become the lowest-cost energy. Pricing problems start when a company finds a prod- Products still in early developmental stages also uct that is a radical departure from existing ways of provide rich opportunities for product differentiation, performing a service and that is temporarily pro- which with heavy research costs holds off competi- tected from competition by patents, secrets of pro- tive degeneration. duction, control at the point of a scarce resource, or But aside from technical factors, the rate of degen- by other barriers. The seller here has a wide range of eration is controlled by economic forces that can be pricing discretion resulting from extreme product dif- subsumed under rate of market acceptance and ease ferentiation. of competitive entry. A good example of pricing latitude conferred by Market acceptance means the extent to which protected superiority of product was provided by the buyers consider the product a serious alternative to McGraw Electric Company’s “Toastmaster,” which, other ways of performing the same service. Market both initially and over a period of years, was able to acceptance is a frictional factor. The effect of cultural command a very substantial price premium over com- lags may endure for some time after quality and costs petitive toasters. Apparently this advan-tage resulted make products technically useful. The slow catch-on from (1) a good product that was distinctive and superior of the garbage-disposal unit is an example. and (2) substantial and skillful sales promotion. On the other hand, the attitude of acceptance may Similarly, Sunbeam priced its electric iron $2 above exist long before any workable model can be devel- comparable models of major firms with considerable oped; then the final appearance of the product will success. And Sunbeam courageously priced its new produce an explosive growth curve in sales. The metal coffeemaker at $32, much above competitive antihistamine cold tablet, a spectacular example, re- makes of glass coffeemakers, but it was highly suc- flected the national faith in chemistry’s ability to van- cessful. quish the common cold. And, of course, low unit price To get a picture of how a manufacturer should go may speed market acceptance of an innovation; ball- about setting a price in the pioneer stage, let me point pens and all-steel houses started at about the same describe the main steps of the process (of course the time, but look at the difference in their sales curves. classification is arbitrary and the steps are interre- Ease of competitive entry is a major determinant lated): (1) estimate of demand, (2) decision on market of the speed of degeneration of a specialty. An illus- targets, (3) design of promotional strategy, and (4) tration is found in the washing machine business choice of distribution channels. before the war, where with little basic patent protec- tion the Maytag position was quickly eroded by small Estimate of Demand manufacturers who performed essentially an assem- The problem at the pioneer stage differs from that in bly operation. The ball-point pen cascaded from a $12 a relatively stable monopoly because the product is HARVARD BUSINESS REVIEW November–December 1976 3 beyond the experience of buyers and because the “practical” range of prices. Manufacturers of electri- perishability of its distinctiveness must be reckoned cal equipment often explore the economic as well as with. How can demand for new products be explored? the technical feasibility of a new product by sending How can we find out how much people will pay for a engineers with blueprints and models to see custom- product that has never before been seen or used? ers, such as technical and operating executives. There are several levels of refinement to this analysis. In guessing the price range of a radically new con- The initial problem of estimating demand for a new sumers’ product of small unit value, the concept of product can be broken into a series of subproblems: barter equivalent can be a useful research guide. (1) whether the product will go at all (assuming price For example, a manufacturer of paper specialties is in a competitive range), (2) what range of price will tested a dramatic new product in the following fash- make the product economically attractive to buyers, ion: A wide variety of consumer products totally (3) what sales volumes can be expected at various unlike the new product were purchased and spread points in this price range, and (4) what reaction will out on a big table. Consumers selected the products price produce in manufacturers and sellers of dis- they would swap for the new product.

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