Understanding the product life cycle (PLC) is critical to decisions made regarding price changes, especially in a Business-to-Business (B2B) environment. Whether you are in the introductory, growth, maturity, or decline stages should alter your view on how price changes can impact revenues and margins.
First, I must give credit where credit is due. The impetus for this post came from Reed Holden’s book, Pricing with Confidence. If you have not read it yet, it is very well-written and provides practical examples of ways to improve pricing; find it on Amazon here. After reading this book, the PLC discussions stuck with me. How could I apply what I read to what I had experienced? The below is the result of that though process.
For example, early on in the introductory stage, price plays an important baseline role. Setting the price is crucial to the value perceived by the targeted audience. What price to set is another topic for another day, but price too low and you are potentially forgoing future profits. Price too high and you may never gain the adoption necessary to move into the growth stage.
Assume for this post that we are beyond the introductory stage of the PLC (new product pricing is another entire topic to cover). Next up: the much-anticipated growth stage. During this stage, increasing prices leads to higher revenues and higher profits. However, we must pay special attention to competitor actions. Is this product quickly converted into a commodity? If so, the growth stage could be short-lived. If competitors can quickly reproduce the product and your customer’s switching costs are low, raising prices too fast and too often can lead to declining revenues through lost volume. Moreover, if the product cannot be easily reproduced or your customers’ switching costs are high, there is more value offered by TE that could be captured in the price. By raising prices to match this value, we can increase our revenues and margins exponentially, due to increasing volumes during the growth stage.
To put this in context, I have seen this work well and fail spectacularly. Focusing on the latter for the moment, when product managers at an industrial manufacturer failed to recognize the small switching costs of their customers, they ended up underestimating the duration of the growth stage. The result? They kept prices elevated; competition circled like hawks; and before they knew it, their products were an afterthought to their customers: priced too high with other, fully-substitutable products available to purchase. However, the flip side is just as dramatic. When those same product managers (on a different product line) were able to quantify the value their customers should achieve, and in this case, no other competitors could offer anything close to their product line, they priced to the value during the growth stage and helped secure other, ancillary business as well as dramatically exceeding profitability expectations.
Moving along, the maturity stage is next in line on the PLC curve. During this stage, demand elasticity is commonly correlated to your customers’ switching costs. Raise prices too much, and they will switch. However, lowering prices is highly unlikely to increase demand. This is a characteristic of the B2B environment. TE’s customers are rarely, if ever, end-users. Therefore, the demand for our products is not set by our customers, but by our customers’ customers (or ever further down the supply chain). For example, if BMW is expected to make 500,000 X5 automobiles for Europe in 2011, this is not driven by the price of our wire assemblies. Their demand is driven by their market analyst’s prediction of what their customers want. Therefore, is we lower prices to BWM, all we are doing is giving away revenues and margins. They will not purchase more from us, simply because the price went down.
This is why it is crucial to understand which stage of the PLC you are in for any given product. Raising prices in the growth and maturity stages typically has a positive impact on revenues and margins. Lowering prices typically only works in the decline stage in order to liquidate stock or manufacturing capacity as we move on to the next product evolution. Recognizing in which stage we are operating, along with the competitive pressures and abilities, greatly enhance our ability to change prices to meet the market expectations, while maximizing revenue and margin potential (commonly known as price optimization).
And yes, there are always exceptions. Where have you seen success (or failure) with pricing strategies and the PLC?