Pricing Innovation
The early adopters of Apple's iPhone paid $599 for the privilege of being the first to have the hot new consumer product when it was launched in June of 2007. But by September, Apple announced that it was slashing prices on its most expensive iPhone by a third. As the early adopters complained about the $200 price cut, Apple shares fell 8.6 percent, losing almost $11 billion in market value in the three days following the announcement. The iPhone illustrates both the challenges of getting pricing right for new products and the dynamic changes in pricing that are needed as the market is developed.
"When you have something new about the product, such as the sleeker design and touch-screen technology for the iPhone, it is a little harder to price it... Apple may have mispriced the product in the first place and then had to make painful, costly adjustments." —Z. John Zhang, Professor of Marketing, The Wharton School
Secrecy adds to the problem. Zhang pointed to the reports that claimed Apple's partner AT&T did not even see the iPhone before its launch. "The whole thing is kept secret to build suspense and buzz," he said. "Just imagine — you have a product that you believe is pretty good, but can't show it to anyone. Then you have to price it properly."
Initial Pricing
Given the challenges of establishing a price for new products, there are several approaches that can be used to determine initial pricing:
Pricing Over Time: Peeling the Onion
The more innovative the product is, the more secrecy surrounds its launch. This makes it harder to get the initial price right. "That may explain why Apple later felt the need to reprice the product," Zhang said. "Perhaps sales were not as great as they had expected. The product might not have been as good as they initially thought."
In general, innovative products are launched at a high price, and then later the price is lowered to expand the market or respond to increased competition. Early adopters are willing to pay more, a phenomenon called "temporal price discrimination." In general, companies might move from the segments with the highest willingness to pay to those with the lowest willingness to pay. This approach is to keep moving to the next level of consumers. "You peel the onion layer by layer to maximize profitability," Zhang said.
Pricing doesn't always start high and go low. In some cases it starts low and goes the other way. "Many software companies will give you the base software free and then charge you the next year for renewal," said Raju. "This may be the case when a product has positive network externalities — that is, it has more value when more consumers use it. For example, the only way a videophone has value is if other users have the same product."
When prices are adjusted downward, there is a delicate balance in determining how far and how fast to drop prices. There are several side effects of falling prices that managers need to watch out for:
Some of the pitfalls related to pricing can be addressed by recognizing that the list price of the product is not the whole story. Instead of dropping price, companies could add features. This gives customers more for their money, while making the impact on price less obvious. Car makers could include air conditioning or other features, for example, instead of relying on sales and rebates.
As the market develops, competition becomes an increasing concern in setting prices. Nokia, Samsung, and other rivals are introducing products to compete with the iPhone. "You are not alone for very long with this type of technology," Zhang said. "Then, you have to realign your pricing. However, even in that case, you probably do not want to lose your cool and overdo it. Otherwise, the product might lose its appeal to your high-end customers."
© 2007 The Wharton School, University of Pennsylvania
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