The purpose of this short essay is to make the case that good pricing starts with a front-end-of-innovation (FEI) that is clearly focused on customer value. Stephan Liozu (www.stephanliozu.com) is the Chief Value Officer at the Thales Group (https://www.thalesgroup.com/en).  He is also an Adjunct Professor & Research Fellow at Weatherhead School of Management at Case Western Reserve University. He can be reached at sliozu@gmail.com. Katie Richardson is Director of Business Development at Vimana (govimana.com), an analytics company focusing on IIoT, Industry 4.0., and Manufacturing as a Service (MaaS). Katie focuses on business models, value propositions, and value-based pricing of technology solutions. She can be reached at katie@systeminsights.com.

The Pricing Advisor, May 2018

We all know that pricing is not easy. If it were that easy, every firm would do it! It is a very complex part of a firm’s go-to-market strategy. And it is even more complex as products get more commoditized and industries get more competitive. It is a real challenge to introduce changes in pricing strategies for very successful and protected core businesses. At the same time, we have to brace for a digital tsunami and be ready to value-price disruptive data-driven offers. We often say that one way to get started is implementing progressive and value-based pricing in the innovation process. It is a way to “infiltrate” a core business and start making small incremental changes in pricing. We dare to say that paying attention to pricing in the front-end of innovation makes pricing a bit easier and customer-centric in the back-end of innovation when products and services are launched in the market. So the sooner you can get started with the customer value analysis and pricing hypotheses, the better. The purpose of this short essay to give more clarity on the topic and to make the case that good pricing starts with a front-end-of-innovation (FEI) that is clearly focused on customer value. For traditional and digital businesses, innovation, value, and pricing are skills of the future. Let us get started.

A Holistic Process to Manage Customer Value

First, it is imperative to connect all critical functions of the go-to-market process and to include innovation as part of this process. That is assuming that you have an innovation process and/or function. This might also work for Research and Development or Research and Technology functions, although more challenging. Value-based innovations have to be tied to the rest of the process and focus on value creation as show in the figure below.

The goal of value-based innovation is to focus on creating value for customers and relevant partners of the eco-system you live in. And that value comes from a FEI that is dedicated to solving customer problems and responds to these problems in a compelling and differentiated fashion. We posit that the heart of innovation must be to create differentiation and focus on the “WOW” differentiators that will shape marketing and pricing later in the process. One way to do this is to beef up the strength of innovation councils by adding representatives of the selling, marketing, and pricing teams. Multi-functional teams can interact in this council to gauge how compelling and value-creating FEI ideas might prove to be. The sooner this is done, the better it is for the rest of the value management process. And the more unfeasible or difficult the new idea is, the more disruptive and value creating it might be.

An Intense Focus on the Customer

Obviously, having a connected innovation process to marketing, pricing, and selling is a great first step for managing customer value. But it is not enough. The value-based innovation process must be extremely customer-centric and must focus on customer problems, on needs, and eventually on solutions, as shown below. We propose that the greater the focus on the customer pains and gains, on customer needs, and on developing differentiated customer solutions, the greater the pricing power when new offers are launched in the market.

Easier said than done! You need to focus on these three components: acquired skills, process, and investments. This focus requires access to customer information and deep customer intimacy, which explains why have highlighted the difference between Innovation and R&D. These are two different functions and activities. If the R&D portion of the process is completed without intense customer focus, chances are you might get lucky once or twice with successful products, but it will most likely result in a techno-push to the market. Innovation suggests a connection to the customer base and a strong collaboration with marketing, sales, and pricing. So ask yourself these questions:

1. Do we have a CTO or a CIO running our new product/service activities?
2. Do we have a true innovation strategy or an R&D strategy?
3. How is innovation defined in our company?

Traditional Customer Insight Methods Are Not Enough

In the first section of this essay, we introduced a holistic customer value management process starting with value-based innovation. Then we discussed the fact that the innovation process must be customer-centric. Now we bring the next critical dimension to our thesis: customer value starts with deep customer insights. The deeper you can go into discovering true unmet and unexplored customer pains or problems, the greater the chance to design a compelling and differentiated value proposition that the customer should be willing to pay for. The key here is the willingness to go deep and to use the best customer insight tools available. We list a few below.

We can no longer explore customer needs by using focus groups, customer visits, and expert interviews. Your competitors can also do that. We recommend graduating from traditional techniques to focusing on value-in-use analysis, customer journey mapping, and customer observations. To do this, your FEI teams must develop strong research muscles and have a way to collect, connect, and mine all the identified customer nuggets. It also means that every function involved in the innovation council must get out of the building and spend more than 50% of their time in the market. Not much is going to be found in your building! These teams are also going to be the ones making sense out of what was discovered from customer interviews, mapping activities, and customer process observations. The interpretation, refinement, testing, and validating of the customer pains and gains remain the most intricate and valuable part of the process.

Pricing Research to the Rescue

Wait, you are not done yet! Even if you are armed with amazing findings and customer insights, someone needs to establish the value of a potential offering versus the customer doing nothing today or against next best competitive alternatives. Then, once the quantification of differential value is completed, it is useful to conduct willingness-to-pay research to establish how much of the value pool your customers might be willing to share with you. This is when pricing research comes to the rescue. A few techniques are listed below.

Less than 10% of firms use systematic pricing research in their innovation process, as per McKinsey. This is clearly not a good enough number. This is why we recommend that pricing experts sit in the innovation council and offer their help to test and validate value creation models as well as price points before the introduction of the new offers. The payback is amazing especially when considering the staggering new product failure rate reported by PDMA or Stage-Gate® International.

Concluding thoughts

We strongly believe that good pricing starts early in the innovation process. The sooner you can get to the heart of the customer pains, the sooner you have a chance to identify pockets of value to be quantified and extracted through price. It is common sense to think that the more painful the customer problem is, the greater the customer’s willingness-to-pay will be, and the higher the price premium might be versus that of competitors. This is of course assuming it is all done well! Remember that your competitors might also be doing the same analysis. The amount of investments you make in your FEI’s customer insight process, the level of collaboration between your innovation and pricing teams, and the unique research capabilities (including pricing research) you develop are three critical components of your future pricing power. Be sure that if your company’s focus is purely on R&D, chances are that you are not a customer-centric innovation company. Learn from the best-in-class and start moving towards a true innovation strategy. You will see an amazing impact of your pricing power and ultimately your performance level.