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Pricing: Innovation vs. enhancement

May 16, 2013 by Dale Furtwengler — President, Furtwengler & Associates, P.C.

Innovations premiums are huge. Early adopters often pay 3 to 4 times the price the mass market does. But what about product improvements? Do they carry the same premium? That’s the question we’ll be answering today.

A couple of definitions will help us avoid the pitfalls inherent in most communications:

• Innovation refers to a product/service for which there is no competing offering, e.g. the initial iPhone or Blu-Ray.
• Enhancements are performance improvements in existing products or services that compete against similar offerings.

Do innovative offerings carry the same price premium as enhancements? Let’s take a look.

Innovation

You can look at the historical pricing of virtually any innovation and you’ll see that the early adopters, those who simply must have the latest and greatest, pay 3 to 4 times what the mass market does for that privilege.

We’re not going to discuss the reason why here. You’ll find that answer in "related posts" listed at the end of this post. For now, we’re merely interested in the premiums themselves.

Enhancements

Product improvements rarely carry that premium. Why? Because buyers use a different formula for calculating the value of enhancements. Here’s a quick example:

You’re using Product A which costs $10. You become aware of Product B which produces the same result 50% faster. How much are you willing to pay for that additional speed? Here’s the math you’ll likely use:

Product B is 50% faster. I’m paying $10 for Product A. If the price of Product B is $15, I’m breaking even; I’m not gaining any additional value for my dollar. If the price is more than $15, I’m losing money. At a price less than $15, I’m ahead of the game.

This logic indicates that enhancements carry a much lower premium than innovations.  

You may be able to overcome this math by showing the buyer an alternative way of calculating value. How? By showing them how much a 50 percent time savings is worth to them.  

If the person makes $10 an hour, a 50 percent time savings is worth $5 — precisely the same value that their math produced. If, however, that person makes $200 an hour, it’s worth $100. That’s a huge difference. The keys to getting this kind of premium is to:

1. Target buyers who will get greater value than their math would indicate;
2. Lead those buyers through a calculation of value that’s relevant to them; and
3. Introduce Product B into markets where it will be considered an innovation.

Having said that, the probability of getting an innovation premium for an enhancement is low. It’s difficult to overcome your customers’ math. Logically they may agree that the time savings is worth $100, but they’ll have a hard time getting past paying more than $15 for Product B.

You’ll find buyers are making the calculations outlined above to determine the value of an enhancement. That’s why a portion of every R&D budget should be devoted to innovation. That’s where the real premiums are.

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