The average American spends $384 per year on dental care between out-of-pocket expenses and insurance co-pays. That’s about $10,000 on dental care over three decades, on top of the hassle of scheduling appointments, getting to them, waiting, and the pain of the care—a pain point if there ever was one.
Now, imagine that you are the CEO of an oral care or medical device company. You invent an amazing toothbrush that detects plaque and cavities before dentists or patients do. Using the insights from this book, your company makes it smart and connected. It guides the patient in the brushing process and schedules a dental appointment if needed. Your toothbrush, let’s call it the Smart Connect XL3000, keeps customers’ teeth so much cleaner that it cuts dental care costs in half and reduces time spent in appointments. Let’s assume it costs $300 to produce and lasts five years, as long as the toothbrush head is replaced every six weeks. At what price would you sell the Smart Connect XL3000?
Before pondering your pricing strategy, be it $500 or $5,000, be it with a 50 percent gross margin or 20 percent more than the competition, note that the issue is about more than price. As far as our connected toothbrush, or any connected strategy, is concerned, the big-picture task is coming up with a revenue model.
Pricing Strategies Through The Ages
Consider the history of pricing in four episodes. The first episode is haggling, still common at many bazaars. The vendor does not pre-announce a price and haggles with each potential customer.
The second episode is posted prices, such as those printed on items in a supermarket, listed in catalogs of mail-order companies, or displayed on billboards. Posted prices simplify transactions, increasing convenience and efficiency. However, they enforce uniformity across customers. If Selena is willing to pay $500 for a phone but Jackson is only willing to pay $300, price discrimination between the two is difficult. Similarly, if a retailer has only one phone left in stock, it might make sense to raise the price, but this is often impossible if the price is posted.
With the arrival of the online marketplace, we entered a third episode. It became feasible to adjust prices dynamically and intelligently. As consumers, we are most familiar with, and sometimes annoyed by, airlines doing this. A flight from Philadelphia to Boston might go from $99 one day to over $400 the next, reflecting seat availability and the airlines’ ability to identify us as a likely business traveler given our travel time. The internet also facilitates more complex pricing schemes, such as customer loyalty programs or group buying.
Yet despite these variations, from haggling at the bazaar to dynamic online pricing, traditional revenue models retain three limitations:
Limited Information: Given the episodic nature of the traditional (non-connected) business transaction, there comes a time when buyer and seller have to agree on a price, be it for a toothbrush or a medication. The problem is that the value the buyer will derive from that transaction is still unknown at that time. Will a new connected toothbrush really reduce my need for dental services?
Limited Trust: One solution to dealing with limited information is to delay the final pricing decision until more information is available. For example, the toothbrush manufacturer could require the customer to pay another $500 if his teeth remain healthy. The problem with that solution is that in the case of a cavity, the customer will blame it on the toothbrush and the manufacturer will blame it on poor brushing behavior. Short of any monitoring data, the conflicting interests of buyer and supplier will erode trust between them.
Transactional Friction: Even if we could overcome the limited trust and find a way to determine whether the customer’s degradation of teeth is due to poor brushing or poor product performance, we still face the problem that the customer derives value from the toothbrush every day. Yet, traditionally, paying every day is a very costly practice. Every transaction requires an administrative overhead for payment processing, which likely will separate the customer’s timing of payment from the timing of deriving value. With advancements in connectivity and the resulting emergence of connected relationships as discussed in our book, we have now entered a fourth episode of pricing.
What Is New With Connected Strategies?
In this fourth episode of pricing, the three limitations just discussed are overcome by longer-lasting, connected relationships facilitated by high-bandwidth information exchange. It is possible to use a whole range of additional variables as part of the revenue model. In other words, the price can now depend on factors that previously could not be used to influence the pricing decision. This includes information about the following:
- When the product was used
- Where it was used
- Who used it
- What benefits were derived from using it
- What problems occurred while using it
In short, the resulting revenue models can now be tailored to the particular use case. As a result, the connected relationship allows the firm to eliminate the three limitations discussed earlier in the following ways:
The problem of limited information can be overcome by delaying payments until more information becomes available. The most common revenue model that results from this is referred to as pay-for-performance. Payments are delayed until more information about the user benefits are known.
The problem of limited trust can be overcome as constant information flow allows for the monitoring of actions taken by two parties with conflicting interests. Such verification is also necessary for the pay-for-performance model.
Because of low transaction costs, there is no reason to lump all financial transactions into a single payment, as is common in episodic relationships. Instead, we can use revenue models such as pay-per-use (pay every time the product is used).
Thus, connected strategies allow us to create completely new revenue models. For our toothbrush, we can make the price a function of how many minutes the brush was used per day, how many different customers used the brush (hopefully with different brush heads), or the degree to which cavities could be avoided. In other words, the constant connection and associated information flow allow us to increase the dimensionality of the pricing space. No longer is there a single price printed on the box; there now exist many different options for revenue models, including different ones for different segments.
Contributed to Branding Strategy Insider by: Nicolaj Siggelkow and Christian Terweisch. Excerpted from Connected Strategy: Building Continuous Customer Relationships For Competitive Advantage, (Harvard Business Review Press, May 21, 2019] Copyright 2019 by Harvard Business School Publishing Corporation. All rights reserved.
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