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New Concerns about the Pricing of New Products

Manufacturers and retailers must factor in national sensitivities to price volatility.

(originally published by Booz & Company)

Title: Pricing in the International Takeoff of New Products

Authors: Deepa Chandrasekaran (Lehigh University), Joep Arts (VU University Amsterdam), Gerard J. Tellis (University of Southern California), and Ruud T. Frambach (VU University Amsterdam)

Publisher: Social Science Research Network

Date Published: September 2012

“Product takeoff” is the period when consumers begin buying and using a new item on a large scale. It’s a critical turning point in a product’s life cycle, potentially heralding mass appeal and lasting success. Not surprisingly, price is a critical factor in determining when, and even if, a new product takes off.

It has been suggested by previous researchers that setting an initially high price that gradually declines (a practice known as price skimming) can help attract consumers and hasten the takeoff stage. Indeed, websites that help consumers either pounce on or delay their purchases of cutting-edge items by comparing sales trends and price levels over time have become something of a cottage industry.

Although several studies have focused on the effects of pricing on takeoff within single national markets, how well pricing strategies travel internationally has gone largely unexamined. In addressing that question, this paper finds that high price volatility—sharp deviations from an expected trend—is a key variable across all markets. Big price swings can significantly lower the likelihood that a product will catch on, no matter where that product is being sold, though not always to the same degree. How volatility affects sales within national markets and what other factors can magnify or mitigate its impact is the central theme of the research.

Though volatility looms larger, the study also examines the effect of another important pricing dimension: relative price, the current cost of a product compared with its introductory price. The introductory price typically becomes a reference point for consumers, who will perceive a “gain” when it goes down.

Volatility, meanwhile, tracks short-term deviations from the expected trend in a product’s price. (In other words, a higher price tag suddenly appears on a product when sales in its category are generally slipping.) Because manufacturers often spend large sums on research and development, they sometimes temporarily jack up prices on new products to recoup their costs. As a result of such price hikes, consumers may postpone their purchase or not buy the product at all—delaying or even killing a takeoff.

Most of the previous research on new product growth has relied on annual data, which is widely available but can mask short-term swings in price. To obtain a closer look at early-stage shifts, the authors focused their study on consumer electronics. Because of that sector’s fast-moving nature, marketing managers often launch new products using monthly, bimonthly, or quarterly data. After Apple introduced the iPad, for instance, the new category of media tablets sold more than 3 million units in a few months. That type of skyrocketing demand must be assessed on a more fine-grained level than annual data provides.

The authors obtained sales and price data for every other month of the period between 1999 and 2005 on the rollouts of seven consumer electronics products: digital video recorders (which send data to hard drives and memory sticks), DVD recorders (which record information on blank CDs and DVDs), home theater surround-sound systems, LCD TVs, plasma TVs, MP3 hard disk players, and MP3 flash players. The launches were tracked in the United States and seven European markets: France, Germany, Italy, the Netherlands, Spain, Sweden, and the United Kingdom.

The bimonthly data provided the authors with a more accurate view of volatility—and its impact on takeoff—than had been available from annual figures. For example, annual data on price fluctuations for the plasma TV category in the U.K. showed an overall decline from the introductory price. But the bimonthly graph revealed a much more complex picture of volatility, with occasional spikes in price throughout a downward trend. A short-term view also allowed the authors to control for such variables as seasonality—times when certain products are marked up or put on sale.

Armed with a better understanding of the dynamics behind annual numbers, the researchers used bimonthly data for all the products and markets in the study to reveal a series of declining prices that ultimately led to takeoff in the consumer electronics sector. After one year of commercialization—when a product’s growing sales typically begin making their mark, by reaching a measurable level of market penetration—prices fell 5 percent, on average, from what they were at the launch date. Two years out, prices dropped 27 percent from the launch price, and in three to four years they were at 50 percent of the introductory cost. On average, prices at takeoff were about 52 percent of the initial price tag.

Whether a product reaches the takeoff stage can depend on more than volatility alone, the authors’ work suggests. When pricing decisions are made, it’s also essential to consider such other factors as the level of a country’s wealth, word-of-mouth and advertising campaigns, the relative price, and consumer uncertainty about new products. Marketers also need to be aware of the level of social “contagion” (the overlap with neighboring or culturally similar nations) in a given market.

Several of these factors underscore the imperative for managers to understand each foreign market they are attempting to enter. For example, in countries where consumers are more likely to avoid buying products they are uncertain about (such as Spain and France), the effects of price volatility are magnified, whereas in wealthy countries with a greater appetite for new products (such as the U.S.), consumers are less deterred by pricing swings.

Thus, making sure that the price reductions are steady (and volatility is minimized) is most important in less-wealthy countries and in markets where consumers are less likely to be early adopters. And even when external factors, such as shifts in manufacturing costs or pressure from competitors, threaten to trigger volatility, managers should avoid sudden price hikes or drops. If they don’t, they will fail to get an accurate feel for the product’s market value—and that may threaten to derail or delay a product’s takeoff.

The research also highlights the need for manufacturers to set a reasonable opening price and for retailers to adopt a schedule, subject to adjustments mandated by short-term sales data, that lowers the price in a trajectory that is tailored toward takeoff.

Finally, the authors write, managers need to be aware of precisely when takeoff is happening—especially in an era when products can become ubiquitous or forgotten in a matter of months. Thus, they urge companies to favor more granular data, particularly bimonthly numbers, over annual prognostications. Pinpointing takeoff within a period of months, they say, gives firms greater control and flexibility in managing new products.

Bottom Line:
Shifts in pricing—especially volatility (sudden hikes or discounts that run contrary to an expected trend)—play a critical role in determining whether a new product will take off in the international marketplace. Managers must be aware of particular sensitivities to pricing in different countries, and adjust their strategies accordingly.

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