Price Market Research Case Study: Imagery analysis software for UAV market    

Disclaimer: The following Price Market Research example is a case study of a fictitious client (an amalgamation of clients) and it's software product created for the Defence / Defense market.

Any resemblance to a specific real company is completely coincidental. The software prices are chosen arbitrarily for illustration purposes only. The case study does however explain the value of price research and the necessary product and service requirements for a price skimming policy.

Have you ever had a new product that you have wanted to sell, but could never figure out an optimum price point for it? The issue increases dramatically when you think you have a unique product that might be able to satisfy a niche market, and you have been tentatively trialling your product with potential resellers for a while. It is easy to become attached to an arbitrary premium price, without or without a consistent sales history. Some of the questions price research should consider are: how will the price affect current and future sales, what are the brand consequences and will it provide optimum profit?

The Product Scenario

This pricing research case study considers a high tech start up company that makes software for an industry prone to secrecy and patent protection. Imagine that it has survived so far by private investors or Government grants but is now beefing up its sales function to commercialise a product and earn revenue from sales.

Imagine that there are three versions of this product and no direct competitors, because it is believed that the product is a breakthrough in technology. Yet in reality there is a substitute product with far better specifications but at a much larger price.

Imagine the current pricing strategy is based on a skimming strategy that ‘first to market’ companies often employ until initial R&D investments are recouped or similar products enter the market.

Being a software product, the marginal cost revenue maximisation theory does not hold, as the software can essentially be transmitted almost for free. Assume training may be needed, but since this is an international product, a ‘train the trainer’ video has been created. In this case, except for fixed costs of an office and paying programming and management staff, there is very little marginal cost. Sell one disc, sell 1,000, the overall incremental cost increases are negligible compared to the revenue generated by just one sale.

Now this seems idyllic, however randomly chosen prices can have several very nasty side-effects. One is that your brand and sales support needs to live up to a premium price. Marketing Collateral (user guides etc), Service Level Agreements and contact you have with a customer, including relationship maintenance contacts triggered by a robust CRM system all need to be premium in nature. Let’s assume that these are in place and can be communicated to customers or survey respondents.

Consider that a random high price is still being used because third party resellers all nod that it ‘seems good’. The unfortunate thing is that these guys won’t be buying the product, but again, a high price means high short term commission, if in fact any products are sold.

This kind of scenario is not one that you will find in the FMCG industry (Fast moving consumer goods) or even in luxury durables (like sports cars), because there are enough competitors around to compare prices, and these large kinds of companies will definitely run their own price trials.

One should also be aware that it is very hard to dramatically increase or decrease a product's price without backlash from current and future clients. Many hard to answer questions by these people and irreparable brand damage can result if you are suddenly forced to significantly lower or increase a price.

Product Specific example

Consider that a skimming price policy was enacted primarily for short term gain, without consideration of long term affects. This may be because sufficient market information such as competitor prices or specifications are very hard to find because the secretive nature of the market.

Industries where price elasticity seems to abound are one such as the pharmaceutical and Defense industries. For example if you have a patent on a life saving drug and the Government does not limit the price, companies can charge any value they want and people will have to find money to purchase a drug.

For this pricing case study, the software product is also in a relatively price elastic industry - the Defense industry. If you have a unique high tech product that gives your military forces the edge, some people/ countries may seemingly be willing to pay anything for your product, for which it is tempting to take advantage of this short term advantage. But note, this will only happen while you stay technologically in the lead. What happens if you have a Defense product, and a foreign Government such as the US already has a better version, but for strategic reasons can’t reveal this to anyone. There are many unforeseen things that can derail even the best pricing strategies.

Consider this software company makes image analysis software that is designed for use on UAV (un-manned aerial vehicles). The software could potentially save lives or help destroy the enemy. It could give a massive advantage to an ally, but of course needs to be highly reliability. Let’s assume that this product has these independently verifiable features.

Also consider that the client has three versions of their product suited to three types or tiers of UAV. The tiers mainly relate to the size of the unmanned aircraft. However as they go up in size they also fly at higher altitudes, cost much more to buy and maintain and have many more expensive payloads and/ or weapons on board. The cost of associated ground stations that control these UAVs can also add significantly to the purchase cost of the UAVs.

Let’s assume that the core of the algorithms for each of the three tiers of software is essentially the same. Also assume that the tier 3 (biggest plane) software works on video up to true HD video resolution (1980x1020) while the lower versions work on SD (standard definition video) giving much less resolution analysis. However the tier 1 software for the hand launch planes needs to process very unstable imagery as the planes get buffeted about at low altitude. In some cases the tier 1 processing is actually technically  harder.

It is possible that potential purchasers will understand that the difficulties in processing the different tier imagery are equal in complexity and therefore they may reason that the development costs should be similar. There is a strong caution never to underestimate the intelligence of the customer, particular in the high tech markets.

This means that any research project will need to make clear differences in the benefits for each product if several tiers are to evaluated together by any particular respondent.

While there may be discounts for volume purchases and limited time licenses (say six months or a year) consider that this study concentrates only on outright sale prices for single units.

The table below shows a comparison of tier class UAVs and UAV purchase price versus the pricing studies current software prices.

Product Differentiation

As you can see, in this fictitious example, the ‘client’ initially chose software prices to be somewhat relative to the purchase price of the UAVs. As the tier and tier price of the UAV increases, so does the software cost price point, but the UAV/ Software Cost % dramatically decreases. One could argue that if the software versions are relatively similar (the core engine) and that either the highest tier price is too expensive or the lowest tier is too cheap. Justification for the price points could be that the software is really worth $68,000 but the company is discounting the tier 1 product greatly as a favour to Defense departments or just to get the product name out there.

You can also see that there are many more UAVs in the smallest range (tier 1) meaning it is a much larger market and potentially more open, so price needs to be more competitive at the low end.

Assume that competitor 'substitute products' are made by an established high market capitalisation company but that it is mainly suitable for tier 3 UAV applications because it is attached to specialist hardware and comes at a price close to $2M per product. The US Government is may also be pouring millions of dollars in grants for R&D to develop this highly evolved tier 3 image analysis competitor version. This substitute video analysis software can also be used in all weather conditions (uses SAR technology rather than EO) and for many more applications (such as IED detection). This suggests that the client’s product may then be more competitive in the tier 1 and 2 market.

How the prices are currently justified.

Because the product is software, there is very little marginal cost in the finished product. Years of Government grants have made this company hungry for high margin sales. But is this what the market will bear? In an effort to differentiate the product, different GUIs (graphic user interfaces) and product manuals can be created, but when the software essentially performs at a similar level (quality of analysis) on each tier, how can the product price differential be justified to a client?

As the ‘% of the UAV cost’ diminishes as the tier increases, one might think that the absolute price cost will escape scrutiny, however the US DoD is increasingly coming under Senate review committee scrutiny. Can a different GUI and different marketing collateral satisfy a customer enough to pay triple the price for something that is a very similar product?

Price research can be skewed on product ranges where the cheapest version is essentially the same as the premium version but has some of its performance locked out. For example in this price case study the different versions could be based on the same algorithm core however the cheaper versions are artificially performance reduced by allowing them to ONLY process the lowest resolution video. Differentiation may be reduced further since the most expensive version can only analyse high definition video when the software is running on high performance PCs, thus its performance may be considerably downgraded when working on standard PCs.

This question cuts to the core of price point determination and something that software makers have had to learn the hard way. The market eventually uncovers pricing information once your product has been out there for long enough, and unless the specifications and real performance are markedly different between products within your range, very bad word of mouth can kill your product and company.

This is why for something like the above example (when there are no easy to be found competitors to benchmark) that some form of formal price research is strongly recommended.

Price Market Research

What some companies opt for is to 'in-house' quickly perform some form of focus groups with knowledgeable industry leaders. All they have to do is encourage them to talk freely about their views on the topic. But pricing is a very sensitive matter and is not easily defined in open forums. When you want hard data some form of quantitative analysis, such as a survey is a better fit. In fact there is one price research technique that I (Bruce Dwyer) have used before that has decades of history in quantitatively defining price ranges for a product. It is still the most regularly used research method available and I thoroughly recommend using it. However like any tool, it has limitations and the tool must be administered objectively, which usually means externally to the company.

This research tool alone requires only a few questions to be asked and makes an online survey an ideal method. For an extension to this method a conjoint analysis is usually the preferred tool of market researchers. Conjoint  analysis, is  a tool that assists in determining how your potential customers might trade-off different price levels versus the features of your product that they most desire.

Conjoint analysis could be useful in this example where there are three version of the product as it can help find the ‘must-have’ features of a product segment by segment, so that marketing efforts can be refined for each segment. Conjoint analysis questions often centre on brand price and features mix. When a company isn’t well known and isn’t in large consumer or business market the questions typically reduce to price and main benefits.

In this case since the core algorithms of the software is essentially the same, the product differences mainly centre on the differences of the plane applications, i.e. tactical versus strategic etc.

Many small companies are reticent to commission a complete external Price Research study which could easily cost between $30K and $60K, even on as few as 100 respondents.

Survey participant numbers are also paramount. While many companies may think that providing a list of 30 people is sufficient, this would be the bare minimum of active participants for one tier to achieve a 95% confidence interval. Typically, research companies would be more happy with 100 respondents per tier, which would mean 300 participants (assuming that each participant really only has in-depth knowledge of one specific tier. To achieve 300 participants a research project may require maybe 1,000 or more contacts.

As you can imagine, convincing people to fill out a survey even if it is in their particular area of business interest can be difficult. Several phone calls per potential participant may be required and a positive response to filling out a survey will often be increased by providing an incentive, or a chance to win a widely valued prize.

In the above example it is believed that price is not correlated with cost of manufacture to any real extent. The product does not have any independent testing confirming suitability to application. Using a skimming policy in a market with no objective price feedback is a very risky proposition. 

SUMMARY

 From the brief exploration above, there are often many complex issues surrounding a pricing problem than the maximum price that can be charged. Namely:

• Sufficient genuine (not cosmetic) product differentiation should exist to justify price differences. Price is difficult to justify on versions where the differences are caused by performance option lock outs, that basically downgrades the premium version into the cheapest versions.
• Long term skimming price policies are more acceptable to the market when they are used on products that are verified independently by an external agency. For instance the pharmaceutical market is regulated by government agencies and drugs undergo a series of strict tests before they are released to the market.
• Skimming pricing policies are best suited to companies that have a genuine Sustainable Competitive Advantage such as patent protection, rather than relying solely on their long term technical superiority.
• Marketing/ branding, packaging, post sales service need to back up premium or skimming pricing strategies.

RECOMMENDATIONS

If you have a large marketing budget and wish to perform a pricing study and complex conjoint analysis with many hundreds of participants then contracting a large market research company is probably your best choice. Paying a large price for a study will most likely ensure that the recommendations are accepted.

Companies that create a simple product such as a new variety of canned meal often find trialling their product in well defined demographic test markets in sample supermarkets provide them with a great soft launch and real world pricing feedback from actual customer purchase behaviour.

Smaller businesses that have a moderately unique product may feel more comfortable with contracting someone such as myself for shorter version of pricing studies with or without conjoint analysis. This will provide independent pricing information at lower costs than will be incurred by utilising a Premium priced market research firm which has many more overheads.

Getting price points right before entering a market is one of the most important components of the marketing mix. Has your company performed its due diligence on price? 

Limitations

Stakeholders within a company that may want pricing information may also have an active stake in derailing a pricing project or might simply run a study to justify their current price points. If this is the case, the value of a genuine pricing study will be very limited.