Pricing Disruptive Innovations - market-following or value-based pricing?

By: Rashaqa Rahman

At Ibbaka, we periodically conduct research as part of our ongoing work to create ongoing dialogue around pricing excellence. Our latest study captured insights on how organizations create, communicate and capture in price the value of their innovations. Here is a summary of our results

Two categories - sustaining innovators and disruptive innovators.

Sustaining innovations are product-driven, the goal is to create incremental value-add for existing offers or markets. Disruptive innovations are consumer-driven, addressing unaddressed customer needs in unique ways. Interestingly, this clustering was found by our segmentation and clustering software and not imposed on the data. It shows how deeply this framing has established itself among people who work in innovation.

The most interesting insight to come out of this research was the difference between how disruptive innovators and sustaining innovators approach pricing. Sustaining innovators tend to use value-based pricing while disruptive innovators tend to use market-following pricing. We are surprised by the revelation that significantly more disruptive innovators resort to market-following pricing. Perhaps, this finding makes sense in light of  Clay Christensen’s work on disruptive innovations (see diagram below). Christensen distinguishes between "low-end disruption" and “new-market disruption”. Low-end disruption targets customers that are currently underserved as they do not need the full performance valued by customers at the high end of the market. New-market disruption targets customers whose needs are currently unmet by incumbents.

So, disruptive innovations enter the market at a low price point and sell to underserved markets. This low price is set relative to a more expensive incumbent. Disruptors often inadvertently resort to market-following pricing as they are trying to use low pricing as a wedge to enter the market and to reflect lower performance on the well established value drivers..

In value-based pricing, the price of an offer is based on an in-depth understanding of the differentiated economic (monetary) and emotional value of the offer.

The differentiated value is value that a potential customer cares about, is willing to pay for, and cannot easily get from another source. As long as there is a viable product or service, pricing of innovation should not be left to market forces. Market-following pricing takes away pricing power. Passively letting market forces set prices does not get to the core of customer value creation and value capture. Innovations have the potential to shape the market and pricing is central to how the value of the innovation is communicated to the customer. Market-following pricing does not effectively capture customer value creation and without value capture there can be no ongoing innovation.  

Sustaining innovations are innovating on existing value drivers that are already well understood by the market. This makes it easier to map value creation to value-based pricing. Disruptive innovations can create differentiation through new value drivers (economic and/or emotional) or through new ways of delivering on existing value drivers that the customer cares about. This creates the opportunity to price based on new value drivers, for both underserved and unserved markets. Pricing on a new value driver can make it difficult for the incumbent to compete. Under such circumstances, pricing based on market-following would result in weakening the competitive positioning and leaving the door open for larger companies to barge in.

We will be conducting follow-up research soon to better understand the reasoning behind and implications of market-following pricing on disruptive innovations.