Review: Monetizing Innovation by Madhavan Ramanujam and Georg Tacke

A worthwhile read for any founder or product executive to understand the importance of thinking through monetization up front for any new product. In particular, the book argues that products should first and foremost be designed around the price. That’s a fairly bold claim, and one that seems different from many other books on product development! However, once you get into the details, it makes sense. And while I don’t agree with every detail in this book—for example, the types of questions they recommend you ask your customers may leave you open to misleading answers (see The Mom Test and Continuous Discovery Habits)—the general ideas are very much worth considering.

Here are some of the key insights for me from this book:

Design products around price

The central point of the book is that products should be designed around price. Note that in this context, “price” is not just a single dollar figure (e.g., $500); that’s a price point. What they are really talking about when they say “price” is to design the product around the perceived value of the product. Almost everything else—the type of product you can design, the service you can provide, the way you’re perceived, the size of the company you could build, the profit you can generate, and so on—is derived from price.

“Price is more than just a dollar figure; it is an indication of what the customer wants—and how much they wan it. It is the single most critical factor in determining whether a product makes money, yet it is an afterthought, a last minute consideration made after a product is developed.”

The traditional way to build products is to design, build, market, and finally price. This book recommends an alternative order: start with market and price, then design, and then build.

The 4 types of monetization failures

This book argues that monetization failures come in only 4 flavors:

1. Feature shock: cramming too many features into a product—sometimes even unwanted features—results in a product that doesn’t resonate with customers and is overpriced. Typical symptoms include over-engineering, unclear value proposition, difficulty selling, and frequent price cuts.

2. Minivation: it’s an innovation that is the right product for the right product, but it’s priced too low, and doesn’t achieve its full revenue potential. Typical symptoms include easy selling, but due to lack of ambition and low-ball targets, it doesn’t go far.

3. Hidden gem: a potential blockbuster product that is never properly brought to market, generally because it falls outside of the core business. Typical symptoms include that your company is doing something outside of your comfort zone, everyone is playing it safe, and no one is responsible for getting the most out of this gem.

4. Undead: an innovation customers don’t want, either because it’s the wrong answer to the right question, or an answer to a question no one was asking. Typical symptoms include sales struggles, negative press, and a lack of objectivity (especially around pet projects for an exec).

Rules for avoiding monetization failures

Here are a few of the key rules for avoiding the 4 types of monetization failures from the previous section:

1. Have the “willingness to pay” talk early. It is essential to have the “willingness to pay” talk early in the product development process.

2. Segment on willingness to pay, not demographics. Your customers are not all the same, so one-size-fits-all solutions don’t work, and you instead need to do segmentation. However, the traditional way of doing segmentation, along demographics, is not effective for most products. You should instead segment based on differences in customers’ willingness to pay for your product.

3. Pick the right pricing model. It turns out that how you charge is often more often than how much you charge.

More on each of these below.

Willingness to pay (WTP)

One of the key ideas this book tries to get across is to have a “willingness to pay” (WTP) conversation with your customers as early in the process as possible. Key information you want to get from a WTP conversation:

1. Overall WTP. The right price range a customer would consider reasonable for your product—including whether they’d be willing to pay for it at all. You can then figure out if that price range would work for your company: e.g., can you deliver a product that would work at that price and still make a profit?

2. WTP for each feature. You also want to dig deeper and figure out the WTP for each individual feature. This helps you prioritize your roadmap, avoid feature shock, and figure out segmentation.

How to have the WTP conversation

1. Problem. The first step is to discuss pain points with the customer and to build a deep understanding what problems they are hitting.

2. Solution. If the problems the customer described align with what your product is intended to solve, then you can move on to the second step, where you talk about the solution you have in mind. Show your product, its features, and its benefits.

3. Value. Next, try to get an understanding from the customer on whether they value the features you are discussing. Note that you are NOT discussing price yet! This is purely about value: would they find this product useful? Do they find these features valuable? Would it potentially solve the problems they are facing? And after each of these questions, always ask “why,” so you can build up your mental model of what the customer is looking for.

4. Price. Now, finally, you can talk about price. See the price questions in the next section.

Price questions

1. Direct questions. Examples:

• “What do you think could be an acceptable price?”
• “What do you think would be an expensive price?”
• “What do you think would be a prohibitively expensive price?”
• “Would you buy this product at $XYZ?”

1. Purchase probability questions. You show a product concept, explain its benefits, attach a price to it, and ask customers to rate it from 1-5, where 1 is “I’d never buy this product” and 5 is “I’d definitely buy this product.” If you get a 3 or less, you lower the price, and repeat. Repeat a few times until you start to get 4s or 5s, which tells you you’re in the right range, or if that never happens, it tells you there is something wrong with the product offering in general. Note: a 5 typically represents a ~50% probability the person would actually buy it; a 4 represents a 10-20% probability.

2. Most-least questions. Start with a list of features (e.g., 10 features). Pick a subset of those features (e.g., 6 of the 10 features), and ask customers to pick the feature they value most and the one they value least. Then show a different subset and ask the question again. Repeat this process 5-7 times, until all combinations are exhausted. This helps you identify the most valuable features (the “leaders”) and the least valuable ones (the “killers”). This method takes advantage of the fact that people are better at comparative ranking than absolute valuation, and that they are better at identifying extremes (best/worst) than at figuring out the stuff in the middle.

3. Build-your-own questions. This method should only be done after you have a rough sense of WTP from other methods, such as the 3 methods above. The idea is to give your customers a list of features and ask them to assemble their “ideal product” from this list; the catch is that each time they pick a feature, the price goes up. You then see how many and which features customers add before they stop.

4. Purchase simulations. This method should only be done after you have a rough sense of WTP from other methods, such as the 3 methods above. You show a customer a product with a specific feature set and a price point and ask if they would buy it. You then change the feature set and price, and ask the same question. You repeat this 5-8 times, until all combinations are exhausted.

For all the methods above, after a customer has made some choices, always try to follow up with, “why?” Your goal is to tap into the mental models customers are using to make their choices.

Important note: Some of the methods above ask the customer to predict their future behavior, and there is considerable research showing that this can lead to very misleading answers. I agree with the book that understanding WTP is essential, but I worry some of the methods the book recommends aren’t likely to be effective. See The Mom Test and Continuous Discovery Habits for alternatives techniques/questions.

Segmentation principles

1. Leaders, fillers, and killers.

• Leaders are the must-have features that get a customer to buy a product. These are usually the features with the highest WTP. You must include them and you design product offerings around them.

• Fillers are features of moderate importance, but they are nice-to-haves, and not enough by themselves to get someone to buy.

• Killers are features customers don’t want at all: in fact, they are features that may kill the deal if the customer is forced to pay for them. These should be eliminated entirely from the product. You can usually identify a killer by looking for features that are (a) valued by less than 20% of customers and (b) not valued at all by more than 20% of customers

1. Good, better, and best (G/B/B).

• The most common bundling is to offer 3 options (e.g., bronze/silver/gold or pro, business, enterprise): a good option that has core features, a best option that has all the bells and whistles, and a better option somewhere in between.

• Ideally, < 30% of customers go for the good option, and > 70% opt for better or best, with > 10% going for best. Note that customers often avoid extremes, so going for the middle option is very common.

• G/B/B works because instead of a single option—a yes or no decision—you can now cater to customers that are optimizing for price (the good option), quality (the best option), or somewhere in between (the better option).

Segmentation traps

1. Avoid the “average” trap. Don’t just look at averages; look at distribution too. For example, you may find that customers are willing to pay an “average” of $60 for your product, but if you dig into the distribution, you’ll find out that everyone falls into one of two buckets: either they want to pay $20 or $100. So if you set the price to the average, $60, then you’d be leaving money on the table with each sale for the $100 customers, and you wouldn’t be making any sales to customers in the $20 bucket.

2. Don’t try to serve every segment. You are not obligated to serve every single possible customer. Every segment takes some investment, so it’s only worth pursuing if you’re confident the segment will deliver enough customers and money. So for each segment, you’ll need to estimate not only its size, but also how much it’ll cost you to build for, acquire, and, retain the customers in that segment, and at what prices, and then targeting only the segments that make sense for your business.

3. Don’t give too much away in your entry-level product. If more than 50% of your customers are on your entry-level product, you have a problem where you are able to “land” but not “expand.” The ideal breakdown is < 30% of customers go for the good option, and > 70% opt for better or best, with > 10% going for best. If you’re not seeing this, then you should consider removing features from the good option.

Monetization model

Before you can settle on any sort of price points, you will need to pick a monetization model for your product. Here are five of the most common monetization models:

1. Subscription. A periodic and automatic payment for continued delivery of or access to a product. Example: Salesforce.
2. Dynamic pricing. The price fluctuates based on factors such as season, time of day, weather, and anything else that affects WTP, supply, or demand. Example: airline ticket prices.
3. Market-based pricing. The price of the product is determined through competition in an auction. Example: Google Ads.
4. Pay as you go. Pay per-unit pricing, ideally for a metric closely tied to product value and customer benefits. Example: GE charging per mile flown on its engines.
5. Freemium. The product has free tiers and paid tiers. You try to “land and expand,” getting people in the door with free tiers, and then upselling them to paid tiers. Example: Dropbox.

Pricing strategy document

You should define a pricing strategy in a written document. This way, you are more likely to think through pricing holistically, based off a concrete strategy, rather than random guesswork. Moreover, you’re less likely to make wild (and potentially harmful) pricing changes later if things aren’t going as expected.

The pricing strategy document consists of 4 parts:

1. Goals. The goal you’re aiming for has a profound impact on your pricing strategy, so it’s critical to define it clearly, up front. Are you optimizing for maximum revenue? Market share? Total profit? Profit margin? Customer lifetime value? Something else? You can’t maximize all of these at the same time, so you’ll have to make trade-offs. Example: if you sell your product at $10, you might get 10,000 customers, with a 30% profit margin, whereas if you sell it at $15, you might get 8,000 customers, but at a 50% profit margin. So would you go for 20% more margin, at the cost of 20% fewer customers? Different execs (e.g., CEO, CMO, CTO, CRO, etc) are often optimizing for different goals, so it’s critical to get everyone aligned. One exercise for doing this is to put all the possible goals in a list and give each exec 100 points to allocate amongst those goals. This forces everyone to make trade-offs: e.g., do I give 50 points to this goal or all 100 points? When you compare your answers, you may find shocking disparities. Talk them out and get everyone on the same page.

2. Pricing strategy type. There are three primary types of pricing strategy:

• 2a. Maximization, where you pick the maximum price that helps you achieve your goals. Most companies go with this option.
• 2b. Penetration, where you intentionally set price below the maximum in an attempt to rapidly gain market share and then systematically raise prices later. This works well if your product creates highly loyal customers; otherwise, they will flee when prices go up.
• 2c. Skimming, where you intentionally set a price above the maximum to cater to the early adopters and then systematically lower prices later. This works well when your technology is a significant breakthrough, or if you have production limitations early on.

1. Price-setting principles. Defining these principles up front helps you systematically figure out your initial pricing and to avoid changing pricing in a panic if things aren’t going well:

• 3a. Monetization model. Which of the monetization models discussed above will you go with?
• 3b. Price differentiation. Will you differentiate your price? If so, based on what factors (e.g., channel, industry vertical, region)?
• 3c. Price floors. Is there a price below which you’ll never go?
• 3d. Price endings. The most common endings are 0.00, 0.50, 0.99, and 0.95. Endings matter more in B2C; for B2B, whole numbers are usually better.
• 3e. Price increases. Will you increase price over time? If so, how much and at what frequency?

1. Reaction principles. Defining these principles up front helps you systematically modify your pricing after launch, based on what actually happens in the market. Reactions fall into two buckets. The first bucket is reaction to what customers do, and mostly consists of defining your promotional reactions up front: e.g., will you offer discounts or seek premium pricing or something else. The second bucket is reaction to what competitors do, and this involves anticipating what your competitors might do using war-gaming sessions. How likely are competitors to react? Will they react by changing price? Will we update our pricing to match theirs? And so on.

Communicating the value

After you’ve figured out your pricing strategy and built a product, you have to figure out how to communicate the value of that product to customers. There are two techniques to use here:

1. Benefits statement. Don’t describe the features your product has; describe the benefits those features bring to your customers. These are usually tied to the specific pain points your customers are facing. You’ll want different benefit statements for each segment. For example, Adobe’s benefit statement for SMBs is “Get the entire collection of creative apps and business services, including easy license and management”; for enterprises, it’s, “customized provisioning and deployment, plus enterprise-level support”; and for students, it’s “save 60% on the entire collection of apps.”

2. Value-selling. Create an easy way for customers to calculate/estimate the value of the benefits in the benefits statement. For example, if one of the key benefits of your product is that it saves time, you could offer a simple spreadsheet where the customer can see how much time they save per year, and based on some assumptions, how much money that’s worth: “product XXX saves you $5M per year!” The value should be vastly higher than the price you’ve set.

Rating: 4 stars