Impact of pricing strategy on market sizing

market size Market sizing pricing pricing strategy
New answer on Nov 27, 2019
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Thibault asked on Nov 26, 2019

Hi everyone,

I came across a case today where I was asked to, first, estimate the market size for a new technology that doesn't exist yet, and then, propose a pricing strategy for it. The difficulty I had is that the potential number of customers depends on the price we suggest.

In this type of situation, do you usually go with estimating the market, proposing a price, and then refining the market size accordingly depending on customers' price sensitivity?

Thanks for your help.

Thibault

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Antonello
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replied on Nov 27, 2019
McKinsey | MBA professor for consulting interviews

Hi Thibault,
generally speaking it can work, but it really depends on the problem. Could you provide us with more context?
In particular, if we identify a potential client well defined/niche we could close our problem by simply understand the price this segment is willing to pay (therefore the third iteratitive step will not be necessary). In the case we identify 2 well-defined clusters, we could think about developing 2 product, 1 per cluster (e.g. a standard version and a premium one)

Hope it helps,
Antonello

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Francesco
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replied on Nov 27, 2019
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Hi Thibault,

good question. In general, it would make more sense to first derive the price of the product, and then estimate the market size for a certain price point.

In case you must estimate the market first, the only thing you can do is to assume a price equivalent to the current one used by indirect competitors or substitutes, and use it to assess the people that can and want to buy the product, and therefore the total market. After that, as you wrote, if you find that the optimal price for the client is significantly different from the one you initially assumed, you can point out it would make sense to revise the total market given the new price (it is unlikely the interviewer will ask to do again the market sizing though).

Best,

Francesco

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Vlad
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replied on Nov 27, 2019
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Hi,

The general framework for pricing is: Cost base - Value based - Competitor based - pricing strategy

1. Cost based - you actually check what are the costs and apply standard industry / target markup

2. Value based pricing can be done in 2 ways:

  • For existing products you compare the value proposition and features of your product vs. the VP of your competitors. If you have a significant difference in value prop - you have to define how much value you propose to the customer in $ terms.
  • For new products you have to calculate the value of the closest alternatives and think how much additional value we provide by replacing them. Basically it's the customer WTP - the willingness to pay. Think of the discount airlines compared to trains or buses

3. Competitor based pricing - basically it's benchmarking against competitors. Make sure you take into account the segment (i.e. in premium higher price may be the proxy for quality)

4. Pricing strategy - here you define how you will price the product taking into account 1,2,3 and your company strategy. Maybe you decide to have a zero margin if you can crossell other services. Or maybe you would like to subsidize to win the competition. Also think of price differentiation and having different pricing tiers (e.g. basic, premium or even fremium) and how it helps to drive price perception and fulfill strategic goals

Good luck!

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Deniz
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replied on Nov 27, 2019
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Hi,

You can first size the market assuming that the customers would have the same budget to spend on the new product (compared to existing alternatives or adjacent products), thus you can assign a price level that is comparable to the market.

Based on the number of customers you find, you can then talk about multiple scenarios where the number of customers varies as per the price level (dependent on their price sensitivity and how the new product's value proposition aligns with the customer demands).

Best,

Deniz

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Sidi
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replied on Nov 27, 2019
McKinsey Senior EM & BCG Consultant | Interviewer at McK & BCG for 7 years | Coached 300+ candidates secure MBB offers

Hi Thibault,

I believe your starting premise is not correct. The POTENTIAL number of customers does not depend on the price! It is the adressable market of users that would use this product if it was for free. You can estimate this potential as a first step as a standalone exercise.

The second step depens on the data available. If there is market research data on the demand structure, then you just choose the price point which maximizes revenue. If not, then value-based pricing is the way to go. You have to discuss with the interiewer whether there are different customer types/segments who value the product differently. If so, you need to derive the value for each segment and then correspondingly arrive at the price.

Cheers, Sidi

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Antonello gave the best answer

Antonello

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