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The Innovator's Pricing Dilemma

|Includes: International Business Machines Corporation (IBM)

This week IBM introduced an innovative new line of servers.  The eX5 line of servers features some truly exciting technology and after reviewing IBM’s press release, it is clear that they have done their homework on how much that technology could be worth to customers.  They have done a nice job defining in simple terms key value drivers and the financial benefits that customers can get – and some of the number are big, really big.  Here are a couple of nuggets from the release.

  • IBM eXFlash technology would eliminate the need for a client to purchase two entry-level servers and 80 JBODs to support a 240,000 IOPs database environment, saving $670,000 in server and storage acquisition costs.

  • A 1,000 user SQL Server 2008 database will cost $50,000 on a two-socket eX5 system. IBM is expected to be the only vendor to deliver a two-socket system in this space, therefore users of competitive systems will have to purchase a four-socket server to run a 1,000 user SQL server database and pay $100,000. Pricing based on Microsoft List Pricing as of January 2010. Pricing model used is per processor licensing which is based on $24,999 per physical socket on the server (logical cores are not counted)

These numbers don’t take into account additional savings in space, power, labor, or maintenance.  So what we have here is a really interesting dilemma.  How the heck do you price something that potentially brings hundreds of thousands – maybe even millions – of dollars of benefit over and above competitive offerings when those competitive products cost around $7,000?

In theory IBM could get a significant premium here.  Based on the data above, a pure value-based pricing approach would point to prices that range from 3 to 50 times what the competition is charging.  After doing a little internet sleuthing, I found prices on the IBM Canada website that seem to indicate that new machines are priced roughly at parity with inferior competitive offerings.

Pricing innovations really does present a dilemma.  On the one hand, why not go with premium pricing?  Maybe cost-conscious customers won’t buy, no matter how compelling the value is.  Also, it is a safe bet that IBM wants to move quickly to grab share before competitors move in.  And yet, the value seems so compelling.  This is the other side of the Innovator’s Pricing Dilemma – worrying too much and under-pricing what seems like a breakthrough technology. Unfortunately this is what usually happens as nervous managers take the safe route.

So let’s assume a market share grab has something to do with this but let’s also give IBM credit for being a well-run company.  What questions should they have addressed to support such low pricing?

  • For each unit sold, is there a significant stream of ancillary revenue from additional hardware, software, and services?  If so, how much is it?
  • Do customers tend to be loyal?  Put another way is market share sticky?  If so what is the value of each point of market share gained?
  • Is IBM’s technological advantage going to be short-lived?  If so, how long before a credible competitor appears and what is their likely price point?

Pricing is so much more than analyzing value and setting price levels proportionally.  As these questions indicate, it has to be conducted with a view toward a specific set of strategic goals and honest assumptions about the competitive environment.  Did IBM get it right here?  It’s hard to tell but my bet is that they have left a lot of money on the table.

Disclosure: No Positions