While it’s true that economies of scale lead to lower prices, it’s an incomplete explanation of why that’s so. Let’s expand our thinking to incorporate the broader implications of economies of scale.
Lower prices
The questions that come to mind when I think of economies of scale is: Why would you lower your prices? Why give up higher profit margins to share your cost savings with customers?
The obvious answer is to increase demand for your offerings. Price elasticity tells us that, all other things being equal, when a company lowers its prices unit sales go up. Theoretically, the increase in unit sales more than offsets the lower margins you get.
While that’s great theory, it doesn’t answer these questions:
- Where is the offering in terms of the innovation life cycle?
- Is your company the innovator or are you catching up?
- How do the answers to the above questions alter your approach to creating demand?
Where in the innovation life cycle?
Here are the five commonly used customer categories of the innovation life cycle:
- Innovators
- Early adopters
- Early majority
- Late majority
- Laggards
Innovators are fascinated by the latest, greatest of what you’re offering. Early adopters don’t enter the market until they see a practical application for what you’re offering. Early majority become interested when the early adopters’ uses demonstrate proven results. The late majority join the parade only when necessary or the price is so low as to make it impractical not to buy. Laggards don’t enter until there aren’t any alternatives available.
Economies of scale, and their resultant lower prices, won’t make sense until early adopters see practical uses of the offering. A lower price alone won’t trigger demand, early adopters must envision a practical application.
Similarly, the early majority won’t buy, even at lower prices, until they see proven results that the early adopters achieved.
I’m not going to waste time talking about the late majority or laggards because lowering prices for these highly-price-sensitive buyers means that you’re adding infrastructure costs while margins are shrinking…a veritable prescription for failure.
Innovator or catching up?
Interestingly, this can go either way in terms of who has the edge. I’ve seen innovators who were too early…the public wasn’t ready for what they were offering…or they didn’t do a good job of demonstrating practical applications for their offering. In situations like this, the second to market can gain an advantage, and economies of scale, that enable them to be the first to the early adopter market.
Generally though, the innovator, assuming good timing and effective marketing, will benefit from having others in their industry playing catch up. By lowering their prices and capturing significant chunks of each of the three early-stage customer groups ahead of their competitors, they force their competitors to incur significant development (catch up) costs while prices and margins are falling…a very expensive position to be in.
This brings us to the question of what approach to use in creating demand for each customer category.
Creating demand
With innovators, you only need to appeal to their interest in the latest and greatest. There are no economies of scale needed. They pay significant premiums to be the first to experience your offering. These folks enjoy regaling others with stories of the challenges faced in dealing with the early versions of the offering.
To make economies of scale worthwhile, you need to alter your marketing to appeal to the early adopters. In other words, your marketing has to demonstrate practical applications for your offering. Absent practical applications, lower prices won’t attract these folks. Remember these folks are visionary so demonstrating applications that, to many may seem bizarre, will appeal to these folks.
As you capture significant portions of the early adopter market, and they get demonstrable results, you need to switch your marketing to highlight the results the early adopters have gotten. That’s what the early majority are interested in. Again, just offering a lower price won’t get the job done.
The final two customer categories, late majority and laggards, are a minefield. Do NOT enter. These folks do not value what you offer and will only buy when the price is so low as to no longer be worth your time and energy or they have no alternative but to switch.
Takeaways
As is all too often the case, the idea of creating economies of scale to lower prices and increase demand is too simplistic. It fails to incorporate other essential information needed to know when to create economies of scale and have them pay off handsomely. It also requires an understanding of what marketing messages to employ to attract each of the three primary markets: innovators, early adopters and early majority.
Creating economies of scale and lowering prices only make sense in light of the answers to these questions:
- Where your offering is in its life cycle.
- Whether you’re the innovator or playing catch up.
- What marketing messages are needed for each customer category in the offering’s life cycle.
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