Pricing Strategy Part 1: The Customer
Start with the customer, understand their perception of value, price elasticity and calculate their willingness to pay.
This is a follow on from the Pricing Strategy & Psychology - Understanding the Art and Science behind Monetisation article.
Learn how to put this into practice with the Pricing and Monetisation Strategies Masterclass
When looking at what pricing strategy to choose for your product, start with the customer. Who they are and how they value the product benefits may be different.
Clayton Christensen, in his famous jobs to be done milkshake example, talks about the job a product is hired for is different based on the context and the value it provides for the user - the emotional job (be a good parent providing a nutritious snack for their child after school), the functional job (a fast and easy breakfast you can have while you’re driving with your other hand) - as an alternative to other products that could be hired for the job (banana, chocolate bar etc).
Similarly, when looking at how you could monetise your product or set your pricing, great product managers start with the customer and explore customer value perception before understanding price elasticity and evaluating customer willingness to pay.
So let’s dive in!
Customer Value Perception
To understand how your customer values your product, or what their value perception may be, you need to ask the following.
1. Who Are They?
Understanding your target customer is paramount. Are you catering to businesses (B2B) or individual consumers (B2C)? Beyond that, what specific segment within these categories does your product resonate with? Identifying these distinctions is the first step in comprehending how your customers perceive value in your product.
2. What Problem Do They Need Solved?
Every product should be seen as a solution to a problem. Customers "hire" your product to do a specific job. Identifying this job is crucial. For instance, if your product is a mobile app, does it solve a communication problem, a productivity issue, or a source of entertainment? Knowing this guides your value proposition.
3. What Are Their Needs?
To truly grasp customer perception of value, you must get inside their heads. What do they need from your product? Is it speed, convenience, entertainment, or security? This is where tech companies often excel because they can cater to a wide array of needs.
4. What Price Would They Be Willing to Pay?
Price sensitivity is a significant factor in customer perception of value. Some customers are budget-conscious and seek the lowest cost alternative. Consider prepaid mobile services – a hit among students and seniors who prefer control over their spending. In the world of water, these individuals would turn to the tap without hesitation.
5. Are They Early Adopters or Wait for Perfection?
Tech adopters are diverse. Some eagerly embrace the latest and greatest innovations, even if they come with a few bugs (early adopters). Others are content to wait until all the kinks are ironed out before making a move.
What do Customers Perceive as Valuable?
Now, let's translate these principles into the tech world with some engaging examples:
1. Price-Sensitive Enthusiasts
Think of the student who scours the internet for the best budget smartphone. They want all the essential features without breaking the bank. These individuals are the first in line for Black Friday deals and are quick to jump on any cost-saving tech trends.
2. Convenience-Oriented Users
Imagine someone rushing to catch a flight, needing access to their data on the go. They opt for a simple, no-fuss cloud storage solution, allowing them to access files seamlessly from anywhere. For them, convenience is paramount, much like someone who carries a basic water bottle or brings their reusable one from home.
3. The Pursuit of Premium Experience
Now, consider the tech enthusiast who views their gadgets as status symbols. They want the best product available to showcase their success. These are the ones who invest in top-of-the-line smartphones, cutting-edge gaming consoles, or high-end laptops. Their tech choices parallel the customer who enjoys sparkling water on ice, served in a chilled glass with a lemon wedge, purely for the premium experience.
4. Enthusiasts Who Want It NOW
Lastly, there are those who refuse to wait. They crave the latest tech innovation and are willing to pay a premium for early access. These are the customers who pre-order the newest iPhone or camp out at tech stores on release day. In the world of water, they'd opt for the convenience of bottled water from a vending machine at a premium price.
To understand more about how customers perceive the value of your product, we’re going to dive into Price Elasticity.
Price Elasticity
Price elasticity of demand is used to determine how a change in price affects consumer demand.
Ever wondered why people rush to buy certain items when they go on sale, but stay indifferent to price changes in their daily cup of coffee? It's all about price elasticity, a fascinating concept in economics that can turn your pricing strategies into a superpower! 🦸♂️💰
Like a Rubber Band – think about how much you can stretch a price before it breaks – or rather your product suffers from less adoption, customer churn and other negatives.
Price Elasticity of Demand (PED)
You can calculate Price Elasticity of Demand (PED) using the formula:
% Change in Quantity Demanded DIVIDED BY % Change in Price = Price Elasticity of Demand.
PED is like the superhero of consumer behavior. It tells us how much we love or hate changes in prices. Think of it as a secret formula:
If PED > 1, it's the Elastic Hero!
A small price change makes customers swing into action. For instance, when that fancy car's price nudges up 10%, and suddenly, 20% fewer are sold—PED is greater than 1.
Customers perceive these products as more of a 'nice to have’. Sales suffer when the Price goes up. Another example includes movie tickets. If prices increase, people will stay home and watch Netflix or switch to alternative entertainment.
If PED < 1, meet the Inelastic Defender.
Here, prices might do the cha-cha, but the quantity demanded just shrugs. Petrol prices up 10%, and people buy 5% less? PED is less than 1.
These are products or services that can withstand stretching of the price or Price Increases. People see these products as essentials and will continue to buy even though they have to pay more. Other examples are vapes or medication. For a parent of a baby, nappies and milk may be essential. These products may be addictive, have no competition or alternative and consumers can’t live without it.
If PED = 1, it's the Unitary Elasticity Champion.
Changes in price and quantity hold hands and dance in perfect harmony.
The concept of price elasticity helps you understand if your product or service is sensitive to price fluctuations.
Ideally, you want your product to be inelastic — so that demand remains stable if prices do fluctuate.
What impacts Price Elasticity?
A few things to think about are
Product - if a product is deemed necessary for survival, quality of life or pleasure it’s INELASTIC (e.g. baby formula, nappies or Milk)
Customer Options – where there are more options available (alternatives, competitor offerings) to meet a particular functional or emotional need, price is ELASTIC (e.g. if Mars Bars is on sales this week, you may purchase them over Twix or Cookies)
Customer Budget – if a price change would impact a buyers budget, they can’t pay anymore for the product or service, then they won’t. At this point, you might stop buying nappies and start toilet training and avoid the expense.
If your customer perceived your Brand as better than alternatives, the price is INELASTIC and demand won’t decrease the higher the Price. Example - iPhone
Next it’s valuable to understand Willingness to Pay and how to calculate it.
Willingness to Pay
Willingness To Pay is a term for the highest price a consumer will pay for one unit of a good or service. But how do you calculate it?
There are 3 ways….
1. Gabor-Granger
The Gabor-Granger method, created in the 1960s by Clive Granger and André Gabor, is a way to figure out how much people are willing to pay for something in a survey. Here's how it works:
Finding the Highest Price: The main goal of using the Gabor-Granger method is to discover the highest price that people are willing to pay for a product or service.
Setting Up the Survey: To do this, you set up a survey with five different prices for the product. These prices cover a range from low to high.
Asking Questions: You then ask the survey participants a question about whether they would buy the product at one of these five prices. They have five choices, from "Definitely Buy" to "Definitely Not Buy."
Checking Responses: If someone says they would "Definitely Buy" or "Probably Buy" at a certain price, you ask them the same question again but with a higher price to see if they would still buy it.
Finding the Highest Price: You keep doing this until you reach the point where the person says they wouldn't buy it anymore. That's when you know the highest price they are willing to pay.
Dealing with Non-Buyers: If someone never says they would buy it, even at the lowest price, you might consider their response as a zero or exclude them from the analysis because they aren't interested in buying at any price.
There are a few ways to use the Gabor-Granger method in surveys:
Monadic Querying: In this approach, each survey participant is shown only one price and asked if they would buy the product at that price.
Randomized Querying: Here, each participant sees a range of prices and has to say whether they would buy the product at those prices. This can involve around 5 to 10 different prices to get a better understanding.
Systematic Querying: This method aims to determine the exact price limit for each survey participant. It involves a more structured approach to finding their willingness to pay.
Gabor-Granger Method is best for:
Best For: when you want a quick and straightforward assessment of customers' willingness to pay for an existing product, especially when you are considering price increases.
Advantages: Simplicity, speed, easy to understand, no need for prior price knowledge.
Disadvantages: Potential bias, limited to price increases, doesn't consider competitive factors or existing price perceptions.
2. Van Westendorp Price Sensitivity Meter (PSM)
The Van Westendorp Price Sensitivity Meter (PSM) is a tool created by Dutch economist Peter van Westendorp in 1976. It's been widely used for the past two decades to help businesses figure out the right prices for their products or services.
Here's how it works in simple terms:
Four Questions: In the traditional PSM approach, you ask people four questions about prices. These questions help you understand how they feel about different price points. The questions are:
What price would make the product seem too expensive for you to consider buying it? (This tells us when it's too pricey)
What price would make you think the product is so cheap that its quality must be bad? (This helps us find when it's too cheap)
At what price would you start to think it's getting expensive, but you'd still think about buying it? (This indicates when it's getting a bit costly)
At what price would you see it as a great deal, a bargain worth buying? (This shows when it's a fantastic value)
Plotting the Data: After collecting answers to these questions, you plot the results on a graph. The graph helps you see where people's opinions intersect.
Interpretation: The spots where the lines on the graph cross each other have specific meanings:
When "too cheap" and "expensive" intersect, it can give you the lowest acceptable price range. Some call this the "point of marginal cheapness" (PMC).
When the lines for "expensive" and "cheap" intersect again, it represents the highest acceptable price range. This is sometimes called the "point of marginal expensiveness" (PME).
Van Westendorp Price Sensitivity Meter (PSM) is best for:
Best For: lower-priced consumer goods or FMCG products where customers can easily relate to the items. It's also useful when you want to gauge perceived value at different price points.
Advantages: No bias, suitability for consumer goods, supplementary questions, perception of product value.
Disadvantages: May not be ideal for new products, limited pricing knowledge, doesn't consider competition, doesn't provide specific purchase behavior data.
3. Conjoint Analysis
A third way to uncover a customer’s willingness to pay is Conjoint Analysis.
Conjoint analysis is a powerful market research technique used to understand how customers make decisions when faced with multiple product or service options. It helps businesses determine the optimal combination of features, attributes, or pricing that will maximize customer preference and satisfaction. Conjoint analysis is especially valuable when designing or improving products, services, or marketing strategies.
Here's a simplified explanation of how conjoint analysis works:
1. Creating Product Profiles:
Imagine you have a product, like a smartphone, with various features: screen size, camera quality, battery life, and price.
Conjoint analysis starts by breaking down the product into different attributes, each with several levels or options. For example:
Screen size: Small, Medium, Large
Camera quality: Low, Medium, High
Battery life: Short, Medium, Long
Price: $500, $700, $900
2. Designing Choice Sets:
Conjoint analysis then creates hypothetical product profiles or combinations of attributes and levels.
Each respondent in the study is presented with a series of these profiles, usually in pairs or sets, and is asked to choose their preferred option from each set.
3. Collecting Customer Preferences:
Respondents make choices based on their preferences. For example, they might choose a smartphone with a medium screen size, high-quality camera, long battery life, and a price of $700 over other options.
The choices made by respondents are recorded for analysis.
4. Analyzing Data:
The collected data is used to build mathematical models that estimate the importance of each attribute and its levels in influencing customer choices.
These models quantify how customers trade off one attribute for another. For instance, customers might be willing to pay more for a larger screen but less for a longer battery life.
The analysis generates utility scores or part-worth utilities, which represent the value customers place on each attribute level.
5. Identifying Preferences and Optimal Solutions:
Conjoint analysis helps businesses understand customer preferences and priorities. It reveals which attributes and levels have the most significant impact on purchasing decisions.
Businesses can use this information to design products or services that align with customer preferences and optimize pricing strategies.
The analysis can also simulate scenarios to find the ideal combination of attributes and prices that will maximize customer satisfaction and profitability.
Conjoint Analysis is best for:
Best For: Conjoint analysis is versatile and suitable for a wide range of products and services. It's particularly powerful for product development, pricing strategy, and market segmentation.
Advantages: Realistic decision insights, product optimization, market segmentation, pricing strategy, competitive analysis, informed decision-making.
Disadvantages: Complexity, resource-intensive, reliance on assumptions, potential respondent fatigue, requires expertise, may not predict real purchase behavior accurately.
If you need a quick assessment of a customer’s willingness to pay for an existing product, the Gabor-Granger method might be all you need. If you're dealing with lower-priced consumer goods, the Van Westendorp PSM could be suitable. But, for a more comprehensive and versatile approach that can address various aspects of value inclusions, pricing, and market segmentation, conjoint analysis is recommended. Well this is what I used heavily when I was looking at the pricing for products I managed in telecommunications.
This is a follow on from the Pricing Strategy & Psychology - Understanding the Art and Science behind Monetisation article.
Next up is Read more with Pricing Strategy Part 2: Product. Make sure you subscribe so you don’t miss the next update
Learn how to put this into practice with the Pricing and Monetisation Strategies Masterclass
Want to know more about Pricing Strategies and what’s the right one for your product and context? Drop me an email at irene@phronesisadvisory.com