With the help of price sensitivity analysis, companies can make better decisions on how to price a product and services, assigning them the right price and also allowing them to be competitive and increase their revenues. But, what is price sensitivity and why is it important?
What is Price sensitivity?
Price sensitivity is the way in which the cost of a product affects consumers’ purchasing decisions.
It is also known as price elasticity of demand. This means the extent to which the sale of a particular product or service is affected. In general terms, it is how demand changes as the cost of products changes.
Price sensitivity is commonly measured using the price elasticity of demand or the measure of the change in demand as a function of its price change.
For example, some consumers are unwilling to pay a few cents extra per gallon of gasoline, especially if there is a lower-priced station nearby.
The consumer decision-making process
Before understanding how the price sensitivity process works, it is extremely important to understand the consumer behavior when going through their buying decision process:
- Recognition: the buyer realizes that he or she is somewhere between a “real and preferred state.” Whether by marketing, advertising or peer pressure, they want to buy a product.
- Information seeking: The buyer sets out to find out more information about what they want to buy.
- Deliberation: Using the information gathered, the customer determines what options, alternatives or aspects to consider before proceeding. This is where price sensitivity can develop and where you can lose the customer.
- Purchase: The customer determines what to buy and does so.
- Subsequent purchase: The customer decides if this was what he or she wanted, if it was a good decision, if he or she regrets it, and if it is time to return the product or request a refund.
Factors that affect price sensitivity
For organizations, price sensitivity is a crucial factor in making the best decisions and assigning the ideal prices, so it is essential to understand the consumer’s mindset and behavior.
Here are some of the elements that are considered as determinants by consumers when purchasing a product or service.
- Price and quality: Buyers are less sensitive to price if the product offered is of superior quality or defines their status quo, such as exclusive or luxury products.
- Unique value: Product differentiation and unique features affect consumers’ price sensitivity to it. With unique value products or services, the organization can win over its competitors.
- Bottom line benefit: If the utility of the product is high for the buyer and efficiently meets the purchase objective, then he is less concerned about the price.
- Fairness: Price discrimination can lead to a perception of unfair practice among consumers. In such a situation, a slight increase may cause a negative impact, increasing price sensitivity.
- Expense: If the product requires a huge expenditure or involves high cost, the buyer tends to be price sensitive while making a decision.
- Inventory: If buyers need to keep their products in stock, they become more price conscious.
- Sense of urgency: If there is an immediate need for the product or service, the consumer generally overlooks the price factor. An example of this is the case of emergency medical service.
- Cost-sharing: When the price of a product or service is to be paid by someone else, on behalf of the consumer, they may not be price sensitive.
- Ease of comparison: Consumers are more price sensitive if they can easily compare the various options available in the marketplace.
- Perceived substitutes: If consumers obtain an equivalent substitute for a particular product or service at a lower price, they become highly price sensitive.
- Switching cost: When the cost of switching from one company to another is considerably high, consumers prefer to be less price conscious and stick to a single product or service.
- Brand perception: Loyalty to particular brands can become a significant factor that can increase or decrease price sensitivity.
Methods to measure price sensitivity
The key is to have a deep understanding of your target audience and the people who buy. Each of them will perceive the value of your product differently, which means they will have different price sensitivities.
As a result, you should measure the price sensitivity of each of your market segments independently, so that the data you collect will be representative.
After segmenting your target market, the next step is to choose a methodology that goes beyond simply asking people “How much would you pay for product X”?
Cognitively, it is almost impossible for people to accurately measure their own willingness to pay, which is why researchers have invented techniques to get around this mental block.
- Price ladder method
Price laddering involves asking potential customers about their intention to buy a specific product at a particular price, usually ranked on a scale of 1 to 10. If the respondent’s intention to buy response is below a particular threshold (usually 8), then the price is low, so he or she is asked if he or she intends to buy again.
In theory, this process can continue indefinitely, but respondents are only asked about a maximum of three price points to avoid excessive response bias. Subsequently, a data analysis is performed to determine the percentage of the market that would buy at any given price.
Van Westendorp Method
The Van Westendorp question addresses the problem of measuring price sensitivity by surveying people on their willingness to pay in ranges. Each consumer is asked four questions:
- At what price would you rate the product as “too expensive” that you would not consider buying it?
- At what price would you consider the product to be “too low” priced that you would feel the quality might not be very good?
- At what price would you consider the product to start to be expensive, so that it is not out of the question, but you would have to think a little to buy it?
- At what price would you consider the product to be a bargain, a great buy for the cost?
The first two questions force respondents to anchor to an acceptable price range and the last two questions help narrow down an optimal price range. Once a statistically significant number of people respond, you can plot the responses and determine a more specific optimal price point.
The Van Westendorp question offers a clear efficiency advantage in determining the price sensitivity of relatively new products. It will also provide additional information about the price sensitivity of your product, which speeds up the data collection process.
In QuestionPro you can apply the Van Westendorp question and have the answers plotted in real time so you can better visualize the results.
The price sensitivity meter is also the only method that figures in price points that are cheap to the point where customers begin to question the quality of the product. This makes the results obtained from Van Westendorp much more comprehensive than the results obtained from the price scale.
Gabor-Granger Pricing Technique
Gabor-Granger pricing technique is a convenient and practical pricing research method to work out an acceptable price that respondents can pay for a given product or service.
In this approach, respondents are exposed to a randomly chosen price from the predetermined price list after introducing the product.
The respondent is asked for a willingness to purchase the product or service at the given price. Suppose the respondent is willing to buy the product at that price, then the product is shown again, but this time with a higher price from the predetermined price list.
If the respondent is not willing to get the merchandise at the primary price shown, the merchandise is shown again with a lower cost from the predetermined list. This pattern is iterated multiple times until the highest price point a respondent is willing to pay, is determined.
Key differences between Gabor-Granger modeling & Van Westendorp price sensitivity
The Gabor-Granger is most often used for already existing products. This model gives a directionally correct price estimate for willingness to pay for your product or service.
It provides the revenue optimum price point, demand curve, and price elasticity, which helps researchers price a product right. This method is useful only when you want to look at your brand without considering the competition. This model works with limited predefined price points.
The Van Westendorp is most often used for new product pricing. Use Van Westendorp when you are unsure what price points the market can potentially accept. This model works on a whole spectrum of cost. It will provide users with an acceptable price range.
It will help to understand the respondents’ attitude towards a product or service.
Pro’s & Con’s of the Gabor Granger Pricing Technique
The Gabor-Granger method results in a comparatively low survey effort and is straightforward to create and deploy.
This pricing technique provides information that is crucial about how much a consumer can pay for a product and the perceived value to respondents. Hence, it has become a vital tool in pricing analytics.
One definite drawback that we have seen with the Gabor-Granger technique is that competing products are ignored in the study phase.
This means that if a competitor offers a similar product at a lower price, your research’s price point invalidates your study. The above fallacy renders studies useless as they have no context over market conditions.
To mitigate a negative effect on the pricing study, showing a shelf with competitors’ products and prices allows respondents to have comparable price points.
Studies have shown that Gabor-Granger results are much closer to actuals when competitors’ products and prices are showcased upfront.
The Gabor-Granger method is particularly suitable under the following conditions:
- The organization has an acceptable fixed range of probable prices for the product or service
- The offering is so new that there are no similar products or competitors in the market, and the respondents do not have precedence of a similar design and features in the product
- Example & case study of the Gabor Granger price modeling technique
As seen above, the Gabor Granger pricing method is a required survey research method in pricing and consumer research for price elasticity. An excellent example of the Gabor Granger modeling and a case study of our existing clients is as follows.
How to calculate price sensitivity
Price sensitivity can be measured by dividing the percentage change in quantity demanded by the percentage change in price.
To observe price sensitivity, let us consider that when apple nectar prices in a local factory increase by 60%, juice purchases fall with the figure of 25%.
Using the above formula, we can easily calculate the price sensitivity of apple nectar.
Apple nectar is:
Price sensitivity = -25% / 60% = -0.42.
Therefore, we can conclude that for every percentage by which the price of apple nectar increases; it affects the purchase by almost more than half of the percentage. Likewise, all products can be studied taking into account changes in price and increase or decrease in demand.
Those products are said to be price sensitive where the change in price is not much, but demand is affected on a large scale. This is usually the case with convenience products or products that have a wide range of alternatives.
Products that are not very reactive to price change are called price inelastic. Such products are usually products of daily use and consumers have no choice but to buy them.
Tips for assessing price sensitivity
Retailers use several approaches to assess customers’ level of price sensitivity.
To ensure the success of the process, we have the following tips for you:
- Research relevant data. Use historical data to analyze how similar products were sold in the past. Such research is especially useful when launching a new product.
- Communicate with current customers. Social media or post-sale surveys are a good way to assess how customers rate one product or another.
- Track customer activities. Analyzing visitor behavior and, especially the conversion rate can be particularly effective in terms of assessing price sensitivity. Is there customer satisfaction?
- Read customer reviews and opinions. Exploring people’s opinions about particular products is a useful method to get the first impression of price sensitivity.
- Focus on quality rather than price. Advertising prices can increase price sensitivity. However, if customers receive quality information rather than cost information, price sensitivity is reduced, and quality becomes the primary factor.
- Focus on benefits rather than features. Don’t give your competitor ammunition by turning things into a war of equal features. You can certainly point out the differences but always keep your objectives. Tell customers about the benefits of using your product or service, how it will help them and how it will improve their lives.
- Build your brand. When faced with a multitude of seemingly identical products, people often resort to brand loyalty. In fact, the more products there are (more choices mean a harder decision), the more customers will turn to a brand they know and trust.
Importance of knowing price sensitivity
Knowing your product’s price sensitivity will help you determine how much value you are creating in it by revealing your customers’ willingness to pay.
Without understanding price sensitivity, you have no way of knowing whether your product development efforts are producing increased value, i.e., whether customers are actually interested in the features you are creating.
Regardless of the methodology, keep in mind that there is no magic strategy for determining price sensitivity. The data you collect is based on perceptions of value that can vary dramatically from person to person.
QuestionPro’s Pricing Research Software can help you conduct a price sensitivity test so you can get the data you need to make better marketing decisions for your product or service.