Understanding pricing sensitivity is critical for organizations aiming to optimize their pricing strategies and maximize profitability. 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 allowing them to be competitive and increase their revenues.
But what is pricing sensitivity, why is it important, and how to calculate it? Let’s find out!
What is Pricing Sensitivity?
Pricing 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.
Price sensitivity varies from one consumer to the next; for example, although some consumers are willing to pay more when the price of a product rises, others are not.
The consumer decision-making process
Before understanding how the price sensitivity process works, it is essential to understand consumer behavior when going through their buying decision process:
- Recognition: The buyer realizes that they are 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 they wanted, if it was a good decision, if they regret it, and if it is time to return the product or request a refund.
Factors that affect pricing sensitivity
For organizations, pricing 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.
The following factors affect price sensitivity that are considered 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.
Product differentiation and unique features affect consumers’ price sensitivity to it. The organization can win over its competitors with unique value products or services.
Bottom line benefit
If the product’s utility is high for the buyer and efficiently meets the purchase objective, then he is less concerned about the price.
Price discrimination can lead to a perception of unfair practices among consumers. In such a situation, a slight increase may cause a negative impact, increasing price sensitivity.
If the product requires a huge expenditure or involves a high cost, the buyer tends to be price sensitive while making a decision.
If buyers need to keep their products in stock, they become more price-conscious.
Sense of urgency
The consumer generally overlooks the price factor if there is an immediate need for the product or service. An example of this is the case of emergency medical services.
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 tend to be more price sensitive if they can easily compare the various options available in the marketplace.
If consumers obtain an equivalent substitute for a particular product or service at a lower price, they become highly price sensitive.
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 loyalty in particular brands can become a significant factor that can increase or decrease price sensitivity.
Methods to measure pricing sensitivity
The key is to deeply understand 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 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 willingness to pay, so researchers have invented techniques to get around this mental block.
01. 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 a response is below a particular threshold (usually 8), then the price is low, so they are asked if they intend to buy again.
This process can theoretically continue indefinitely, but respondents are only asked about a maximum of three different price points to avoid excessive response bias. Subsequently, data analysis is performed to determine the percentage of the market that would buy at any given price.
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02. 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 your product’s price sensitivity, which speeds up the data collection process.
Hundreds of brands have benefited from the Van Westendorp Price Sensitivity Meter throughout the years. It can assist you in finding out price sensitivity by displaying what various segments of your target audience are willing to pay for your products.
In QuestionPro, you can apply the Van Westendorp price sensitivity question and plot the answers in real-time to better visualize the results.
The price sensitivity meter is also the only method that figures in cheap price points 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.
03. Gabor-Granger Pricing Technique
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 unwilling to get the merchandise at the primary price shown, the merchandise is shown again at 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.
Differences between Gabor-Granger modeling & Van Westendorp pricing sensitivity
The Gabor-Granger is the most often used price sensitivity model 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 the most often used price sensitivity model 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 costs. It will provide users with an acceptable price range.
It will help to understand the respondents’ attitudes towards a product or service.
Pros & Cons 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.
How to measure price sensitivity?
Price sensitivity can be measured by dividing the percentage change in quantity demanded by the percentage change in price. Here is the formula to calculate price sensitivity.
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.
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 considering price changes and increase or decrease in demand.
Those products are considered price sensitive where the price modification 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 most 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 buying 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 useful for getting the first impression of price sensitivity.
- Focus on quality rather than price: Advertising prices can increase pricing sensitivity. It can cause high price sensitivity. However, if customers receive quality information rather than cost information, it can reduce price sensitivity, 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 the price sensitivity of your products will help you determine how much value you create by revealing your customers’ willingness to pay.
Without understanding price sensitivity, you cannot know whether your product development efforts produce increased value, i.e., whether customers are interested in the features you create.
Regardless of the methodology, remember 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.
Businesses must understand price sensitivity to make informed pricing decisions and maximize sales and profit. It helps product creation, market segmentation, targeting, pricing, and customer-friendly promotions. Price sensitivity knowledge also helps organizations convey prices and justify their value proposition.
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.