A company’s pricing strategy is influenced by a variety of factors related to demand, cost and profit, competition, and the legal environment. Demand factors consist of the size of the market and its growth or decline, and the regularity/irregularity and elasticity of demand, while variable and fixed costs and margin per unit are examples of cost and profit factors.
Some competitive factors include market positioning, price sensitivity, and product differentiation. Federal laws, such as Sherman Antitrust, FTC, Clayton Act, and Robinson-Patman Act, as well as State laws, play a role in the legal environment. If you are tasked with developing and executing a pricing strategy, you’ll probably need to conduct some form of pricing research.
However, before putting together a research plan, it’s important to understand that consumers often possess imperfect knowledge related to product pricing and that they assess pricing differently. Thankfully, there are several structured options for measuring pricing sensitivity to overcome these issues.
Pricing is Not Assessed Equally
It’s not surprising that consumers approach pricing in different ways. What is considered a “deal” to some may be “overpriced” to others, and the psychological aspects of pricing are just as important – and may be more important to some individuals – as the economic aspects. Consumers have threshold price levels, above and below which they are not willing to consider making a purchase, and these can vary by person.
“Price” itself can also have different meanings – when shopping for a car, are consumers focusing on the total price of the vehicle (likely several thousand dollars), the immediate price (i.e., the down payment), or the monthly payments (which may be a few hundred dollars)? Keep in mind that not all consumers look for quantitative differences to explain and justify differences in pricing.
Effects of Reference Prices
Consumers often consider more than just the immediate price of the product; they are also motivated by the perceived difference between what they pay and what they think the product is worth. This is known as the reference price. For products purchased frequently, reference prices will be close to actual prices. Products purchased infrequently, on the other hand, may result in a level of “sticker shock”, so effectively managing consumers’ reference prices can help improve your pricing strategy. Reference prices are influenced by current prices consumers have observed, past prices they’ve observed, and the purchase context.
Current price references include other prices in the product line. If a premium product was added, this can raise the consumers’ reference price, and, as a result, increase the sale of lower-end products that now may be perceived as bargains. Conversely, it can result in decreasing the sale of lower-end products because products that are mid-range priced look more attractive now.
Retailer suggested prices can also impact the current reference price as consumers compare a sale price to a previously higher price (originally $100, now $75) or to a competitive price (our price $55, their price $70). The order in which current prices are observed also impact consumers’ decision making as they often give greater weight to the first prices they see (top-down selling: retail layouts and shelf placement).
Past prices consumers have observed can have a variety of effects on the purchase decision. For example, low introductory prices used in a penetration strategy will establish a low reference price, and this can negatively affect repeat sales if the price is raised later. Sale prices significantly reduce the reference price, even if combined with regular or MSRP pricing information.
Also, the last price consumers paid has a strong influence on referencing pricing. The goal should be to establish regular price levels to set the reference prices and use pricing tactics such as coupons and rebates to motivate the sale.
It’s important to note that the purchase context can be changed to make a price seem fair and reasonable.
Measuring Price Sensitivity
Your specific product pricing will fall somewhere in the range between the minimum acceptable price and the consumers’ willingness to pay, so it is essential to understand what consumers think a product is worth.
However, directly asking them often results in unhelpful data; you may see “bargaining behavior” where respondents indicate a lower price than what they would actually pay, or respondents may be prompted to please the researcher and state a higher price than they’d actually pay. Alternatively, asking respondents if they would purchase the product at a specific price may result in more useful data.
Unstructured, qualitative research like focus groups and in-depth interviews are typically not the best methods for determining a price. Consider employing quantitative structured methods that assess actual purchases (behavior) and preferences/intentions (attitudes). To measure purchase behavior, you can examine aggregate sales data, store audit data, or consumer panel data.
You can also conduct controlled experiments in-store or in a laboratory. To collect attitudinal data, you can field buy-response surveys, or utilize Van Westendorp’s price sensitivity meter. AYTM also offers a Price Optimization Model known as VanKonan. It can handle a wide range of business models, and you simply need an understanding of your business objectives and market realities to begin (total addressable market, estimated retail price, and cost of goods).
Your data output consists of a sophisticated prediction of acceptable price ranges and optimal price points for maximizing revenue, profit, and frequency of sales. VanKonan also measures the probability and frequency of purchase at each of the key price points.
Additional quantitative pricing research methods include simulated purchase surveys (where you test concepts at various price points), brand/price tradeoff analysis, conjoint and conjoint/value analysis, and discrete choice models/choice-based conjoint analysis.
Pricing strategies are a key component of a company’s overall business strategy. Before conducting research, keep in mind that consumers perceive price differently. A clear understanding and management of consumers’ reference prices will help strengthen your overall pricing strategy. There are a variety of quantitative methods available for measuring price sensitivity and assessing actual purchase behavior and consumer preferences and intentions.