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Understanding how much customers are willing to pay for your product is crucial for setting the right price. Let's explore some key techniques to effectively gauge willingness to pay (WTP). We'll start with three practical methods from Madhavan Ramanujam, followed by scientifically rigorous approaches. While none of these methods can answer the pricing question with absolute certainty, they will help you move closer to the most competitive price over time.
Expert pricing consultant, Madhavan Ramanujam emphasizes that straightforward questions to customer asking "what would you pay for this?" can be very unreliable since most people are price takers. He provides three methods companies can use to improve their pricing without trial and error.
Compare your product to a known benchmark (e.g., Salesforce). People don't know what a product is worth absolutely, they can only estimate relatively. By using a competitor as a benchmark, we can get a sense of how our product might be priced relative to a competitor.
"Let's pretend that [competitor] is $100 per month. How would you price our product, would it be higher or lower, and by how much?".
We can then compare this against the known competitors price to guide our pricing strategy.
This method has two parts. First conduct a full sales pitch, fully showing the benefits of your product with necessary evidence, then ask three questions:
The acceptable price is the price the customer will consider a bargain.\
The 'prohibitively expensive' price is the upper ceiling for the customer. It is the price where the customer does not think the product is worth it.
The expensive price, through numerous trials, tends to be closer to what customers are willing to pay.
Another effective technique is to gauge purchase probability at different price points. Just like example two, the researcher presents the product with all benefits and features clearly presented. The researcher then sets the price and asks the customer how likely they are to purchase the product. The customer answers on a scale from 1 to 5 (less likely to highly likely). Repeat studies have shown that:
Conduct multiple tests with different customer types and adjust the price presented to them. This helps clarify the optimal pricing levels for each customer segment.
The following methods are methods used by economists and professional researchers to determine a customers willingness-to-pay. While they're more verifiable than the above methods, they are much more difficult to implement and will require the recruitment of subjects for the studies.
The Van Westendorp Price Sensitivity Meter is a popular technique that involves asking four open-ended questions:
While this method is simple and intuitive, it can suffer from hypothetical bias, where people might state higher valuations than what they would actually pay in real situations.
The BDM method tries to address the hypothetical bias by creating a more realistic scenario. Here, respondents state their maximum WTP, and if this price is higher than a randomly generated price, they buy the product at the lower price. This approach discourages overestimation and ensures more genuine responses. However, it can be complex and assumes respondents have a pre-determined price in mind, which isn’t always the case.
The MPL method builds on BDM but acknowledges that people might not have a specific WTP in mind. It presents a series of price options, asking respondents to choose between the product and a sum of money for each option. A random choice is then selected, which the respondent must follow through on. While this method is widely used in economics, it might underestimate WTP by emphasizing opportunity costs.
CBP presents multiple product options with different features and prices, asking respondents to choose which one they’d buy. This method reflects real-world decision-making by showing trade-offs and preferences, providing a more nuanced understanding of WTP.
Understanding customer WTP is both an art and a science. Using these techniques can provide a more accurate picture of how much your customers are willing to pay, helping you set a price that maximizes both sales and customer satisfaction.
