Your customer’s price sensitivity is the degree to which price determines his or her inclination to buy your product or service. Typically, price sensitivity is measured by price elasticity of demand, i.e. how does a % change in price affect the quantity demanded by your customers.
If the demand for your product or service is highly inelastic -- that is, your customers are not very price sensitive -- then you’ve got a good business as it leaves you with the power to increase prices without a substantial decline in demand.
Price sensitivity is very much determined by the product or service you’re selling and the industry you’re in: the price elasticity for milk is naturally higher than it is for consumer electronics. But you can, to some extent, influence your customers’ price sensitivity yourself: therefore, we look at some of the factors that determine price sensitivity, and how you can use these in your favour.
#1: Reference Price
Consumers compare products. All. The. Time. Even the simplest purchases are most likely preceded by a subconscious evaluation of the alternatives out there, and the cost of this alternative. Here, we talk about the reference price, i.e. what is the price/value combination that the consumer uses to benchmark the purchase.
In theory, all prices are reference prices as they make up the general price level benchmark, and as such, the price of an iPhone can act as a reference price for Chinese takeout. However, often there is just a handful that is significant to the consumer, and the bigger the difference between the price of your product and the reference price in the customer’s mind, the higher the price sensitivity. It’s quite obvious, we know: if a product is very expensive compared to the rest, people will stop buying it. But it’s a very important thing to remember, as you can do something to influence this reference price yourself!
This is called price anchoring: often, the reference price for your product is another one of your products! We like to use smartphones as example; when Apple launches an iPhone 7, the most obvious reference price is the price of an iPhone 6, which Apple can set themselves: by setting the iPhone 6 price quite high, they make the difference between the iPhone 7 price and the reference price smaller. Consequently, the price sensitivity is reduced.
#2: Ease of Comparison
All products are substitutes to each other, but some are more obvious than others. How obvious, depends on the ease of comparison. The easier it is to compare your product to alternatives, the higher the price sensitivity will be. Products with a strong brand, for instance, are very hard to compare. How does a Coca-Cola really differ from a Pepsi? Can you tell us why you prefer one over the other? Brands are so unique that it would take a complex, holistic analysis to determine how they differ.
Products with weak brands, on the other hand, which primarily sell their features/attributes are VERY easy to compare. If you go to the supermarket to buy potatoes, how do you decide which brand to buy? If they’re all similarly priced, you take a quick glance and look at which ones look more appetizing. If prices differ, the price will play a very important part in determining your purchase decision.
Lesson: Make sure to differentiate your product, so there are no direct alternatives. This includes branding efforts, but also your pricing. Studies have found that similar products priced similarly reduces the buyer’s inclination to make a purchase at all, as the choice difficulty increases the cognitive load on the customer.
#3: Switching Cost
In some cases, the switching cost is explicit: for example, it is common for SaaS-companies to charge an “onboarding fee” to set you up with their software, and so it follows that switching from your current provider will result in you having to incur this onboarding fee again.
In other cases, it is less obvious and may not be a monetary switching cost, but more so the risk associated with switching. If you switch cereal brands, for instance, the switching cost may be the risk that your kids will make a fuss about it next morning.
There are several ways you can make the ‘switching cost’ higher for your product. For example, marketing automation software vendors or social media management platforms typically offer calendar-functions that teams can use to plan out their activities, creating yet another switching cost. If you switch software, you need to set up your calendar from scratch.
Several studies have found that consumers’ fairness perception has substantial influence on their price sensitivity. Unfairness typically arises from various price discrimination practices, or discrimination in general, which is not necessarily a bad thing as such practices make a key component in profit maximization. However, when unfairness perceptions are created a small price increase can be the straw that breaks the camel’s bag.
Therefore, mitigating such unfairness perceptions can be of key importance. In fact, we have written an entire article about just this: read it here
Summary: Price Sensitivity is a Complex Construct
These are just a few of the factors that influence price sensitivity and price elasticity of demand. There are several others, such as how the price compares to the size of the customer’s budget, however, we have selected the ones above as you can do something about those yourself.