Customer Willingness to Pay: Implications for Your Business
For companies to pursue a pricing strategy that is tailored to their marketing environment, maximizes profitability and minimizes the risk of leaving money on the table, knowledge of customers’ willingness-to-pay (or WTP) is crucial. Despite significant advancement in pricing research that now allows you to measure the customer’s willingness-to-pay with great accuracy, researchers have found that as little as 8% of companies use this best-practice approach when developing their pricing strategy.
Breaking down willingness-to-pay
When consumers go shopping for a product or service, they look at two things; the attributes of the product or service and the price. The consumer then looks for the optimal combination of the two that offers the most value for money, and you want to make sure you know what price makes your product part of such optimal combination for the customer, without leaving money on the table and losing out on profits.
Product (or service) attributes
Imagine going shopping for a new computer. When deciding what computer to buy, you may look at two different computers and compare their specifications to their respective prices:
If you really care about RAM, you might be willing to pay 10% more for Computer 1, 20% or even 50%? That will depend on how much you value the extra RAM in Computer 1. On the contrary, if your tech-savvy friend told you that these days it’s essential to get an i7 processor, then you may be willing to pay more for Computer 2.
Or, perhaps the most common example - if you’re set on getting a MacBook, you’re willing to pay 100% or even 200% more where the only difference in computer attributes is the brand - and thus you disqualify both Computer 1 and Computer 2.
Product (or service) price
Let’s assume you prefer Computer 1, but you haven’t looked at the price tag yet. Recall from above that the consumer will look for an optimal combination of product attributes and price; what price can be on the price tag and still leave Computer 1 as the optimal choice for you - that is, the choice that offers the best value for money?
This price is commonly referred to as a customer’s willingness-to-pay.
Denotes the highest price that can be on the above-mentioned price tag, without you find it too expensive and decide to buy a different computer (i.e. computer 2).
Denotes the minimum price that can be on that price tag, before you find the computer too cheap and start suspecting the quality of the computer, and look for alternatives.
Determinants of willingness-to-pay
There are a variety of factors that influence a customer’s willingness-to-pay, and this complexity is why many managers choose to rely on the far easier, but essentially useless, “intuitive” pricing strategies such as cost-plus, market price or guesses and gut-feel.
Value and needs of the buyer (own-value)
One of the primary determinants of willingness-to-pay is the value the buyer derives from the product or service, also referred to as own-value. This includes the usefulness of the attributes and how often the buyer expects to use the product, but also the buyer’s budget as the value derived from a product or service is relative to the buyer’s purchase power.
Is the price fair compared to what the buyer perceives to be typical market prices?
The buyer also factors in how much she thinks others would be willing to pay for the product or service, and generally how attractive she thinks other people would find the product or service. This especially applies if the buyer plans on selling the product in the future (i.e. in 5 years) - and thus stop deriving own-value from it - as the buyer wants to make sure that the price she pays is less than or equal to the own-value she derives from it in the next 5 years, plus the price she receives from the eventual sale.
Many buyers face value uncertainty when making a purchase. It could be a family father who buys a car, but isn’t sure if he will sell it in the future or if his daughter will decide to get a driver’s license. Or a senior couple who buy a holiday home in Italy, but don’t know how often their children will be using it (that is, how much value their children will derive from it), and if they will ever get those grandchildren they have been asking for, so they can take their first steps on the front porch.
Such uncertainty is impossible to predict as personal motives change from customer to customer, as does the impact of the uncertainty on the buyer’s willingness-to-pay. Thus, data-backed pricing research is essential for capturing it and including it when setting your price.
Do you want to be among the top 8% ?
The majority of managers find an effective pricing strategy to be a cornerstone of a business; yet only very few take out proper data-backed, scientific pricing research for measuring the willingness-to-pay of their customers. Those who do, however, end up sometimes doubling their profits. Is that going to be you?
See how PriceBeam can help you measure the willingness-to-pay of your customers.