What’s the best price for a new product you’re launching? Are sales slumping and could a drastic price drop reduce interest? These might seem like difficult questions to answer, but they can be easier to answer if you know your customers’ price sensitivity.
Price sensitivity is defined as how much the price of a product impacts the customer’s demand or willingness to buy. It describes the degree of importance that buyers place on price—relative to other product dimensions or purchasing criteria. This includes the quality of the product, or the brand name under which it is sold. High consumer price sensitivity means that there is a strong relationship between the price and customer demand. When the price increases substantially, sales will fall. In contrast, if the item price is too low, sales may remain largely unaffected by a change in price.
Typically, the concept of price elasticity of demand is used to measure price sensitivity. Price elasticity describes the responsiveness of demand changes in price levels. A product is price elastic if even minor fluctuations in price are associated with changes in demand. When the demand for a product does not alter, or alters very little in response to price changes, the product is price considered inelastic. If your customers exhibit low sensitivity to your prices and demand for your product is inelastic, you’re in a strong position. You would be able to increase prices without expecting sales to fall.
Finding the optimal price for your product is a complex and challenging process. Many companies use one of two common pricing strategies—cost-plus pricing or competitive pricing.
Cost-plus pricing means calculating your cost base and simply adding a percentage mark-up. This is typically used to reach a target revenue or profit level.
Competitive pricing, or market-led pricing, involves setting prices based on competitors’ pricing strategies. This rests on the assumption that competitors already know the best price for the product.
Both of these strategies have flaws, however. The most significant limitation is the failure to take into account the willingness of buyers to pay the price that is determined. Even if prices are competitive compared to those of rivals, or mark-up is low, customers might still be unwilling to purchase the product. Alternatively, customers might buy the product, but not in a way that could optimize sales. Using a pricing strategy that does not take into consideration your key stakeholder—your customers—means you’re overlooking a key opportunity to use data-driven, real-life evidence to set the best possible price for your product.
Many retailers face situations where in-demand, appealing products are simply not selling.
A commonly held assumption that lower prices are always better if you want to drive sales could tempt you to slash your prices. In fact, this might not always be the best approach. For a range of different reasons which we discuss below, some consumers are not price sensitive. Others are, but in unexpected ways. For example, we know that for some specific goods, consumers subconsciously hold an acceptable price range which has both lower and upper limits. Based on buyer suspicions that a deal can be “too good to be true” or that if “you buy cheap, you buy twice” many consumers have a lowest acceptable price. Once the price falls beyond that limit, their willingness to buy will also fall.
Without knowing your customers’ price sensitivity, you could inadvertently drop your prices below this threshold and see sales tumble.
Conversely, measuring price sensitivity can help you to understand your customers’ upper price limit or ceiling price. This is the price above which customers believe the product represents poor value for money. Knowing these upper price limits essentially gives you flexibility to control your prices within a range that is acceptable to your market.
In short, knowing whether and how the highest and lowest price influences the behavior of your customers helps you come up with a good pricing strategy. In turn, this can boost your profits.
Online surveys are a very effective way to capture the data that you need to measure this concept. Using SurveyMonkey Audience, you can access a highly targeted, representative panel of consumers to gather rich data such as reference, preferred, and acceptable price ranges, purchasing habits and willingness to buy—data that can be turned into actionable insight. Since SurveyMonkey Audience already knows exactly who is taking the survey, you can ensure that you’re reaching the right market for your product. And, using SurveyMonkey’s price sensitivity tools, you can easily compare and contrast how different price points translate into different purchasing intentions—helping to ensure that you set the optimal price for your product.
A variety of different types of data can be gathered to estimate price sensitivity:
Once you’ve collected your data, it’s time to perform price sensitivity analysis. Let’s take a look at two of the most popular approaches: price laddering and the price sensitivity meter.
Price laddering involves asking customers about their willingness to buy a product at different price points. You can do this by building a survey that presents customers with different prices and then asks them to indicate the extent to which they're willing to pay on a 1 to 10 attribution scale. This data can be very effective in helping you set an optimal price. One common strategy is to set a target interest score (such as 7 out of 10) and continue to decrease prices until customers’ willingness to pay reaches this score.
Developed in the 1970s by Dutch economist, Peter van Westendrop, the price sensitivity meter is a very popular approach to price sensitivity analysis. It’s a standard approach to surveying that asks customers four questions about the price levels at which they perceive a product to be too expensive, expensive/on the high side, cheap/good value, or too cheap:
This data measures the range of price points that customers find acceptable, as well as the change in willingness to buy if the price changes. This insight can be especially useful if you’re planning a price change in the future, or if you simply want to know how your customers perceive your product in terms of price and value. If you’re ready to dive deeper, make sure to read our comprehensive guide to Van Westendorp's Price Sensitivity Meter.
Get a feel for what price sensitivity surveys look like. See the Price Sensitivity sample survey template below.
The standard formula is:
Price Sensitivity = % Change in Quantity Purchased / % Change in Price
For example, imagine that you observe that when prices for your yoga classes increased by 25%, attendance at class fell by 15%. Using the standard formula, you can calculate the price sensitivity of your clients to your yoga classes:
Price Sensitivity = -15/25% = -0.6
This can be interpreted as follows: for every percentage point with which your price increases, purchases of yoga classes fall by more than half a percentage point. With this information, you could set an optimal price to help make sure your classes are always full and your sales goals are met.
We know that some, but not all customers are sensitive to the price of some goods. It turns out that there are multiple influences including the type of product, reference prices, product uniqueness, brand perceptions, ease of switching and customer traits and attitudes.
Consumer price sensitivity varies depending on the category of product. Goods which are widely available, or mass marketed tend to have higher price sensitivity because customers can easily switch to an alternative. For example, in busy cities, a gas station that raises the price of fuel, even by a few cents, is likely to lose customers who can easily buy gas elsewhere. Buyers also weigh up the prospective benefits of buying a product against the sacrifice they make in acquiring it. Customers are more likely to be price insensitive towards products that are seen as having a range of benefits for them such as functional benefits, social benefits and emotional benefits. These factors sometimes outweigh the price.
Another influence is when a buyer has a predetermined expectation of the price for a particular good. This is known as the reference price. Reference prices are determined by consumers’ price knowledge, which in turn is based on previous experiences of buying your product and those of your competitors. That price point is stored in their memory and used as a baseline or benchmark for comparison when making future purchasing decisions. When products are very similar, customers tend to be more vulnerable to price sensitivity because they're able to perform quick comparisons. In other words, the bigger the difference between the price of your product and the customers’ reference price, the higher the price sensitivity, and the less likely the customer will buy your product. However, when customers find a product that falls significantly below their reference price, they see this as a gain, and are more likely to buy.
That said, a minor gap between the reference price and the advertised price—known as the zone of indifference—is unlikely to affect consumer behavior at all. In addition, some research has found that many consumers regularly buy convenience goods like groceries without ever bothering to check the prices, indicating that they do not have a reference price at all for goods like these.
Some products are so unique that they do not seem to have a ceiling price, and customers will continue to buy them, however high the price rises. Take the Bentley car, for instance. It may seem paradoxical, but as the price of a Bentley has increased, so has demand for it. In fact, if the price falls, a Bentley is perceived to be less desirable among its key market—consumers with high income and who tend to buy luxury items—and demand may also fall.
Price sensitivity is hugely influenced by the ease with which buyers can switch to competing goods. Goods that have no close substitutes tend to be less price sensitive than other goods. For example, there are no close substitutes for salt, so the demand for this table staple likely changes very little with price variances. People who are addicted to goods like coffee or tobacco will also find it difficult to switch to an alternative, and therefore will continue to buy those goods at similar levels in spite of a price rise. Strong brands also have very few direct competitors because they're so unique. A customer that is loyal to Coca-Cola is unlikely to switch to a Pepsi, making them relatively insensitive to Coca-Cola’s price changes.
Measuring brand perception is helpful for doing research on price sensitivity. Over time, the price buyers pay for your product or service could be affecting how your brand is perceived. Utilizing Brand Tracking Solutions can help identify your brand perception.
Loyal customers are also price sensitive. A supermarket, for instance, is often able to increase sales of certain goods to its regular shoppers through price-driven promotional techniques such as “buy one, get one free” deals, or through offering loyalty cards that allow customers to obtain a discount at a later date.
Some consumers are loyal to particular brands, and that loyalty can impact the degree to which consumers are price sensitive. Interestingly, there are competing theories surrounding this. According to conventional wisdom, loyal customers are price insensitive because they're already willing to buy the brand again and again. However, non-loyal customers—those who switch regularly between brands—are price sensitive because they could be tempted to buy the product at the right price. When a dentist offers new customers a 20% discount for their first cleaning, or a credit card company offers huge sign-up bonuses for new applicants, they're basing these price strategies on the assumption that non-loyal customers can be recruited through appealing price points, but that there is no need to try to tempt loyal customers with similar strategies.
Each consumer has their own intrinsic price sensitivity which influences their reactions to price changes. Essentially, there are known consumer characteristics which influence the extent to which customers are price sensitive. One of these traits is consumer willingness to buy innovative products. Innovators are people who are willing to buy brand new, untested products. Their role in supporting product launch and success is vital because not only are they’ll to buy first, but they provide firms with feedback on the new product, are ready to champion the product, and to influence later buyers through positive word of mouth.
Importantly, innovators are less price sensitive than other types of buyers. According to recent research, it's been noted that less than 3% of consumers are “innovators,” but more so loyalists. This makes it crucial to know who they are, so you can target them appropriately through optimal pricing and promotional campaigns. Another consideration is what marketers call deal proneness. Certain customer segments are more inclined than others to make purchases if offered a deal.
With this comprehensive guide, you’re ready to start on your journey to measuring price sensitivity. Start your trek with SurveyMonkey Audience and find out how consumers react to your pricing strategy.
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