Choosing the right pricing for your products can be the difference between making profits and struggling to survive in a competitive marketplace. And while most businesses focus their growth efforts on customer retention and acquisition, an elaborate pricing change can dramatically increase your revenue with half the effort. However, to find the optimal price point that will balance customer satisfaction, product value, and revenue, you should consider conducting pricing research.
What Is Pricing Research and Why You Should Do It?
Pricing research, also known as market research price analysis, is a market research type used by companies to estimate their customer’s willingness to pay (WTP) for products. It can be used to set a price for a new product or update that of an existing one in accordance with the evolving market requirements.
Pricing research is a quantitative type of research, although, depending on the stage of the study and the methodology, some qualitative data can be accumulated as well.
Depending on the industry and the dynamics of the market, companies should update the prices of existing products regularly and periodically perform market research price analysis to ensure a lucrative value-revenue ratio.
Product pricing is directly related to customer satisfaction and profits. However, without research, companies have no way of knowing how much their customers are actually willing to pay for their products.
For instance, overcharging can cost a company clients who would, otherwise, buy a product at a slightly lower price – decreasing it will convince them to buy and that would boost revenue from sales volume. Undercharging, on the other hand, can be a missed opportunity to generate more profits from existing and potential clients that are willing to pay more. By increasing the price with the right percentage, you will improve revenue without any extra effort, and without losing any customers.
All in all, choosing the wrong price for a product can cost you millions of dollars in losses from unrealized profits. By studying your target market’s specifics, preferences, and solvency, you can make data-driven decisions, minimize the guesswork and grow your business.
Pricing Research Methodology
Different situations call for different research methodologies, and while some approaches are often considered superior to others, each one has its benefits.
However, before you start conducting your study, there is some preliminary work to be done.
Regardless of whether you are updating the prices in your existing catalog or conducting new product pricing research, you should start with updating your data. The market is constantly changing and the information you’ve gathered a year ago may not be applicable today.
1. Gather Preliminary Data
Before you start working with a sample of your market to estimate what is their willingness to pay, you should first consider two other important factors – your production costs and the competition you are up against.
Estimating Production Costs
Your production costs are an important factor when setting a price for your products. These include everything from loans, rents, bills, employee wages to materials, storage space, and so on. All in all, you should calculate how much it costs you to make the product, compared to if you were not making it at all.
If customers are not willing to pay enough to cover your expenses and deliver profits, your business will be operating at a loss.
However, basing prices only on production value plus a margin (a.k.a. value-based pricing) is not considered a good approach, although many companies are settling for it in order to save themselves the trouble of conducting market research.
Opting for value-based pricing without taking additional factors into account can actually cost you a lot of revenue and missed opportunities to capitalize on your target markets’ specifics. People may be willing to pay more, but you’ll never know if you don’t ask. Or your product’s manufacturing can be too expensive to be cost-effective and you may lose a lot of money before you discover this empirically.
Estimating production costs before you conduct pricing research and adding the profits you expect to earn, will give you a minimal price benchmark to refer to. And conducting pricing research will let you know how realistic this is.
Research the Competition
No product exists in isolation on the market and knowing what your competitors are offering will give you a better perspective on how to set your own pricing and how to position your product in the marketplace.
Consider researching the quality of other similar products your audience has access to, studying their features, and making note of how much companies are charging for them. By comparing your products to others, you’ll have a benchmark when deciding what price and what pricing strategy to choose.
For example, if your product is of better quality and has advanced features, you can go for a premium pricing strategy and market it as a high-end alternative. This will call for setting a higher price than the average knowing your customers will, supposedly, be willing to pay for the better quality they’ll be receiving.
However, whether they are, indeed, willing to pay it, you’ll only find out when you conduct the proper pricing research.
2. Identify the Right Sample
Depending on the goals of the research, the participants in the sample should be familiar with the product or similar products to at least some extent. If you have a completely new innovative solution, you should focus on subjects who may potentially benefit from the product and start with probing how they feel about the idea.
Also, you should first perform customer segmentation to identify a sample who would be interested in actually buying the product in the first place. People can easily contemplate a product price even if they have no intention of purchasing it at some point in the future. To make your study relevant, your sample should consist of people who need the product and would indeed buy it at the right price. Otherwise, the theoretical self-reported behavior will not match reality and your study would’ve wasted time on the wrong audience.
Gathering this information in advance will allow you to build precise customer profiles for the sample, and achieve reliable results.
3. Choose a Pricing Research Method
As mentioned, different situations call for different research methods. However, no single approach can deliver a full picture of your market’s willingness to pay without leaving important factors out. To achieve optimal results, you should analyze your particular case and mix and match research methods at different stages of your study.
Generally speaking, there are three ways to approach pricing research – direct elicitation, indirect elicitation, and conjoint analysis. Each has its pros and cons and can be appropriate or not depending on the objectives and the stage of the study.
With direct methods, the researcher describes a product, and the participants have to come up with a price they’d spend on it. Indirect methods suggest a product and a price and the person responding has to judge whether they are willing to pay that amount. Conjoint analysis adds up other factors to the equation to further clarify the decision.
The most common direct elicitation method is the Van Westendorp Price Sensitivity Meter. It is most useful at the initial stages of the research, especially when you are developing a new product and are yet uncertain of the exact features it will have.
The pricing research methodology is simple and straightforward. The participants in the sample are all asked the same four open-ended questions:
- At what price the product will be too expensive for you to consider buying it?
- At what price the product will be too cheap for you to consider buying it?
- At what price the product will start to become too expensive, but you would still consider buying it?
- At what price the product will seem like a good bargain and you will feel you are getting a good deal for your money?
The intersections of the price curves formed by the answers to the four questions will give you the price range for your product.
By using this approach, you can obtain an overall idea of what customers may be willing to pay for a product like yours, and by defining a pricing range you can narrow this down with further research.
The cons of the Van Westendorp technique are that it analyzes the product in isolation without comparing it to other brands. Also, it doesn’t take into account actual buying intent, as it doesn’t ask whether the person would, indeed, buy such a product, only what price they would hypothetically pay for it. Hence, the focus is only on the price, not the product itself.
The Gabor-Granger technique is often referred to as the most simple and effective indirect method. It is a type of sequential monadic research designed to determine the price elasticity of products. In other words, it can help companies identify how lowering or raising the price would affect sales volume and revenue.
The pricing research methodology is straightforward. The researcher asks the participant how likely they are to buy the product at a certain price. If the answer is negative, the person is asked the same question but the price is lower. On the other hand, if the respondent feels positive about the amount from the initial question, they are offered a higher price and asked again.
This approach allows companies to estimate a demand – revenue per customer ratio and find the optimal price for the product.
The elasticity of demand can be calculated using the following formula:
When the result is above 1, you have a high elasticity. This means that if you lower the prices, the increase in sales volume will be substantial enough to deliver higher revenue than that you would have had at the higher price.
Results below 1 indicate lower product elasticity. In this case, increasing the price will reduce the sales volume, but the profits will exceed those of the lower price.
The Gabor-Granger is a very good pricing research approach and the only notable con is that it doesn’t take into account the competition.
A different monadic approach is to perform a similar methodology but with two different sample cells that are offered different prices. This technique allows you to A/B test your price range, and receive more unbiased results. Each of the two groups sees only one price and is thus uninfluenced by previous suggestions.
Mondanic research provides an even better pricing precision but is more time-consuming and requires a larger group of participants.
The most popular type of conjoint analysis is Discrete Choice. It aims to simulate a real-life purchasing experience where the customer is faced with a number of choices.
The participants are offered a list of similar products by different brands and at different price points and other varying attributes. The person has to choose one of the products or can state that they would buy none of them.
Conjoint analysis is considered to be the most precise pricing research methodology because it takes into account many different factors including competitor brands that the product will be up against on the marketplace. It also evaluates what is most important for the customer – the brand, the price, the quality, or the features. By removing the focus from the price, researchers can obtain a better overall view of the value-revenue ratio of the product and how it affects customer satisfaction.
What can potentially compromise the results is offering “easy” choices. For example, everyone will most likely choose a cheap product of high quality before an expensive unreliable one. However, the most significant disadvantage of the discrete choice method is that it is complex and time-consuming to organize.
Regardless of which method you choose for your market research price analysis, you should consider doing real-life A/B testing to compare self-reported with real-life behavior and further refine how much you charge your customers.
Conducting a pricing research study will give you valuable information on how much people are willing to pay for your products and other important market insights. Leveraging the data you gather, you can balance customer satisfaction, sales volume, and revenue, and accelerate your business growth.