Price sensitivity: What it is and how to calculate it
Price sensitivity analysis measures customers’ feelings when price changes on a product. Discover ways to overcome the price sensitivity of your customers.
Whether you’re an established company or a fledgling startup, deciding how much to charge for your product can be a daunting task.
Where is the sweet spot between maximizing your profit and holding customer interest? Will a price change affect how customers perceive your brand.
From my experience, price sensitivity becomes an important topic when companies launch a new product or adjust prices on an existing product.
Price sensitivity is how the price of a product or service affects a consumers’ intentions to buy it. In simplified terms, it helps you understand when you raise prices if your customers hesitate to buy it.
Companies will weigh how sensitive customers are to their business goals before making a big decision. Companies need to consider if customers view their product as affordable, cheap, or premium; if they’re trying to break into a new market, focus on maximizing profits. Each variable, combined with knowing how sensitive your customers are to price, will determine where to price your product.
Understanding your customers' price sensitivity allows you to set the optimal price point for your product. Overcharging for a product will lead to lackluster sales and stagnating revenue. On the flip side, pricing your product too low may create a perception that the product is cheap, and you’ll be leaving money on the table.
When you understand your target market’s price sensitivity, you can create a pricing strategy that allows you to confidently enter new markets, adjust pricing to maximize profits, and develop and test new value-based messaging. By learning to maximize these levers, you can optimize the retention of current customers and attract new customers.
Price sensitivity is measured by dividing the percentage of change in quantity by the percentage change in price.
Price Sensitivity = (% change in quantity / % change in price)
For example, if you sell dog food and increase the price by 50% and sales drop by 12%. Using this formula, we can calculate the price sensitivity of the dog food.
Price Sensitivity = (-12% / 50%) = -0.24
The higher the number, the more sensitive people are to price increases. In this scenario, for every percent the price increases, it will impact the amount purchased by almost a quarter of a percent.
Price sensitivity can be affected by several different factors. The first step towards addressing price sensitivity is understanding each of those factors and how they interact.
The most significant price sensitivity factor is likely what type of product or service you are selling. In economics, certain kinds of goods have a high elasticity of demand (high sensitivity to price changes) and others that have a low elasticity of demand (low sensitivity to price changes). This elasticity helps us know how much control you have over influencing the price sensitivity of your particular product.
High elasticity items include clothing, electronics, or luxury items. On the other hand, low elasticity items include medications, food, or electricity.
The “anchor price” is the first price that a potential customer comes in contact with. This price will be the price they keep coming back to as they evaluate your product compared to your competitors. If your prices are 2X, 3X, or 5X the price of your competitors, then you better have some excellent reasons for why your product is worth the additional price.
How specialized is your product on the market? Are you offering something widely available or easily reproduced? The scarcity of a product allows for aggressive pricing strategies. The lack of market availability for a product can sway consumers with high price sensitivity.
Most consumers will look at the upfront costs for purchasing a product (e.g., purchase price, how often you’re buying, etc.). Intelligent customers will look at the upfront costs + hidden costs of purchasing a product.
Perhaps a customer is looking at purchasing a new phone. They may look at hidden costs like:
When consumers look at the price of your product + these hidden costs, it can cause specific consumers not to buy.
Brand loyalty describes a committed relationship between a consumer and a brand. It is real, and it is powerful.
A recent Brandwatch study found that almost 40% of brand advocacy discussions mention brand loyalty happens when consumers are offered quality products and equitable prices. Cultivating a relationship with your customers strengthens their brand loyalty. It also makes it easier to retain them when you adjust prices.
How does the market see your product? Is it a prestigious or luxury product? Or, is it viewed as a low-quality item that will probably break after a few uses? How you position your product will influence potential customers' perceptions and price sensitivity.
Now that you know the ‘why’ behind price sensitivity, here’s the “how” that will help you measure it:
One of the most common and effective ways to conduct pricing research is the Van Westendorp Price Sensitivity Meter.
This technique asks participants 4 questions to determine at what price point a product becomes too expensive, too cheap, expensive/high side, and cheap/good value. The final output of these surveys is the optimal suggested price point and a range between too cheap and too expensive.
Gabor-Granger is another pricing exercise that is similar to the Van Westendorp study. The product is described to respondents, and they’re given a starting price point. If the respondent answers yes, it increases to a new price point until they answer no.
This study allows for a more linear progression to find the maximum price point. In contrast, Van Westendorp identifies the optimal price point and provides you with a range of where you could sell.
Do you know what attributes are most important to your ideal customer profile (ICP)? Or, do you know if your ICP gives more consideration to quality over affordability?
Buyer intelligence surveys allow you to understand your target customer’s pain points and how they think about a problem. You can take the learnings from these surveys to refine your messaging, identify if potential customers are price-focused or quality-focused, and position your product.
Make sure to analyze your and your competitors' online reviews around price. You’ll be able to get a good feeling on price sensitivity if customers are consistently raising the price as an issue with you and your competitors. This tactic can help you get a rough estimate of where you rank price-wise next to your competitors.
For B2B retailers, listening to sales calls is an overlooked step to understand how often potential customers negotiate the price. These calls can teach you how often price is a dealbreaker. Or, if the price is even coming up on calls. In B2B, if prospects aren’t negotiating the price, you’re likely priced too low.
Make sales call research a priority. These calls will help you understand the pain points of your ICP and gain a better understanding of pricing concerns.
Your business goals will have a heavy impact on your pricing strategy.
Are your plans to break into a new market? If so, it might be better to come in on the lower end of the Van Westendorp Meter. Are you focused on maximizing revenue? Then it might be best to price at the maximum price point.
For example, BambooHR introduced its payroll software to the market several years ago. BambooHR priced its payroll software lower than many of its main competitors to break into a new market. BambooHR did this to entice new customers and grow its consumer base.
When defining your audience, you want to be as in-depth as possible. For example, your audience should not just be females between 18-35 who like sports.
Each audience has specific things that motivate them to buy, cause them pain and lead to them evaluating your product, or make them hesitate from closing the deal. Knowing the demographics and psychographics of your audience allows you to understand what pricing structure to use.
Is your product new and unique? You can define a new category. Before the iPhone burst onto the scene, there wasn’t an established smartphone category. Now there are more smartphones than humans on the planet. When trailblazing a new product category, you get to set the anchor price. Other might follow and you'll always have to keep adjusting your pricing.
It’s vital to know who your top competitors are and what makes them who they are. Why do you win/lose deals against Competitor ‘X’? Keep tabs on your competitors to understand the most or least expensive option. Or who’s priced closest to you. Google Alerts is a free and simple way to keep tabs on your competitors.
So the big question: How do you reduce price sensitivity?
You won’t eliminate a customer’s (or prospect’s) sensitivity, but there are ways to help lessen the impact of a price increase.
Research has shown that customers with strong brand loyalty can withstand price increases. Look for ways to build a connection between consumer and company. One way to do that is to talk about how your product alleviates pain for your customer. You’ll develop a strong relationship that can weather most price changes by doing this.
Two companies that excel at this are Hubspot and Salesforce. Hubspot has established itself as an industry leader for marketing operations with an expansive online presence. Salesforce has developed its brand to be the premier CRM for SaaS businesses. It’s rare to talk to a large SaaS business that isn’t using Salesforce as its CRM.
Help customers see the value of your product. For SaaS companies, this is often shown by ROI or time savings. For example, after buying software ‘ABC’ it improved your efficiency by 5X over the quarter. This software resulted in savings ‘X’ in dollars. FloQast does an excellent job of showing the ROI of using its software with its Excel sheet.
Another important strategy is a robust packaging page. When customers can see the value they’ll get by becoming a customer; then price becomes less of an issue. Marketo excels at doing this. Their packaging page conveys its value proposition while also listing the functionality.
For consumer brands, companies will often look towards showcasing social proof. You’ll see badges that showcase where products are featured on TV or online outlets or how they’ve been ranked on third-party review sites. It can be as simple as, “The #1 recommended dog food.” Or as well remembered as, “4 out of 5 dentists recommend.”
What are the parts of your product that stand out? Blue Buffalo dog food does this well. Yes, they sell dog food, but they emphasize the all-natural ingredients in their dog food compared to their competitors’ generic ingredient list. By emphasizing the natural ingredients and positioning their brand as premium dog food, they can reduce price sensitivity.
You don’t always have to do it as a comparison matrix when visualizing your differentiators. Twist does an excellent job of this. They combine page layout, visuals, their own claims, and outside when emphasizing its differentiators against Slack.
To help account for price sensitivity - especially after a price increase - some companies will bundle products together for a limited time.
In SaaS, this is done by saying, “If you buy product ‘A’ now, you’ll get ‘X’ months free of [insert product ‘B’].” This tactic helps the customer feel like they’re saving some money.
For B2C consumers, it can be a little bit more difficult to give something away. However, this is an excellent opportunity to look at partnerships.
For example, a used car dealership may find a local mechanic and partner up. The dealer would provide free oil changes for a year for any customer that buys a car. Ideally, this would bring more customers into their shop for oil changes and any future mechanical issues.
It is critical for you to customize your pricing strategies around your customer demographics and your product positioning. To kick this off you’ll want to:
Remember that there isn’t only one way to measure price sensitivity. Each customer will have their own concerns and needs when evaluating your products. One thing is true though, brands need to have a strong understanding of their customer and that their value proposition resonates with them. It can be vital to winning a market when you understand and adapt.
Out now: Watch our free B2B messaging course and learn all the techniques (from basic to advanced) to create messaging that resonates with your target customers.
