Willingness to Pay: A Metric for Better Pricing Decisions

For a customer, price is one of the top factors that affect their purchase. For businesses, it’s one of the most complex numbers to arrive at. A number that will determine the success and failure of a product or service, the customer perception of the brand, brand loyalty, revenue and profitability of the business.

So, how can you get your price just right? By taking into consideration your customer’s willingness to pay.

What is the customer’s willingness to pay or WTP?

A customer’s willingness to pay (WTP) is the highest price a customer is willing to pay for a product. This could be an exact number or a range.

The WTP for a product is not necessarily the right price for the product because the willingness to pay changes from customer to customer and there are many factors that affect it. However, you will be wise not to price your product above this number or range.

Why is it a metric you should care about?

Knowing the customers’ willingness to pay allows you to find the pricing sweet spot that is higher than your cost (the lowest you can price while breaking even) but lower than the WTP (the highest you can price knowing there’s a buyer).

In other words, The WTP helps you price your product in a way that works for you and your customers. A business that can satisfy its customers without compromising on revenue is bound to thrive!

Factors that affect a customer’s willingness to pay

During the early days of the COVID-19 pandemic, people were willing to pay anything for toilet paper as long as they could clean the shelf. This was not the case before the pandemic nor is it one now that the companies have caught up on the demand and are likely holding a good safety stock of it.

A customer’s willingness to pay is constantly changing and various factors affect it including,

Demographics or extrinsic factors: These include gender, age, geography, qualification, income level, etc. How these factors affect a customer’s willingness to pay can be easily discovered and understood.

Emotional or Intrinsic factors: These are unobservable factors that require a little more effort from the business to understand and influence. This includes customer perception, personal preference, desire to fit in, etc.

Urgency: if the product is something your customer needs and needs immediately, they are likely to pay a higher price for it. On the contrary, if your customer can wait, they are likely to wait till you run a promotion or for the price to drop before they make a purchase.

Availability: Customers are likely to pay more if they see a shortage coming. Conversely, the willingness to pay tends to decrease when a new competitor enters the market as this gives customers options and increases availability.

Economic conditions: when the market goes through inflation, customer’s willingness to pay will decrease for products that they consider a want and not a need. On the other hand, when people see a hurricane or typhoon coming or a pandemic, their willingness to pay may increase in anticipation of a shortage.

How is WTP determined

Considering WTP has a lot to do with the customers and every customer is somehow unique, there is no one formula you can use to determine a customer’s willingness to pay.

However, there are various methods you can use to determine the WTP quite accurately.

Customer survey or focus group: a surefire way to know the customer’s willingness to pay is by asking them. However, while surveys or focus groups are a good way to get accurate data, remember that WTP is constant. So, this is a good method if you’re launching a new product or trying to enter a new market and require new data. (launch or new market entry)

Experimentation: If you’ve got the time and resources, you can gradually increase the price to determine at what point you begin to lose customers and therefore determine what the customer’s willingness to pay is. This, however, could be a risky method as you might lose or frustrate customers. Furthermore, this is very time and resource-consuming.

Competitor monitoring and price intelligence: a more efficient way to determine a customer’s willingness to pay is to closely monitor your competitors and know their prices, promotions, and stock information. This will help you understand the correlation between their prices, sales, and demand. From here, you will be able to gauge the customer’s willingness to pay. Not only that, you’ll also be able to price and promote your products strategically to beat the competition.

The idea is to create a consumer surplus without compromising on your margins. I.e., price your product below the price your customers are willing to pay so you can maximise customer satisfaction, but also not price it too low so that you compromise on your margins and affect the quality perception of your customers. Knowing the WTP for your product can help you do this most effectively.

Pricechecker is a pricing technology that offers the best accuracy in the market that not just helps you understand prices your customers are willing to pay, but also the price they are willing to pay with your competitors.

The analytics dashboard with powerful data visualisation is the key for any retailer to set the right pricing strategy.

To schedule a chat with our pricing experts visit here.