Any subscription product is built on recurring revenue, growth, and retention. For each product, it is important to have a comprehensive pricing strategy. This strategy needs to be a balanced one that does not leave the customer with a hole in the pocket and also not incur losses for the company. For this, it is necessary to know how much customers are ready to pay for the product. A balanced strategy is one that keep the pricing point in view while formulating a strategy that works for both parties. This needs a proper understanding of the customer willingness to pay and that is what this article is about.
What is Willingness to Pay (WTP)?
Willingness to pay (WTP) is the maximum amount a customer is ready to pay for your product or service. This is basically the ‘willingness to pay’ which is a crucial factor in finding the ideal price to sell the product. This agreed price must be something both parties agree with and find comfortable to reach a sale.
Why is WTP important?
You cannot attract a buyer if your margins and prices are too high. With the price you set, you keep some customers and send some away. This is why good pricing decisions will help keep customers. If the customer’s WTP amount matches with your quoted price, there is a conversion.
WTP is important as it helps segment customers better- by demographics, location, frequency, retention, income, purpose, retention, and more factors.
Improved Market Understanding
WTP helps you analyze costs and research to see what competitive advantage you have. This will help you understand what the price of competitors values as against your own. You can offer a seamless experience based on market understanding. As per research, a customer is becoming price sensitive due to higher costs and reduced income levels.
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How to calculate / determine / discover WTP?
Here are some ways to measure WTP.
Researching the customer is the most important thing in any strategy. You need to know the customer- their requirements and more. The market for your product may be ready but your target customers may not. So you need to know what features are most valued by customers. This is a huge component that determines willingness to pay. A product that fits the customer market better will understand the price point better.
Market (competitor) research
This is the basic economics of what happens. If your market is new and you have the first-mover advantage, you can spike your prices. But if you are focused on an already saturated market, you need to position the price at a near equal value of competitors. Market research of the product shows the competition around it and how much you can estimate the pricing to be.
Surveys (direct, indirect) and Focus Groups
Surveys are a great way to understand what customers want. They can be direct or indirect and give an estimate of a feature. You can understand how loyal they are to the company or competitors. You can use these surveys to get data points that will offer a base into customer willingness to pay.
Experiments and Revealed Preference
Experiments ensure you know of customer demands and needs in a simple manner. Experiments in a lab are simple ways to simulate purchasing environment and customer behavior. You can also conduct field experiments to know some behaviors as opposed to others.
Conjoint analysis is a popular way to understand customer preferences on pricing and product and use that to forecast market shares, prices, predict product adoption and features. Conjoint analysis helps in discovering customer sentiment around products.
Auctions are a great way to understand customer willingness to pay. The initial bidding behavior shows insights on how the product is and what is the value ascertained by customers.
A Practical Example of Customers’ Willingness to Pay
This is an example of willingness to pay. Let us assume you work at a company that makes chatbots. Let us also assume that there are 1000 customers in the market you’ve chosen to target. You feel that the product in hand meets their needs and will satisfy their requirements. There are some competitors, but you feel your product can ace them.
You must send out a survey to understand how much you can price your product. This survey will let you know how much customers are ready to pay for your product. This shows the result that customers are willing to pay $100 for the chatbot. If it is a premium, highly intelligent one – they wouldn’t mind shelling out $175.
Let us assume that 750 respondents agreed to buy the product for 175$. This makes your profit $75x 750 people = $56250.
If you charge $100, all the 1000 people will buy the product. However, you will make only $50000.
This means more sales do not always mean more money. There is a possibility of more sales driving in less money and overall profit.
A business can grow only if companies keep both services and products in mind while charging. Keeping all costs in mind is important as it gives customers an idea of the company’s worth.
Factors that affect WTP
In all fairness, multiple customer characteristics affect willingness to pay. These differences can include psychographic, demographic, or behavioral features.
Though demographic variables like education, income, race, sex, age, and location impact customer willingness to pay, other aspects are not counted as much.
The effect of customer research
Customers research a lot. This customer research effect has an impact on willingness to pay. If a customer thinks a specific price is fair, they will assume this product is at the same price. This will make them inclined to buy.
The effect of fashion
For consumer products or lifestyle products, fashion changes everything. Fashion influences the demand for certain services and products. This increases the customer’s willingness to pay. This can be extended to include environmental health products. If the health decline cases are on the rise, people may be more inclined to choosing health options, increasing their willingness to pay for a specific brand or tagline.
The effect of the environment
Environmental factors like state economy, and national issues can influence what the customer wants to pay. For example, if the customer has a well-paying job in a downturn economy, they may still be more willing to pay. On the contrary, if a customer has a low-paying job in a booming economy, they may not be willing to shell out a certain premium.
State of the economy
If the state of the economy looks bleak, chances of customers spending on a product are less. Their willingness to pay decreases unless it is an essential item. In case the economy is thriving, customer willingness to pay will only increase.
WTP depends on the season- and no its not the weather. Its more of the business season. What trend is new in the market? Are SaaS products thriving? Will your product help align things on that aspect?
Customer demographics and preferences
Based on where the customer lives, the willingness to pay differs. For example- take a product ‘Jeans’ pants. A customer in an urban setting with an age under 50 living a certain lifestyle will prefer it more than one in a rural location. Their willingness to pay will differ and this is a huge factor that affects pricing decisions.
Another important factor affecting WTP is reference prices. Reference prices in similar products can help fix a price for the current product. This will help ascertain the price for products to arrive at a proper price point.
Product scarcity + Availability of alternatives
WTP is influenced by product scarcity and availability of alternatives. You can understand customer willingness based on how available the product is. You can check what resources are helpful. This pricing pattern changes as per various alternatives available.
Product quality (real and perceived)
What if the customer perceives your product to be of a certain quality and that does not match up? Willingness to pay is something that goes hand in hand with the product value. In some cases, the product quality does not match what the customer expects, and this affects pricing.
If the company has an established brand image, it is easier for customers to relate and expect a certain price. This is a major factor as brand recall value is an important business attribute.
How to influence WTP?
You can change or impact customer opinion with the value proposition. Value proposition is an important concept that determined and influences willingness to pay.
WTP is high for premium brands and low for consumables because there are hundreds of alternatives. This is why you need to have a brand presence and customer attention. People discuss why a certain product is good. Unique products have higher willingness to pay.
You can influence WTP with influencer campaigns. These can be prominent personalities in the field whose expertise and experience is valued by prospective customers.
Customers will pay more if there is social proof, testimonials, and the like. When other customers vouch for the product, prospects might feel interested in buying it. This increases willingness to pay.
WTP vs Willingness to accept (WTA)
Willingness to pay or WTP is the highest monetary amount one would pay for a product. Willingness to accept compensation is the minimum monetary amount that needs to be let go for a product.38
Measuring WTP will bring you closer to your audience. You will be able to acquire more customers, understand them better, and retain them. You van know your target market better and arrive at a better understanding of buyer interests, requirements, and expectations.
Dattatraya Shetty is an IT Professional with 2 Decades of experience in areas of Product Development, Implementation & Service Delivery Management. As the Head of Implementations and SOC Compliance in Smartkarrot he is on a mission to provide relishing customer experience.
Published July 15, 2021, Updated March 02, 2023