Price segmentation – how to evaluate your customers’ willingness to pay
The questions you’ve got to ask to determine how much you charge
Segmentation (offering different prices to different market segments) is an important step in any pricing strategy.
You want to know the range of price sensitivity, or willingness to pay (WTP for short) among your potential client base. Often, this range will divide into several clear categories based on what alternatives people compare your product or service with.
It is hard to span distinct WTP categories with a single product. If you are able to attract a customer base at £2.50, it's dangerous to also offer a 30p version of your product – customers might trade down, and the profits you lose on the £2.50 client will be hard to make up unless you can sell huge volumes of the cheaper version.
The more unusual your product is, the more you should aim for a premium price segment; if you have close competitors you may have to hit a particular price point to capture a volume market, but if not, the cons usually outweigh the pros.
How to determine potential pricing segments
Determining the segments of your potential customers is important but not easy. If you rely on looking at existing customer behaviour, you don't measure whether people would really be willing to pay more.
If you speak to people who aren't your customers at present, you are asking them to think about a hypothetical situation and this makes it hard for them to give you accurate answers. A question like “Here's £10. If I asked you to go and spend some of it on buying tea, where would you go?” puts people in a situation which is relatively similar to the real buying environment, and asks them to make a real decision.
This prompts the customer to go through at least some of the same mental processes that they go through when buying a real product.
Having done that, their answer to a question like “How much would you expect to pay for it there?” is more likely to be accurate and to reflect what they might really be willing to pay for the product.
It's risky to ask direct questions such as ‘How much would you be willing to pay for this?' Apart from the difficulty for the consumer of trying to predict their potential behaviour in a hypothetical situation, many people will deliberately give you an underestimate – in some kind of strategic attempt to influence you to lower your prices.
As far as you can, you should structure your questions to replicate the real process and mind-set of a consumer buying a product.
Conducting market research
You can use the following questionnaire as a starting point, but feel free to modify it.
Identify different groups of people whom you think might have a different attitude to your product, or use it differently. Then speak to as many individuals as possible.
You should target at least 10 in each group, though you can probably benefit from talking to more than that if you have the time and patience to do so.
Your customers do not necessarily know, and will not necessarily say, what they would do when presented with your product in a real environment. Therefore, try to ask the question in such a way as to make the scenario as realistic as you can.
Some techniques for doing this include the following.
- Ask the person to place themselves in the shoes of a third party – for instance, to predict what their friend would do instead of what they themselves would do. This creates distance, takes away a source of bias and a degree of subjectivity that might result in a false answer to the question if they tried to imagine their own behaviour.
- Give them some money and ask them to spend it on products in your category. Although this isn't perfect – because people treat newly acquired money in a different way from their own money, and because they might feel a moral obligation to buy a product they wouldn't normally want – it makes things much more realistic than simply asking the consumer to imagine how they might behave.
- Put them in a physical environment which is appropriate to the decision you want them to make. For example, when interviewing people about a luxury housekeeping service, I booked the interviews in a five-star hotel in central London in order to convey the brand values that I wanted to present. When interviewing about a new coffee product, try asking people in a café.
You should modify this to reflect your particular product or service:
- How often do you buy (or use) this type of product or service?
- What variety, or which brands, do you normally buy?
- Where do you buy it?
- What are the experiences or feelings you most associate with using this product?
- If you decided not to buy this particular product today, what might you buy instead?
- What do you buy, or use, alongside this product?
- If I gave you £10 [or an appropriate amount] and asked you to go and spend some of it on buying this product, where would you go?
- How much would you expect to pay for it when you got there?
Asking questions of your customers or potential customers is an important way to get insight into what they will spend money on, however, as we've seen, you can't take the answers literally.
The responses customers give will indicate what they really think, but you have to read between the lines.
One of the most important insights you will gain is what kind of questions or what context will change the answers that people give. This gives you a clue to how you can influence their decisions, a key factor in ensuring your price points equal profits.
The Psychology of Price: How to use price to increase demand, profit and customer satisfaction, published by Crimson Publishing is available on Amazon now.