Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
Price sensitivity helps a business with one of the most difficult tasks it will encounter: the striking of a balance between selling its products at a price consumers can afford while making a profit at the same time.
High price sensitivity indicates that consumers are more likely to reject purchasing a product in favor of another product.
Low price sensitivity, on the other hand, indicates that consumers are willing to pay the stated price and may even be willing to pay more.
Understanding the machinations of the consumer mind when faced with a purchasing decision is critical if a business is to price its products appropriately.
With that in mind, here are some of the many factors that influence price sensitivity:
Price and quality
Buyers are less sensitive to price if the product is of superior quality or a status symbol, such as a luxury car or designer watch.
Uniqueness
Price sensitivity also depends on whether the product or brand is unique. A consumer is likely to be less sensitive if purchasing a pair of Air Jordans because they cannot be substituted with something else.
However, the consumer purchasing a loaf of bread will be more sensitive to price because there are many alternative brands.
Ease of comparison
If a product can be easily compared with similar products in the marketplace then price sensitivity tends to be higher. This is related to uniqueness.
Reference price
When comparing similar products from multiple merchants, consumers form a reference price based on their observations and comparisons. Provided the products are more or less the same, the consumer may be more willing to choose a product based on price.
Available income
Price sensitivity also increases when consumers have less money in the bank, whether that be due to personal circumstances or broader economic factors such as a recession.
This is especially true of more expensive items.
How can businesses measure price sensitivity?
For best results, the business should have a deep understanding of the various market segments within its target audience.
Each will perceive the value of a product differently, which means their price sensitivity will also differ.
Once the audience has been segmented, the business needs to move beyond the simple question of “How much would you pay for this product?”
In practice, this can be done in several ways.
Price ladder method
This involves asking potential customers about their intention to purchase a specific product at a specific price on a scale of 1 to 10.
If the customer reports an intention to buy below a particular threshold, then the price is considered low and they are asked if they intend to purchase again in the future.
Data analysis can also be performed to evaluate the percentage of the market that would buy at any given price point.
Van Westendorp model
Named after Dutch economist Peter van Westendorp, this method asks a series of questions to identify critical psychological price points and gauge consumer purchasing power.
Importantly, the method is based on real-world market data.
It can be adapted according to whether the business plans to introduce a pricing change or wants to determine consumer perception of its products with respect to competitors.
Gabor-Granger method
The Gabor-Granger method was developed in the 1960s by economists Clive Granger and Andre Gabor.
The method is a convenient and practical survey method where participants are introduced to a product and then exposed to a random price chosen from a predetermined list.
If the participant is willing to buy the product at that price, they are shown the product again with a higher price attached.
This process is repeated until the highest price a participant is willing to pay is determined. In some cases, the price may need to be lowered on multiple occasions until an agreeable price is reached.
Key takeaways
Price sensitivity is the degree to which the price of a product affects consumer purchasing behavior. High price sensitivity indicates that a consumer is more likely to choose an alternative product, while low price sensitivity indicates that the consumer is willing to pay the stated price or maybe more.
Price sensitivity can be understood by considering the machinations of the consumer’s mind when making a purchasing decision. Indeed, they may be weighing up price, quality, uniqueness, ease of comparison, reference price, and available income.
The price sensitivity of various market segments should be analyzed for best results. Analysis techniques include the price ladder method, Van Westendorp model, and Gabor-Granger method.
Revenue model patterns are a way for companies to monetize their business models. A revenue model pattern is a crucial building block of a business model because it informs how the company will generate short-term financial resources to invest back into the business. Thus, the way a company makes money will also influence its overall businessmodel.
A pricingstrategy or model helps companies find the pricing formula in fit with their business models. Thus aligning the customer needs with the product type while trying to enable profitability for the company. A good pricingstrategy aligns the customer with the company’s long term financial sustainability to build a solid businessmodel.
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.
Price skimming is primarily used to maximize profits when a new product or service is released. Price skimming is a product pricingstrategy where a company charges the highest initial price a customer is willing to pay and then lowers the price over time.
Productized services are services that are sold with clearly defined parameters and pricing. In short, that is about taking any product and transforming it into a service. This trend has been strong as the subscription-based economy developed.
Menu costs describe any cost that a business must absorb when it decides to change its prices. The term itself references restaurants that must incur the cost of reprinting their menus every time they want to increase the price of an item. In an economic context, menu costs are expenses that are incurred whenever a business decides to change its prices.
A price floor is a control placed on a good, service, or commodity to stop its price from falling below a certain limit. Therefore, a price floor is the lowest legal price a good, service, or commodity can sell for in the market. One of the best-known examples of a price floor is the minimum wage, a control set by the government to ensure employees receive an income that affords them a basic standard of living.
Predatory pricing is the act of setting prices low to eliminate competition. Industry dominant firms use predatory pricing to undercut the prices of their competitors to the point where they are making a loss in the short term. Predatory prices help incumbents keep a monopolistic position, by forcing new entrants out of the market.
A price ceiling is a price control or limit on how high a price can be charged for a product, service, or commodity. Price ceilings are limits imposed on the price of a product, service, or commodity to protect consumers from prohibitively expensive items. These limits are usually imposed by the government but can also be set in the resale price maintenance (RPM) agreement between a product manufacturer and its distributors.
The bye-now effect describes the tendency for consumers to think of the word “buy” when they read the word “bye”. In a study that tracked diners at a name-your-own-price restaurant, each diner was asked to read one of two phrases before ordering their meal. The first phrase, “so long”, resulted in diners paying an average of $32 per meal. But when diners recited the phrase “bye bye” before ordering, the average price per meal rose to $45.
The anchoring effect describes the human tendency to rely on an initial piece of information (the “anchor”) to make subsequent judgments or decisions. Price anchoring, then, is the process of establishing a price point that customers can reference when making a buying decision.
A price maker is a player who sets the price, independently from what the market does. The price setter is the firm with the influence, market power, and differentiation to be able to set the price for the whole market, thus charging more and yet still driving substantial sales without losing market shares.
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organizationscale further.
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
