How do you set a price for your products? Deciding on what to charge for a product or a service is a step that many CEOs don’t take seriously enough, and instead of taking a few different factors and a lot of data into consideration, they simply rely on their experience and senses when they set the price. If you are one of them, you might be losing a considerable amount of profit right now, because the price plays an important role in the decision-making process for many customers. But how important is it? It depends from one case to another, and this is where the price sensitivity comes into the spotlight.
Price sensitivity is the degree to which the product or service price affects consumers’ purchasing behavior. In other words, it is a measure of the demand change in the case of the price change.
Price sensitivity is directly related to the elasticity of demand. According to the law of demand, if all other factors remain constant (ceteris paribus) – an increase in price leads to a decrease in demand. If the product elasticity is high, a small price increase will drastically decrease the demand, and if the product is inelastic, the price change won’t significantly affect the demand. This means that usually, there is a high price sensitivity for the elastic products and low price sensitivity for the inelastic ones.
For example, the demand for gas is rather inelastic, so if the price gets a little higher, most of the customers will continue buying it, since they are dependent on it. This means that the price sensitivity is low for gas. However, you should be aware that there are a lot of factors that affect the purchasing decision. So, if only one gas station raises the price and there is another station in the area, the chances are that it is going to lose some customers although gas is an inelastic good in general.
If you keep track of price sensitivity, you will be able to understand the impact of a price change on your profits. Furthermore, it will help you with the timing of a price change, since you will better understand the current mood among the customers. Since the price sensitivity is not fixed and constant and depends on multiple factors, keeping track of it will help you always pick the right price.
It will also help you get as close as possible to the equilibrium price. This is the point where supply and demand produce the most revenue possible.
As we already mentioned, the price sensitivity is related to the elasticity of your product. This means that it depends on the industry you are in. Salt is usually a less elastic product than a sports car. This means that even the most price-sensitive consumers will continue buying salt if you raise the price, but the demand for a certain sports car will drop if the price goes too high. However, it’s not only the industry that affects the product’s pierce sensitivity. The sports car we mentioned above can still get good revenue if the following factors are in its favor.
To make things clear, we make a difference between calculating and measuring price sensitivity. The first one is based on a formula and gives us a number as a result, the second one has a more empirical value and provides us with more useful information.
The formula for calculating the price sensitivity is quite simple. It’s the % Change in Quantity / % Change in Price.
For example, a company increased the price by 40%, and the purchases fall by 30%. Using the formula, we can calculate the price sensitivity:
Price Sensitivity: – 30% / 40% = – 0.75
So we can say that for every percentage with which the price increases, it affects the purchase by the ¾ of a percentage. This means that the product is very price sensitive.
To do this calculation, you will need to already have some data, and this would mean that you’re revenue is already affected by the price change you performed on that highly price-sensitive product. So, how to avoid this? The answer lays in the techniques that allow you to measure the price sensitivity instead of calculating it.
This is a set of questions that gives you the chance to gauge price sensitivity from real customers and get an understanding of how much are they willing to pay for a product. This method is great because it gives you information before the product is even launched.
The consumer is enquired about the lowest and the highest price he is willing to pay for the product or service. This allows you to have the lower and the upper limit of the consumers.
In price laddering, the consumer is asked to rank purchase intention at a given price from 1 to 10.
Here, the respondents are asked to pick a brand when the two brands have the same price. Then by keeping the price of one brand, the price of the other is altered, looking for the consumers’ reaction.
When a brand or a retailer wants to reduce the price sensitivity, the first idea that usually comes to mind is simply lowering the price. Yet this is not completely true. If you want to reduce price sensitivity, the much better way to go is by trying to sell value to price-sensitive consumers. Here are a few tips on how to achieve your goal:
The tips we provided might not always be helpful, but with a carefully designed pricing strategy and following some of the advice we provided, you can expect at least some reduction in the price sensitivity.
The whole process of pricing requires a careful approach. If it is done right, it will be the single most important propeller of your revenue. This is why it is important to get it done before you go to market. Always invest in price sensitivity analysis, research your market and your competitors. For this task, a price monitoring tool such as Price2Spy could be of great help. Also, since price sensitivity is not a fixed thing, and it changes depending on a lot of factors, a well-designed, automated solution for repricing becomes more and more inevitable every day. Try Price2Spy free for 30 days and see how it can make your workflow faster and improve your profits in just a couple of weeks.