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® How much should that doggie in the window be? Strategies for maximizing value through pricing research Scott Laing, PRC and Chris Robson, PRC NorthWest MRA Spring Educational Conference, May 8th 2008 Group Exercise: The BMW 330i If you were buying this car, what would you expect to pay? Sticker price on this is $42,000. Is that a ‘fair’ price? Would YOU personally buy this car new at $42,000? At $30,000? $20,000? $10,000 The corresponding Audi A4 is $36,000. Does knowing that change how you look at the price? If (like the Trabant in old East Germany) this were the only car model available in the US, would you be more likely to consider it? Image: FreeDigitalPhotos.net © Parametric Marketing LLC 2008 Client/Parametric Confidential So how much should BMW charge? BMW would obviously sell a lot more if they priced it at $10,000 – why don’t they? How do BMW decide what to list it at? Cost to manufacture and distribute Expected return from service and extras Competitive prices and positioning Company profit goals Why is ‘sticker’ never what you pay? Every constituent has an opinion, some grounded in data, some based on experience and intuition © Parametric Marketing LLC 2008 Client/Parametric Confidential The Perils and Pitfalls of Pricing Pricing is hard. And getting it wrong can be disastrous There is no ‘one size fits all’ formula: However, there are many tried and tested approaches Research can (and should) play a major part in any substantial pricing task However, it’s really easy to do bad pricing research… This is just a brief introduction to the subject © Parametric Marketing LLC 2008 Client/Parametric Confidential Research vs. Business Most of us here are in the MR profession We want to believe that research and business are tightly integrated A lot of our worries about pricing studies center on methodology and client timelines Clients or end users – the people doing the pricing – also have to worry about business context There is a huge opportunity for us to step up and integrate more understanding of the economics and business implications of pricing, and providing more support to our business clients in this vital area © Parametric Marketing LLC 2008 Client/Parametric Confidential Key Concepts We’ve found that it’s really helpful to ensure that we’re all on the same page with respect to a few key concepts. Many of these terms are banded about without people fully grasping their meaning In this area, terms like “Price Elasticity” are often used as imprecisely and incorrectly as, say, “Statistical Significance” in our field Often, people are uncomfortable admitting that they really don’t fully understand the meaning of these terms. You don’t need to understand everything about them, but it’s good to have a “statistically significant” understanding! © Parametric Marketing LLC 2008 Client/Parametric Confidential The Demand Curve The staple of the pricing research business, a demand curve is nothing more than a graphical description of the relationship between the price of a good or service and the number of buyers or amount that would be bought Units Bought $ Note: Economists usually flip these axes © Parametric Marketing LLC 2008 Client/Parametric Confidential Price Elasticity of Demand “Price Elasticity” – or “Price Sensitivity” – is a fancy way of describing the shape of the demand curve. Elasticity refers to the relationship between change in price and change in demand level. For example, a “necessity” is often relatively “inelastic” as changes in price often result in little or no change in demand. Units Bought This good is inelastic: Large price changes result in small changes in demand $ Note: Economists usually flip these axes © Parametric Marketing LLC 2008 Client/Parametric Confidential Impact of Price Elasticity on Revenue The Price Elasticity of Demand is the ratio of the percentage increase in demand given a corresponding percentage increase in price – in effect the slope of the curve We say that a good is Elastic if increasing price decreases total revenue, and Inelastic if increasing price increases revenue Units Bought In an Elastic good the demand falls faster than the price, so total revenue falls as price increases Revenue = Price x Units $ Note: Economists usually flip these axes © Parametric Marketing LLC 2008 Client/Parametric Confidential Price Awareness Consumers have internal models regarding what things should cost These internal models may not be rational or connected with actual current pricing Price Awareness is how well these internal models match the current market realities As researchers, we need always be aware of the likely disconnect between customers’ internal models and reality. Do customers (respondents) really have any clue about the general price level of a 2GB RAM module? It can make a big difference in interpreting results “While few believe that price knowledge is perfect, research has indicated that both academics and industry personnel overestimate its extent. As a consequence, pricing decisions and market research may be based on an erroneous assumption.” Binkley and Bejnarowicz 1995 © Parametric Marketing LLC 2008 Client/Parametric Confidential Willingness To Pay Willingness to Pay is a measure of what a (prospective) customer is prepared to exchange for a good or service. This matters deeply. It’s easy for a respondent to say a product should cost $5, but have no interest in paying $5 Mixing up price awareness with willingness to pay is a common pitfall Often a good is priced lower than an individual’s “Willingness to Pay” Economists call the difference between the price consumers are willing to pay and the actual price of a good the “Consumer Surplus” Sellers often use the tactic of offering premium goods (e.g. coffee with froth) to identify people with a higher “Willingness to Pay” © Parametric Marketing LLC 2008 Client/Parametric Confidential Factors Affecting Willingness to Pay It is important to remember that ‘Willingness to Pay” is affected by many other factors, including: Price Awareness Perceived Utility (relative satisfaction from or desirability of a good) Current financial circumstances and income Competition and substitutes “Willingness to Pay” is notoriously difficult to measure, and is generally hidden in our usual purchasing transactions In usual markets, consumers keep their ‘Willingness to Pay’ hidden, whilst retailers have to make their prices public Some markets – such as housing, cars and e-bay – work by different rules The ‘Holy Grail’ of pricing research is to determine Willingness to Pay effectively © Parametric Marketing LLC 2008 Client/Parametric Confidential Purchase Intent Purchase Intent can be thought of as the “decision plan” to buy a good or service I may have “price awareness” that an appropriate price for something is $5. I may be “willing” to pay $5 for it. But that does not mean that I am going to rush out and buy it this second. I may never get around to buying it. Measuring purchase intent can be slippery (and beyond the scope of today’s session), but here are some pointers: People don’t actually behave the same way that they respond There are transformations that can help map between stated purchase intent and actual purchase rates Specifying time restrictions in survey questions can greatly improve value of results © Parametric Marketing LLC 2008 Client/Parametric Confidential A Few Research Techniques Direct Questioning Monadic pricing Studies Van Westendorp Price Sensitivity Meter (Hedonic) Regression Conjoint Techniques © Parametric Marketing LLC 2008 Client/Parametric Confidential Direct Questioning Q1: How much would you be willing to pay for that Doggie in the Window? Direct questioning, either in Quant or Qual studies, is frequently used and is almost always meaningless The problems with asking this type of question get even worse in open focus groups Please, please don’t use direct questioning! “Very early in the development of survey techniques for marketing, researchers learned that it was futile to ask consumers outright what they would be willing to pay for a product” – The Strategy and Tactics of Pricing, Nagle and Hogan © Parametric Marketing LLC 2008 Client/Parametric Confidential Monadic Price Surveys In a Monadic Price Survey a respondent would be asked to state whether they would buy at one specified price: Would you be willing to buy that Doggie for $5? The respondent group is split so that several different price points are tested – but each respondent only sees one price A Purchase Probability Curve can be built by aggregating the responses Pros: Produces a plausible approximation to the demand curve Cons: Needs a large sample to produce meaningful results. May not fully take into account competitive and market effects © Parametric Marketing LLC 2008 Client/Parametric Confidential The Van Westendorp Price Sensitivity Meter Van Westendorp (1976) proposed asking four very specific questions of each respondent: At what price would you begin to think That Doggie was too expensive to consider? At what price would you begin to think That Doggie was so inexpensive that you would question the quality and not consider it? At what price would you begin to think That Doggie was getting expensive, but you still might consider it? At what price would you think That Doggie was a bargain - a great buy for the money? This question set has the advantage that it elicits a price window for consideration from the respondent – based on their price awareness © Parametric Marketing LLC 2008 Client/Parametric Confidential Traditional Analysis of Van Westendorp Data Traditionally, responses to Van Westendorp questions have been analyzed by drawing the cumulative curves for the “Too Expensive” and “Expensive but” responses, and the inverse cumulative curves for the “Too Inexpensive” and “Bargain” responses © Parametric Marketing LLC 2008 Client/Parametric Confidential Traditional Analysis of Van Westendorp Data Acceptable Price Range: $16-$24 Indifference Price Point ($21) Point of Marginal Cheapness ($16) Point of Marginal Expensiveness ($24) Optimal Price Point ($19) Traditionally the crossover points are given deep and meaningful names… …but this approach has been challenged by many analysts, and it’s theoretical foundation is not regarded as particularly sound © Parametric Marketing LLC 2008 Client/Parametric Confidential Rehabilitating Van Westendorp The dichotomy with Van Westendorp is that the question set is very powerful and the real-estate taken in a survey is small, but the standard interpretation is suspect Newton, Miller and Smith proposed extending the question set to include a pair of purchase likelihood questions How likely would you be to purchase That Doggie if it were offered at [BARGAIN] price? How likely would you be to purchase That Doggie if it were offered at [GETTING EXPENSIVE] price? Using these two additional questions we can build a Consideration Curve by aggregating the individual consideration curves for each respondent This also gives us the opportunity to relax the ‘positive elasticity’ assumptions inherent in the ‘too cheap’ question © Parametric Marketing LLC 2008 Client/Parametric Confidential Individual Consideration Curve Examples of Alternative VW Analysis Aggregate Consideration Curve Margin Curves © Parametric Marketing LLC 2008 Client/Parametric Confidential Recommendations for Using Van Westendorp Do not use for categories that are not familiar to respondents Technique relies on a level of price awareness Use the extended question set Ignore the traditional analysis, instead build consideration curves Use the consideration curves to estimate expected margin curves Note: The VW questions can be very powerful in small-n/focus groups, if administered individually See “Building Price Elasticity Curves”, Evans 2007, for a Monte-Carlo approach to this © Parametric Marketing LLC 2008 Client/Parametric Confidential Hedonic Regression Sometimes we want to understand pricing patterns in existing markets Hedonic Regression treats price as a linear function of a number of contributing features. Specific prices on the market are used as ‘observations’, and a regression model is used to build the contributions of each feature. E.g. How would you price a PC with a particular specification? Caveat: We need to be careful of correlated input variables and other problems typical with regression techniques Hedonic models are often used in Real Estate valuations (where the ‘features’ could be square footage, number of bedrooms etc.) They can also be used in any other established, feature-driven category © Parametric Marketing LLC 2008 Client/Parametric Confidential Conjoint Techniques In conjoint techniques, respondents are shown ‘bundled’ offerings of ‘attributes’ and asked to respond with their preference (and, in some cases, whether they would purchase) Price is usually one of the attributes, and the data can be used to evaluate pricing options in a very rich manner There are many different techniques and approaches to conjoint studies. Recent improvements in raw processing power have made several new techniques viable We will give an example of a Choice-Based Conjoint (CBC) with DualResponse None (DRN), analyzed using Hierarchical Bayes (HB) techniques © Parametric Marketing LLC 2008 Client/Parametric Confidential Example CBC/DRN Conjoint Task Imagine that you happened upon a window and saw the following three Doggies: Which of these would you be most likely to buy? Scruffy Brown Doggie with: Mangey Black Doggie with: Spotty Doggie with: No Tail Non-Wagety Tail Wagety Tail And Fleas $10 And Dog Breath $20 $15 Assuming that these were the only Doggies available, would you actually buy the one you chose? Yes, I would buy this Doggie No, I would wait to see if I could find a better one © Parametric Marketing LLC 2008 Client/Parametric Confidential Conjoint Simulation Example: Price Sensitivity © Parametric Marketing LLC 2008 Client/Parametric Confidential Conjoint Simulation Example: Competitive Scenario © Parametric Marketing LLC 2008 Client/Parametric Confidential Conjoint Simulation Example: Compare Scenarios © Parametric Marketing LLC 2008 Client/Parametric Confidential Application & Strategy As researchers, we often focus on the price that elicits most consideration or purchase When we work on pricing with clients, we must focus on pricing strategy that is best for business Margin should generally be more important than units It is important that we understand how our clients make money, and provide support for business strategies that maximize that Establishing consumer demand at different prices and under different competitive situations is vital, but only part of the business story. A pricing strategy needs to take into account other factors, such as supply capability, channel capacity and dynamics, consumer education needs… As MR Professionals, we have a lot we can offer our clients © Parametric Marketing LLC 2008 Client/Parametric Confidential How Much is that Doggie in the Window? How much is that doggie in the window? The one with the wagglely tail. SKU has been differentiated and utility identified How much is that doggie in the window? Protagonist, having identified SKU of interest, desires to know price supplier would be willing to sell at Protagonist repeats request for information regarding supplier’s asking price, underlining the fact that in our usual markets the price at which a supplier is willing to sell is public, whilst a consumer’s willingness to pay is generally hidden I do hope that doggie's for sale. Protagonist does, however, acknowledge that the supplier is not bound to sell any SKU, if supplier feels that the level of the consumer’s willingness to pay does not make adequate profit © Parametric Marketing LLC 2008 Client/Parametric Confidential 30 Parametric Marketing LLC Parametric® provides research services to the Consumer Electronics and technology industries. We are a research consultancy that specializes in analyzing consumer behavior and advising companies on the financial implications of product, brand and promotional decisions. As specialists in advanced analytic techniques such as conjoint, discrete choice modeling and customer valuation, we are often called upon by other marketing research companies to provide client tools and analytics consulting. Parametric was founded in 2003 by Chris Robson PRC, and Scott Laing PRC 400 E Evergreen Boulevard, Suite 303 Vancouver WA 98660 Phone: +1 360.696.2929 [email protected] www.paramktg.com © Parametric Marketing LLC 2008 Client/Parametric Confidential