Pricing is one of the most underutilized levers SaaS companies have at their disposal to capture more value. We’ve
written somewhat extensively on this topic in the past with the help of Monevate’s James Wilton. He identified key points in the pricing process where companies often leak value, meaning they unintentionally devalue their own product.
One of those points was the “willingness-to-pay” calculation. Willingness-to-pay (WTP) is, as the name suggests, the maximum amount of money your customers are willing to pay for a specific product or service. For a variety of reasons, this is a fairly difficult value to calculate. Thankfully, we’re happy to lend a hand.
What makes WTP so elusive?
Your customers aren’t a monolith. Extrinsic and intrinsic factors can lead to wide variations in WTP between individual customers. For reference, extrinsic factors are differences you can observe or verify. These are things like their age, gender, education, income, location, etc. Intrinsic factors are the opposite, these are internal characteristics like risk tolerance and passion that are less concrete yet just as influential.
Harvard has identified 14 core factors that can impact a customer’s willingness to pay.
- Income
- Geography
- Weather
- Age
- Gender
- Brand Loyalty
- Service Levels
- Advertising
- Competing Products
- Expectations
- Legality
- Packaging
- Environmental/Social Impact
- Necessity
These are all unique to the individual and, unfortunately, you may not have influence over all of these factors. As much as we’d all like to, we can’t make our product necessary for our clients, for instance.
How do I even calculate WTP?
If the thought of calculating WTP is starting to feel less like science and more like sociology—then you might be onto something. Determining your customer’s willingness to pay requires continuous market research, a concept pretty intimidating to many companies.
Irrational Labs, a behavioral economics and consulting firm, found that, out of 60 software companies surveyed, half have never run a pricing study before and only a quarter have even A/B tested a pricing change. These, and other, companies had similar concerns.
- Pricing changes can be risky, and charging different customers different prices
can lead to blowback.
- Testing multiple prices can be technically complex to implement and maintain.
- WTP studies are hard to run! They require recruiting participants, writing the study, and analyzing the data.
These are valid concerns. It’s no wonder a company might be nervous. However, as we wrote in our
Pricing and Packaging blog, a change as low as just a 1% improvement in pricing can increase your profits by up to 11%.
There are a few quantitative ways to determine WTP, but understand that this metric isn’t perfectly quantifiable. As mentioned above, over a dozen factors play into how much a particular customer may be willing to pay—meaning the actual price is only truly part of the equation. Your marketing and your competition equally impact your WTP.
That being said, we can still use well-researched methods to make an educated guess.
The
Van Westendorp method, often called the “price sensitivity meter,” is perhaps the most well-known approach to calculating WTP. However, it probably isn’t the most accurate. There is very little research available to back-up its effectiveness, for one. However, it’s most redeeming quality is that it’s fairly simple to administer. Participants are asked just four direct, straightforward, easy to analyze questions.
- At what price would it be so low that you would start to question this product’s quality?
- At what price do you think this product is starting to be a bargain?
- At what price does this product begin to seem expensive?
- At what price is this product too expensive?
Since these are hypothetical questions, they are open to
hypothetical bias. In this specific scenario, respondents
often overestimate how much they’d actually spend.
The
Gabor-Graner method, or multiple price list, improves upon the Van Westendorp method by eliminating the need to fabricate a price out of thin air. Instead, participants are given a list of price tags and are asked whether or not they would pay that amount.
This method has historically been preferred by researchers due to its simplicity and transparency. Unfortunately,
new research shows that this method may actually lead to systematically lower WTP estimates.
Conjoint analysis sacrifices simplicity in the name of quality by breaking a product down into its components (features and prices), then combining those components into several configurations for the respondents to choose from. Researchers can then ascertain from the participant’s responses how each feature influences WTP.
Conjoint analysis is less of a strategy and more of an umbrella for a family of strategies. Qualtrics does a great job explaining a few of the many different types available in
this blog post. The gist is that a conjoint analysis offers far more insight into consumer trade-off decisions at the cost of greater complexity.
How can I increase my WTP?
Suppose you’ve calculated the total amount your customers are willing to pay, and you’re not happy with what you’ve found. Can you change this number? Thankfully, yes.
Willingness to pay isn’t a static value. It is constantly in flux based on the metrics mentioned above, many of which you may have an influence over. WIth that in mind, there are a few clear-cut ways you can increase your WTP.
Increase brand awareness
Your brand is often just as important as, and sometimes even more important than, the product itself. Luxury brands are a great example of this. Consider two otherwise identical shirts, one sold by Gucci and the other sold by Old Navy—one of these is absolutely going to command a higher price than the other.
Clearly express your product’s value
If your product’s value isn’t clearly articulated to your customers, that will have a significant impact on your customer’s WTP. They need to see the full benefit of your product before they can hope to assign it a fair price. If your marketing doesn’t highlight the right features or benefits, then you can’t expect an appropriate WTP.
Consider influencer marketing
Influencer marketing is a great way to create an aura of popularity around your product, even if it doesn’t exist yet. Consumers often rely on the opinions of their peers to make purchasing decisions. This is another avenue towards strengthening your brand, an important lever in controlling your customer’s WTP.
Are you sensing a pattern in some of these methods? They all rely on the consumer’s perception of your product. While a customer’s willingness to pay is absolutely dependent upon material facts, it is also heavily influenced by more emotional concepts. How popular your product is, how premium it appears—these are all key factors you should attempt to influence.
Do you know how much your customers are willing to pay?
The amount your customers are willing to pay can reveal a lot about the health of your business and is an important factor in your overall pricing strategy. However, it isn’t the end-all-be-all for pricing. As we wrote in our
Pricing and Packaging article, there are many routes available to capture more customer value.
In our virtual event “The Vertical SaaS Roadmap to Revenue Expansion” we sat down with pricing experts to explore a few of the ways SaaS companies can boost revenue with smarter pricing strategies. The complete session is available below.
