May 18, 2020

Why you should know what price your customers are willing to pay

Many entrepreneurs determine the pricing of their products based on internal or market related factors such as actual costs, desired profit margins and/or the prices of competitive alternatives. However, research has shown that customers are often willing to pay a different price. In this blog, I'll show you how profitable it can be to know what price your customers are willing to pay and adjust your pricing accordingly.

Let's start with a short introduction to willingness to pay.

Willingness to pay is the maximum amount of money a customer is willing to pay for a product or service.

What I personally find fascinating about willingness to pay, is that this amount differs from customer to customer. We all know that there are customers who are willing to pay a higher price for better quality, but people are even willing to pay different prices for the same product - especially in cases where it is difficult to compare products with alternatives. And there are some marketing tactics which enable you to actually charge these different prices.

Let's illustrate this with an example.

Imagine that you have developed a new innovative consumer product, for example a cool box that is much cooler than existing cool boxes. You know it costs $ 70 to make, sell and deliver one cooler to a customer and are considering a markup of 100% (which is a margin of 50%). The prices of existing cool boxes range from $ 25 to $ 150, but even the most expensive model cannot be compared with your product in terms of product features. Based on this information, you decide to launch the product at a price of $ 149.

The picture below shows the demand curve of this product:

A demand curve visualizes the relationship between price and quantity: the lower the price, the larger the number of units sold.

At a price of $ 149, your profit per unit sold will be $ 79. The demand curve shows that you are likely to sell 302 items at this price. So your total profit at this price will be 302 x $ 79 = $ 23,858.

That's nice, but you are an entrepreneur and want to earn the maximum profit. Therefore you decide to investigate the willingness to pay of your customers and if there are any possibilities for segmentation. This analysis shows that your customers can be divided into 3 different groups: a 'premium segment' that is willing to pay $ 249, a 'medium segment' that is willing to pay $ 199 and a 'value segment' that is willing to pay no more than $ 129.

What does this mean for your profit?

Well, in this case you are selling 102 items for a price of $ 249, 100 items for a price of $ 199 and 140 items for a price of $ 129. Taking into account the cost price of $ 70, your total profit in this case will be (102 x $ 179) + (100 x $ 129) + (140 x $ 59) = $ 39.418.

This is an increase in profitability of 65%.

Based on this research, we can conclude that:

- The value segment is not willing to pay your original price of $ 149. With this price, you would therefore have missed 140 sales;
- The premium and medium segments are willing to pay much more than your original price of $ 149. With this price, you would therefore have missed the opportunity to earn extra revenue and profit.

So this is why you should know what price your customers are willing to pay.

Are you wondering what price your customers are willing to pay and how I can help you to improve your profitability? Then take a look at the solutions I have to offer or start a conversation to learn more.

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