Pricing It Right

To maximize revenues, or to maximize profits: that is the question. Pricing research has the answer.

Pricing research has become an integral element of marketing strategy. A comprehensive and refined approach that produces accurate, reliable data is essential in today's highly sophisticated and competitive marketplace. Take the example of the brand manager of an Internet service provider who wants to introduce "The Reference Center," a website that combines encyclopedic and other online resources to help kids with their studies. In this case, our brand manager has no idea what consumer perceptions of price might be and how willing would they be to purchase this new service. In the world of premium features offered on the Internet, everything from free to $20.00 per month might be perceived as reasonable. The most natural (and deceptively simple) question for the brand manager to ask would be, "How much can would you be willing to pay for this service?" To avoid under-valuing or over-pricing "The Reference Center," the company requires pricing research more sophisticated than bluntly asking the target market, "How much would you be willing to pay for "The Reference Center?"

The perfect price

There isn't simply one possible price for "The Reference Center" either. The typical economic course presents the downward sloping demand curve: as the price is raised, the quantity demanded drops, and total revenue falls. In the case of the new service, if the company increases the price of "The Reference Center" by X, the sales will fall by Y. However, most products exhibit a range of inelasticity. That is, demand may fall, but total revenue increases. It is the range of inelasticity that is of interest in determining the optimal price to charge for the product or service. Consider the following question: if the price of gas were raised 5ў per gallon, would you drive any fewer miles? If the answer is no, then oil companies might raise the price of gas such that the quantity demanded is unchanged, but total revenue increases. For the Internet service provider, the range of inelasticity begins where the maximum number of people would be willing to try "The Reference Center" and ends when total revenue begins to fall. The optimal price--where in this range the brand manager chooses to price "The Reference Center"--depends upon the pricing strategy.

To buy or not to buy?

A traditional method for determining what consumers are willing to pay involves the Monadic Price Concept Test. To determine the optimal price, researchers test "The Reference Center" three times, each time with a different price.

The results showed that the price point of $3.95 elicited significantly more appeal in "The Reference Center" (18%) than either of the other two other price points, which were equal in appeal (14%). As such, the conclusion would be that trial would be highest at $3.95 but that the trial curve would be inelastic from $5.95 to $7.95. Therefore, one interpretation would be that if the Internet service provider were willing to accept lower trial by pricing "The Reference Center" at $5.95, they could increase their revenue by jumping to $7.95, as the consumer is price insensitive between $5.95 and $7.95. While frequently used, Monadic Price Concept Tests are very blunt instruments for determining price sensitivity. The problem with this type of testing is that the data suggests that the range of inelasticity for "The Reference Center" is likely greater than it should be. Another drawback to this technique is that other than by straight interpolation, there is no way to determine the interest in the service at $4.95. The final limitation of this technique is that we have no way of determining if we would have greater interest for the new service at $2.95.

Price Sensitivity Meter

In order to better understand the price consumers are willing to pay for a particular product or service, Dutch economist Peter van Westendorp developed the Price Sensitivity Meter (PSM). The underlying premise of this model is that there is a relationship between price and quality and that consumers are willing to pay more for a higher quality product. Were this not the case, AOL and MSN would not be able to charge $21.95 per month, while other ISPs charge $9.95. In order to determine the price sensitivity of customers for "The Reference Center," researchers asked potential consumers four additional questions:

• At what price would you consider "The Reference Center" to be getting expensive, but you would still consider subscribing to it? (expensive)
• At what price would you consider "The Reference Center" too expensive and you would not consider subscribing to it? (too expensive)
• At what price would you consider "The Reference Center" to be getting inexpensive, and you would consider it to be a bargain? (bargain)
• At what price would you consider "The Reference Center" to be so inexpensive that you would doubt its quality and would not consider subscribing to it? (too cheap)

Key outputs of the model include:

The Indifference Price Point (IPP) occurs where the proportion of respondents who think "The Reference Center" is a bargain matches those that believe "The Reference Center" is expensive. The IPP can be considered the "normal" price for this service. If the Internet service provider chooses to price "The Reference Center" less than the IPP, they will lose potential profits. Pricing "The Reference Center" in excess of the IPP causes the sales volume to decline.

The Marginal Point of Cheapness (MPC) occurs where the proportion of respondents who think "The Reference Center" is too cheap matches those that believe "The Reference Center" is expensive. The MPC represents the lower bound of the range of acceptable prices.

The Marginal Point of Expensiveness (MPE) occurs where the proportion of respondents who think "The Reference Center" is a bargain matches those that believe "The Reference Center" is too expensive. The MPE represents the upper bound of the range of acceptable prices.

The Optimum Price Point (OPP) represents the amount at which an equal number of respondents see "The Reference Center" as too expensive and too cheap. This represents the "ideal" price for this service.

The range between the OPP ($3.58) and the IDP ($4.95) is typically the range of inelasticity.

Price and probability The Internet service provider can assume that the probability of consumers purchasing "The Reference Center" if they believe the service is either too cheap or too expensive is nil. In order to determine the probability of consumers purchasing "The Reference Center" if they believe the service is a bargain or expensive, researchers asked an additional two questions:

• How likely would you be to purchase "The Reference Center" at $ (the bargain price point)?
• How likely would you be to purchase "The Reference Center" at $ (the expensive price point)?

The addition of purchase probability questions allow for the integration of price perceptions into the model. By asking consumers the probability of purchasing "The Reference Center" at each price point, it is possible offer additional insight into the pricing question using the Trial/Revenue Curves. The trial curve for "The Reference Center" is generated by plotting the probability of purchase at each price point. The revenue curve is generated by multiplying the proportion of people who would purchase "The Reference Center" at each price by the price of the service. The apex of each of these curves indicates the price that will stimulate maximum trial and the price that will produce maximum revenue for the company. The difference between the point of maximum trial ($3.50) and the point of maximum revenue ($5.00) represents the relative inelasticity of "The Reference Center."

The price is right Both the Monadic Price Concept Test and the Van Westendorp Price Sensitivity Meter reveal about the same optimal price point for "The Reference Center" (around $3.58--$3.95). However, using exclusively the data from the Price Concept Test, "The Reference Center" brand manager might conclude that the best price for "The Reference Center" would be $7.99. Using the more comprehensive Price Sensitivity Meter and including probability testing shows that if the brand manager were to price "The Reference Center" at the price suggested by the Price Concept Test, both trial and revenue would decrease significantly. The greatest number of consumers would be willing to try "The Reference Center" at $3.50. The Internet service provider would achieve maximum revenue by pricing "The Reference Center" at $5.00. Therefore, the true range of inelasticity is between $3.50 and $5.00. Beyond these price points, pricing is very elastic; both trial and revenue would decrease significantly as price increases. A complete understanding of pricing options can be achieved by integrating consumers' price sensitivity, brand-price perceptions and the probability of purchase into pricing research. With this sophisticated approach, the brand manager can be assured that "The Reference Center" is priced right for both the consumer and the company.