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Glossary
18.06.2024
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Price Sensitivity: Definition, Factors & How to Measure It
There are various reasons why you might lose customers, and one of them is a poor pricing strategy. Ignoring price sensitivity and failing to predict customer reactions to price changes can lead to a decline in sales and revenue.
Understanding price sensitivity is crucial, as it helps you determine how price fluctuations impact sales volumes. In this article, we explore the concept of price sensitivity and the factors influencing it. We also explain how to measure it using Peter van Westendorp’s Price Sensitivity Meter.
Price sensitivity indicates how changes in a product’s price affect people’s willingness and readiness to buy it. Simply put, price sensitivity is a marker of the extent to which demand depends on price.
High price sensitivity means that even small changes in price can significantly affect the sales volume, while low price sensitivity indicates that price fluctuations have a minor impact on demand.
Product and service categories have varying levels of price sensitivity. This is related to several factors: particularly, the product’s value to the consumer and the breadth of market offerings. For example, in an online electronics store, a mid-range smartphone may have high price sensitivity, whereas a branded original charging device may have low price sensitivity.
If the price of a $450 smartphone increases by 10%, consumers might choose an alternative brand or model. A charger, on the other hand, is a relatively inexpensive and essential accessory. If it costs $25, a slight price increase (say, by $3) is unlikely to significantly affect consumers’ purchasing decisions.
Importance in Market Dynamics
Price sensitivity is a crucial factor influencing the behavior of your target audience. When price sensitivity is high, your potential customers may:
Forego purchasing: If the price of a desired product seems too high, potential customers might forego purchasing it.
Seek alternatives: Potential customers might find product substitutes or sellers offering a lower price.
Change their purchase frequency: A price increase can reduce demand from customers, leading to a decrease in sales volume. Conversely, product discounts can encourage more frequent purchases.
Data on the price sensitivity of various products and categories should be used to optimize your pricing strategy. By analyzing customer behavior and testing different prices, a category manager can determine the optimal selling price to maximize profit and sales.
Additionally, understanding differences in price sensitivity between product categories is important when launching promotions. A category manager can set discounts according to the price sensitivity level of each category (large discounts on smartphones, smaller ones on accessories) or create bundles, pairing a highly price-sensitive product with a less price-sensitive one.
Price Sensitivity and Elasticity of Demand
Price sensitivity and price elasticity of demand are interrelated concepts describing customers’ reactions to price changes.
Price sensitivity is a qualitative parameter indicating how price changes affect consumers’ willingness and readiness to buy a product.
Price elasticity of demand is a quantitative parameter showing the percentage change in sales volume with a 1% change in price.
High price sensitivity usually corresponds to elastic demand, whereas low price sensitivity corresponds to inelastic demand.
For example, premium-segment smartphones have high price sensitivity and elastic demand: even a slight price reduction (by 5%) is likely to significantly increase sales. On the other hand, an HDMI cable is an example of a product with low price sensitivity and inelastic demand.
Factors Affecting Price Sensitivity
Various economic and psychological factors, as well as the competitive environment, affect price sensitivity:
Income level: People with higher incomes are less sensitive to price changes. Conversely, low-income buyers are more price-sensitive, tracking and comparing prices across different stores.
Macroeconomic situation: In unfavorable macroeconomic conditions, such as during a recession or war, consumers become more attentive and sensitive to prices.
Brand loyalty and habit: Customers accustomed to a specific brand or product are less sensitive to its price fluctuations.
Market competition: In highly competitive niches, consumers have more options. If one supplier raises prices, customers can easily switch to another offering a lower price.
How to Measure Price Sensitivity
The most popular method for determining price sensitivity is Peter van Westendorp’s Price Sensitivity Meter (PSM). It allows you to determine the optimal price range for a new product by assessing consumers’ perceptions of its benefits and their willingness to pay for it.
Key Steps to Measure Price Sensitivity Using the van Westendorp Method
Consumer Surveys:
Respondents are shown a product and then asked four key questions:
At what price would you consider this product to be a great deal? (Good value)
At what price would you still consider purchasing this product, but it starts to seem too expensive? (Getting too high)
At what price would you consider this product too cheap and question its quality? (Too cheap)
At what price would you consider this product unacceptably expensive? (Unacceptably high)
Respondents evaluate the price of a particular product within the range of very cheap to too expensive.
Creating a Van Westendorp Graph:
The responses to each question are aggregated and presented as curves for each of the four price points.
Price sensitivity measurement
Analyzing the Intersections of the Curves:
Point of Marginal Cheapness (PMC): The point where an equal number of people consider the product too expensive and too cheap
Point of Marginal Expensiveness (PME): The point where an equal number of people consider the product a great deal and unacceptably expensive
Optimal Price Point (OPP): The point where an equal number of people consider the product unacceptably expensive and too cheap
Finding an acceptable price range
Acceptable Price Range: Between the point of marginal cheapness and the point of marginal expensiveness.
Advantages: Simplicity and clarity; quick results
Disadvantages: Does not account for price elasticity of demand; results depend on subjective factors (e.g., respondents’ mood and context)
Conclusion
Price sensitivity is a marker that helps online stores better understand their customers and more effectively adjust their sales strategies. Understanding price sensitivity is crucial for setting optimal prices, launching effective promotions and sales, and creating targeted marketing campaigns aimed at specific customer groups according to their price sensitivity segmentation. Therefore, it is an important indicator that helps online stores adapt to their customers’ needs, improve marketing strategies, and increase business efficiency.
FAQ
What is high price sensitivity?
High price sensitivity means that buyers strongly react to price changes, and even a slight increase in the price of a product can make customers change their buying behavior and start looking for alternatives.
What products are price-sensitive?
People spend a significant part of their budget on consumer goods, clothing, fuel, electronics, and other product categories. Accordingly, if prices rise for products in these categories, buyers may stop purchasing those products, reduce their spending on those products, or switch to cheaper alternatives.
What is price insensitivity?
It means that people do not change their buying behavior, do not pay attention to price fluctuations, and continue to buy familiar or desired products.
How can you calculate price sensitivity?
You can use various methods to calculate price sensitivity, such as price laddering or the Westendorp method. It is based on a survey of consumers about their willingness to buy products at different price levels to determine critical price thresholds.
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