The ultimate guide to willingness-to-pay and the power of a personalized perspective

The ultimate guide to willingness-to-pay and the power of a personalized perspective

Pricing is a crucial aspect of any business, yet many product teams are hesitant to test their pricing strategies. This is surprising considering that pricing is one of the biggest levers to growth. However, only a small percentage of companies have run pricing studies or A/B tested pricing changes. It's time for businesses to realize the potential of pricing and start investing in it sooner rather than later.

One popular method for pricing studies is the Van Westendorp (VW) method, also known as the price sensitivity meter (PSM). This method involves asking people four questions to determine the lowest and highest price they're willing to pay for a product or service. While the VW method is simple to implement, it has a significant flaw known as hypothetical bias. Under hypothetical settings, people tend to state higher valuations than their actual willingness to pay. This bias skews the results and makes it difficult to accurately gauge customers' true willingness to pay.

To overcome the hypothetical bias associated with the VW method, economists have developed incentive-compatible pricing methods. These methods provide participants with an incentive to report their true willingness to pay. One such method involves asking participants to write down the maximum amount they'd pay for an item, and then a random number is selected. If the participant's written amount is higher than the random number, they must purchase the item at the random number's price. This method ensures that participants think carefully about their willingness to pay and reduces the likelihood of misreporting.

Another pricing method that addresses the issue of hypothetical bias is the multiple price list (MPL) or Gabor-Granger method. Unlike the VW method, which asks participants to name their price, the MPL method presents respondents with a list of prices and asks them to say yes or no to each price. This approach mimics real-world scenarios where customers are presented with set prices and have to decide whether to make a purchase or not. However, recent research suggests that the MPL method may lead to underestimating the value of products. Participants may focus on the opportunity cost of money when considering each price, which could decrease their willingness to spend.

On the other hand, discrete-choice-based pricing studies involve presenting participants with multiple product options that have different features and prices. Participants are then asked to choose the product they would buy. This method closely resembles real-world decision-making processes and provides insights into relative willingness to pay. However, conducting discrete-choice-based studies requires strategic choices on product bundles to avoid a lengthy questionnaire that could cause decision fatigue among participants.