Pricing Products the Silicon Valley Way - Van Westendorp Model
Pricing should not be set and forget. Leading companies are experimenting with new pricing strategies all of the time. Optimising pricing is an ongoing process of exploration.
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Introduction
Setting the price for your new product is one of the most important elements of your business model. Product pricing should not be taken lightly.
Product pricing has a very direct impact on the bottom line of your business. As prices are increased or decreased, it has a flow through to operating profits.
The pricing ecosystem is challenging and complex for any business. There are many tightly interconnected variables that influence product pricing and customer demand.
Some key considerations include customer willingness to pay, competitor pricing, market conditions impacting demand, product value perception, product input costs.
The van Westendorp pricing model is a popular way to gauge consumer perceptions of product value.
Combine this approach with qualitative research methods and targeted experiments to get clearer on the right price for your new product or service.
Overview of product pricing
Pricing is how you communicate the value of your product.
Your revenue and pricing are like an arranged marriage. They’re inextricably tied together.
Price your product too low and you leave value on the table. Price your product too high and you throttle customer demand.
“7 out of 10 companies do not do their pricing research” - ProfitWell
There are so many things that can potentially go wrong with pricing. If people can’t understand how your pricing model works, they’re not going to sign up for your product.
The arranged marriage can be headed for divorce very quickly.
Common pricing strategies
There four most common pricing strategies are:
Best judgement pricing
Cost plus pricing
Competitor based pricing
Value based pricing
1. Best judgement pricing:
As the name suggests, best judgement pricing involves using the collective wisdom, knowledge and experience of your team to determine the pricing strategy for your products.
This approach is the least effective and not recommended. Your pricing strategy is based on a host of assumptions about how customers perceive your product and their willingness to pay.
“Best judgement pricing is not a great way to develop a profitable product”
Effectively, you’re just guessing.
2. Cost Plus pricing:
Cost plus pricing works by calculating how much it costs to make, sell and deliver the product, then adding a profit margin on top.
This approach is more effective than best judgement pricing as, at a minimum, you’ll break-even, if not make some money.
“The problem with cost plus pricing is that customers are often willing to pay more than a cost-plus price. This approach can dilute your value”
Also, with many new products now delivered via a SaaS business model, the marginal costs of adding more customers to your service can be low. Cost plus pricing doesn’t take this into account.
3. Competitor based pricing:
When using a competitor-based pricing strategy you benchmark your pricing based on that of your competitors.
There are likely already pre-existing pricing anchors in the marketplace with existing brands and similar products. You price relative to the existing market anchor, based on your level of product differentiation, product quality and brand equity.
For example, if you’re entering the energy drink market, Red Bull is the price anchor in the marketplace.
If your product is not differentiated to Red Bull and, you try and price higher than Red Bull, it’s highly likely that you’re not going to sell many units.
In the B2C space it’s pretty easy to get your hands on competitor pricing.
If a competitor pricing strategy is your play, you’re placing a great deal of faith in your competitors – that they’ve got their pricing right.
“Remember, many companies are just guessing with price”
Be careful that you don’t make the same mistakes as others.
4. Value-based pricing:
With value-based pricing, you base the pricing of your product on value that your product provides.
This is a more involved and sophisticated approach than the previous three pricing strategies.
This approach is customer centric. You’ll need to conduct research with your customers to understand how and why they perceive the value of your product in order to set the right price.
While more time consuming, the key benefit of a value-based pricing strategy is that it gets you much closer to your target customers.
You’ll be able to figure out why customers use your product, what problem your product solves for customers, what features are most valued and what new features could amplify your product further.
Mistakes that businesses make with pricing
There are many different pricing strategies applied by businesses the world over, across SME’s, mid-tier companies and large enterprises.
One of the key challenges that many of these businesses face is that they get their pricing wrong.
Either you price too low, leaving value on the table, and don’t make enough money. Or you price too high, and nobody wants to buy your product.
Where things get difficult is when a company is launching a new innovation into a new market. It can be challenging to identify an optimal price point.
There are potentially no pre-existing price anchors in the market.
In this case, most companies will go and survey their target customers to understand how much they are willing to pay for the new product.
This approach is flawed, and inherent biases exist with this approach.
Customers aren’t really a good judge of determining how much they will pay until the actual product is put in front of them.
There are many psycho-emotional factors that come into play in the purchasing process.
“Many individuals have a really difficult time answering questions like ‘how much would you pay for this?’ since a lot of purchasing decisions come down to emotions”
– Brian Balfour
Customers commonly understate their willingness to pay. Either they honestly don’t know how much they’ll pay, or are just low-balling to pay less.
The pricing cycle of doom!
What is the van Westendorp pricing sensitivity model?
The van Westendorp pricing sensitivity model provides a more comprehensive way to measure customer willingness to pay.
Rather than asking target customers how much they’ll pay, the model determines an acceptable pricing range instead.
The van Westendorp pricing sensitivity model has gained popularity with startup and scaleup businesses in Silicon Valley.
It is the same model that many SaaS businesses are using to nail their pricing.
Conceived in 1976 by Dutch economist Peter van Westendorp, the van Westendorp Pricing Model is a method for gauging consumers’ perceptions of the value of a product.
Also referred to as the Price Sensitivity Meter (PSM), this technique evaluates a range of price points under consideration.
The approach seeks to identify the price point where consumer interest begins to decline due to the product being too expensive.
It also aims to identify the price point where consumers think the product is too cheap, and perception of value decreasing.
Using the van Westendorp model for your pricing strategy
Basing your pricing strategy on customer research is one of the best ways to understand how much your customers are willing to pay for your product.
A holistic approach to your customer research is what’s required. There’s no one tool or method that is superior.
“Devising your pricing strategy is a process of search and discovery”
Setting price is a mix of art and science.
Try using a combination of different research approaches to yield an optimal outcome – qualitative interviews, quantitative research and experimentation.
There are four steps to using the van Westendorp model:
Define your customer personas
Conduct your research
Crunch the numbers
Chart your data
STEP 1 - Define your customer personas
Before trying to measure price sensitivity, you need to have a very clear understanding of your key markets, customer segments and personas.
Each of your customer personas has different needs and drivers, therefore different perceptions of value.
You will need to measure price sensitivity for each of your different personas separately.
STEP 2 - Conduct your research
To gather meaningful data for your analysis, you want to make sure that you’re engaging with the right people.
It’s best to conduct your research with the following people:
- Existing customers
- Product Qualified Leads (PQL)
As for how you gather the data:
- Interviews
- Surveys (SurveyMonkey)
Engaging with people to conduct a pricing specific interview is a bit weird. The likely uptake will be pretty low. The pricing discussion in an interview would need to be part of a broader discussion around improving your product.
Survey is probably the best option. Faster, less invasive and an easy way to communicate pricing ranges and options.
In the van Westendorp model, customers are asked four questions:
At what price do you think the product is priced so low that you question its quality?
At what price do you think the product is a bargain?
At what price do you think the product begins to seem expensive?
At what price do you think the product is too expensive?
You can either provide customers with a range or scale or let them provide open ended answers.
STEP 3 - Conduct your research
Collate all of the information and data from your interviews or surveys.
Ensure that the data is organised in a way that you can easily chart and plot the information. MS Excel will be your go to here.
STEP 4 - Chart your data
You’ll need to start by plotting your data on a Price Map graph. See the chart below.
On the X Axis will be the price that people say they’re willing to pay. On the Y Axis will be the percentage of people who selected each price range.
It’s important to pay attention to the points of intersection.
Where the “Too Cheap” and “Bargain” lines intersect is the Point of Marginal Cheapness (PMC). This is the point where people consider your product cheap, with perception of value declining.
Don’t charge less than the PMC. This is your lower limit of pricing.
Where the “Not Expensive” and “Too Expensive” lines intersect is the Point of Marginal Expensiveness (PME).
This is the best place to set your pricing – where people consider your product to be not too expensive.
This is your upper limit of pricing.
Next, you’ll need to determine the acceptable range of prices.
Once you know your PMC and PME, you’ve found your acceptable price range – the space between both of these points.
As relayed by your target customers, this is the ideal range of your pricing.
Between these boundaries you can run a series of experiments to understand the impacts of pricing on customer demand.
Additionally, the intersection of the “Too Cheap” and “Too Expensive” lines is called the Optimum Price Point (OPP). In the below graph, the OPP is around $600.
This price is located between the PMC and PME, and in theory, this price is the optimal price because it minimises the number of people who are dissatisfied with the price of your product one way or the other.
Benefits
The major benefit of the van Westendorp model is that it is a data-driven approach for understanding customer sentiment, providing a range of acceptable prices the customer may pay.
Bias is reduced because customers are not asked whether they will pay an exact price point, rather a number of questions that help you triangulate true willingness to pay.
As previously stated, no model is fool proof.
It’s always best to test your assumptions by running experiments in-market.
Live testing incorporates all of the possible elements surrounding a person’s decision to convert into a customer. This includes all of the emotional aspects, the context and the intents, which are impossible to capture via a survey.
Customers can more reasonably assess the product offer in totality, also against competitor products, rather than in isolation as a pure conceptual construct.
“Marketplace data should always take precedence over survey results”
Pricing is an ongoing process
Pricing is not set and forget.
Pricing is an ongoing process of experimentation that should be viewed as flexible, dynamic and responsive.
Pricing should also be able to respond to changing customer needs and marketplace conditions.
Pricing will naturally change, and be revised, through organisational maturation, product lifecycle and customer tenure.
Pricing can so often be given little consideration, being not much more than an afterthought, the poor country cousin who receives little attention and love.
However, it is super important.
“Pricing is tightly linked into all of your strategies, whether they be market expansion, geographical expansion, new segments or adding new products and features”
Therefore, your pricing should be scalable in line with your product. As your customers grow and become more successful, so should your revenue growth.
Conclusion
Pricing is one of the most important elements of any business. It shouldn’t be taken lightly.
Pricing can contribute heavily to organisation success or failure.
Entering a new market with a new product can be a challenging prospect. It can often be difficult to set an optimal price without any reference points or anchors.
The van Westendorp pricing model helps businesses to understand customer pricing sensitivity and willingness to pay using a more methodical and data-driven approach.
Combining the van Westendorp model with in-market experimentation provides a holistic way to validate and test your pricing assumptions.
Marketplace data from customers should always win out.
Don’t treat your pricing as set and forget.
Leading companies are experimenting with new pricing strategies all the time.
Need help with your next experiment?
Whether you’ve never run an experiment before, or you’ve run hundreds, I’m passionate about coaching people to run more effective experiments.
Are you struggling with experimentation in any way?
Let’s talk, and I’ll help you.
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