Perspectives on Pricing Services

Pricing studies are perhaps the most technically challenging form of market research. A variety of tools are available for determining the impact of price on marketing success. The following identify some issues to consider in deciding how to price a service, as well as techniques used by researchers to address these issues.

Issue #1: Direct respondent feedback about prices may not be valid. A simple way of determining the price for a product would be to ask consumers outright what they think the price should be. This simplistic approach raises validity issues. For example, a consumer may say a product should be priced at $100, but may be willing to pay considerably more. An approach that directly links behavior to price in a survey, such as asking for the highest price one is willing to pay, is subject to “game playing.” Respondents may realize that their answers will be used to set the real price for a product or service, and deliberately state a low price threshold.

The best way around this problem is through the use of the “split sample” method. Without being told that the question is about pricing, a respondent is asked to indicate the likelihood of purchasing a product or service given the price is X. The survey sample is randomly divided into two or more independent samples, and the purchase likelihoods at different price levels are used to construct a demand function.

Consumer demand curve

Issue #2: The demand for a product or service can be influenced not only by its own price, but by the price of competing and complementary products or services. This might include the price of a competitor’s offering, a substitute service, a product used in conjunction with the service, or the price of different service options. For example, if a basic and enhanced option of a service were offered, consumers would switch to the basic option as the price of the enhanced option increased.

To account for multiple pricing effects, a price experiment can be introduced into a survey. Instead of the simple split sample design described above, a survey sample might be divided into groups based on two or more price variables. To illustrate, a study sample might include 9 cells, three with prices A, B and C for Service X, and three with prices D, E and F for Competing Service Y. The demand for service X can be estimated based on two prices: the price of Service X (the lower the price, the higher the demand) and the price of Service Y (the higher the price, the higher the demand for X). We have implemented such studies with as many as 11 competing products, testing four price levels for each. It might seem that such a design would involve tens of thousands of sample cases, but several variables can be captured with a relatively small sample using a “fractional factorial design.”

Issue #3: Respondents may not be able to predict their own behavior related to price. A respondent in a study may not be fully aware of exactly how they would evaluate price unless given time to deliberate on the value they are receiving in return. A trade-off design gets respondents to consider the trade-off between pricing elements and service features. This can be illustrated by one of the more common trade-off designs, a conjoint, which asks respondents to rank order or rate hypothetical product/service offerings. Each offering varies the prices and features offered in a systematic manner, making it possible to derive the utility a consumer associates with different prices and features. For example, a study might show that a 3 point annual cap on a mortgage is worth a .75% higher rate, while the convenience of a fast approval is worth .25%.

Trade-off designs are valuable for creating price/demand curves and simulating preference and demand for different product offerings. One of the major criticisms is that some designs may overstate the importance of price in the purchase decision. Such designs often require long questionnaires and are difficult to administer, but Rockbridge has developed an approach that minimizes the burden and can be implemented by telephone.

Issue #4: Buyers may use price to assess quality. A Dutch Economist observed that buyers may use price as information about products. This pattern of behavior can result in price/demand relationships that defy the rule of downward sloping demand. To illustrate, a club once decided to raise money at their booth at a town festival by selling apples. Two baskets of identical apples were placed at the club’s booth, but by mistake, one basket was labeled 5¢ and one was labeled 10¢. The 10¢ basket was the first to sell out, since buyers didn’t mind paying for what they assumed were the “better” apples.

A pricing method we call Price Sensitivity Analysis can be used to determine prices most consistent with the positioning of a product’s quality. Such an approach involves determining what prices are assumed to be “cheap,” “expensive,” “too cheap” (so quality is doubted) and “too expensive” (the point where the product is priced out of the market, even if it is a premium buy). Special question wordings are needed to capture this information in a survey, but the results can be used to produce a powerful analysis for determining how price affects perceptions of the brand.

Issue #5: The product or service is so radical that it is not possible to judge price. Once in a while, a new product or service represents a true “leap frog,” so dramatically different from past alternatives that a buyer cannot easily judge the price, and the marketer is puzzled as to what price to charge and how it can be justified. One example was an early document reproduction process that replaced mimeograph machines and carbon copies in the 1950s. Market researchers documented the costs and benefits of the new process, including tangible benefits (e.g., labor savings, reduced materials) and intangibles (e.g., less mess, faster turnaround), and found that a huge savings would result from adopting the new process (as you might have guessed, the new process was the photocopier). Modern examples of such innovations include software systems, networks, and even reproduction processes that will replace the copying machine.

We call the methodology for documenting the value of an innovation “Net Benefit Analysis.” Using a survey approach, all the costs of the old and new technology are documented in detail, and calculations are made of the payback from making a change at different price levels. By understanding the true economic benefit, it is possible to establish logical guidelines for setting and justifying prices. The methodology is also useful for helping technology managers identify the benefits that product features have for buyers, and to formulate sales cases that demonstrate value to customers.

Clearly, researchers have many options for answering pricing questions. The choice of methodology depends on the situation, including the existence of cross-elastic services, the influence of product features, the role of price in communicating quality, and the relative newness and complexity of the service.