There are many methods to determine prices for products. In this post, we will focus on three main approaches:
- Conjoint analysis
- Van Westendorp’s Price Sensitivity Meter
- Gabor-Granger method
There are several ways to do conjoint analysis but the most popular is called Choice-based Conjoint (i.e., CBC). In CBC studies, customers are presented with hypothetical products with different features and are asked to choose the product that best matches their preference. An example of a typical question in a CBC study is shown below:
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Thus, a question consists of different products (i.e., Products A, B and C) where each product is a combination of levels for the features in the study. For example, the first product A is constructed by combining ‘4 GB’ for ‘RAM’, ‘500 GB’ for ‘Hard Drive Space’ and so on. The idea behind a conjoint question is that customers will have to consider the trade-offs they are willing to make when making a choice of which product they prefer. Customers are asked several such conjoint questions and their choices can then be analyzed to address questions such as the following:
(a) What is the incremental price a consumer is willing to pay for a laptop with 8 GB RAM as opposed to a laptop with 4 GB RAM?
(b) What percentage of the market is likely to prefer a laptop of a particular configuration (e.g., RAM: 8 GB, Hard Drive Space: 350 GB, Price: $950)?
(c) How important are the different features for a customer?
(d) Are there segments of customers who value different features and thus are willing to pay different price premiums? If so, we can obtain information on the features the different segments value the most and associated price premiums.
Apart from the above analytical advantages, the conjoint methodology has two key advantages over other methods: One, it requires customers to explicitly consider the trade-offs they are willing to make and two, the methodology can incorporate competing products as part of the design. On the downside, the methodology requires specialized expertise in statistical analysis in order to answer all the questions outlined in (a) through (d) above as the only information we obtain are the choices customers are willing to make.
Van Westendorp’s Price Sensitivity Meter
As explained at Wikipedia, the Van Westendorp’s Price Sensitivity Meter (henceforth referred to as PSM) asks customers four price-related questions:
At what price would you consider the product to be so expensive that you would not consider buying it? (Too expensive)
At what price would you consider the product to be priced so low that you would feel the quality couldn’t be very good? (Too cheap)
At what price would you consider the product starting to get expensive, so that it is not out of the question, but you would have to give some thought to buying it? (Expensive/High Side)
At what price would you consider the product to be a bargain—a great buy for the money? (Cheap/Good Value)
The answers provided by customers are then analyzed to identify a range of price points that customers find acceptable. The PSM methodology is very simple to understand and the analysis is simpler than for conjoint analysis. However, does not offer the same rich analytical insights as conjoint analysis. While the implications of different price points on market share outcomes can be analyzed the PSM methodology is unable to offer an insight into incremental price premiums that consumers may pay, the degree to which they consider different attributes as important and hence the PSM methodology is unable to uncover any segments that may exist in the marketplace.
The goal of the Gabor-Granger method (henceforth referred to as GG) is to find the highest price customers are willing to pay. The usual approach to choose 5 price points and then ask customers a purchase intent question for a random price from among the 5 price points as shown below:
Will you buy product A if it were priced at $B?
If the customer answers either ‘Probably will buy’ or ‘Definitely will buy’ then they are asked the same question again but with a higher price point. If not then they are asked the same question again but with a lower price point. The process continues till we identify the highest price point the customer is willing to pay.
The highest price customers are willing to pay are then analyzed to generate a demand curve that shows how purchase tendencies change with price and a revenue curve that shows how revenues change with price. Similar to the PSM methodology, the GG method is simple to implement but comes with the same set of drawbacks as it does not offer the rich analytical insights that conjoint analysis does.
The rich analytical insights provided by choice based conjoint makes it a preferred methodology to address pricing related questions. However, if the business context does not require the additional insights provided by conjoint analysis then simpler methods such as the Van Westendorp’s Price Sensitivity Meter or the Gabor-Granger method may also be used.