How to Price your Products in a Competitive Market: A Case Study of a Line Extension for a Consumer Appliance
By Sara Farbry, Research Director
A global retailer offered a sophisticated water purification system in North America and Asia, but wanted to test the potential for a lower-end system that would cost less, be simpler to install and take up less space. Pricing was a critical decision for the product, not only because it would have an impact on demand, but because this new offering could cannibalize sales from the existing high-end product. The company faced many trade-offs in their decision-making. For example, a lower price would expand market reach, but would also reduce sales of the more expensive and more profitable alternative. A higher price would leave the door open to competitors. What price would optimize profitability?
eBrain conducted a pricing study for the client, the core part being a discrete choice exercise to gauge consumer behavior in a competitive context. A choice methodology is suited to a situation where demand is strongly affected by competing brands (e.g., how Brand X and Brand Y are priced), or by competing product offerings distributed by the same company (e.g., a budget and premium brand). Both situations occurred in this study. A choice study can also accommodate multiple price elements, which in this study included pricing for a base unit and replacement parts. Companies often face the decision of whether to profit immediately or to keep the initial price to consumers low in exchange for a long-term revenue stream such as replacement units, subscription costs, etc.
The task for respondents in a discrete choice study is to choose their desired course of action from a set of brand and product alternatives with different prices. In this study, consumers were presented with 16 scenarios, each with a different set of prices, and asked "given these prices, which brand would you choose, or neither?" From these choices, it was possible to derive the precise impact of pricing on demand, providing the necessary input for building a price/demand curve and optimizing the price, revenue and profitability. In this study, data were collected via online from consumers in the U.S. and a market in Asia.
One output that was provided to the client was a spreadsheet with a built-in demand function that allowed users to enter prices and obtain demand, revenue and profit estimates. The demand curves were constructed using the statistical model that best fit the data pattern. eBrain's client was then able to project the demand and revenue for its products with different prices. For example, they could answer a question such as: if the base unit of the new offering was priced at $150, and the replacement parts cost $10 a month, what would the demand be for the new offering? The simulation in this study also allowed our client to assess the impact of pricing of its existing, higher-end product on demand, and how the prices of both offerings affected overall market reach and revenue.
As a result of this initiative, the retailer was able to price its products at a level that met market share and revenue goals. They were also able to gauge what the total demand of their two competing products would be and how much their new offering affected sales of the original offering.
Research to the Rescue
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How to Get Valid (i.e., "Honest") Feedback from Your Customers for Product Pricing Decisions
by Gina Woodall, Vice President and Charles Colby, Chief Methodologist
It may seem like the easiest way to price a new consumer electronics product is to ask consumers how much they would pay for it. But in reality, it is likely to cause companies to under-price their products. Consumers know that their survey answers will affect the ultimate price on the shelf, so they are likely to play games with their answers and deliberately give a lower price than they are really willing to pay. So, can a company get valid feedback from its potential customers to optimally price a product? The answer is yes.
The simplest method involves using a "split sample" approach. Without being told the question is about pricing, consumers are asked their likelihood of purchasing a product 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.
Admittedly, the split sample approach assumes a very simplistic view of the market. In many cases, the price of a consumer electronics product will be influenced by competing products on the shelf. In this case, a more complicated price experiment can be conducted. Consumers are divided into groups based on two or more pricing variables in the survey. To illustrate, a survey sample might include 9 cells, 3 with prices A, B, and C for your Product X, and 3 with prices D, E, and F for competing Product Y. The demand for your product can be estimated based on two prices, the price for Product X and the price for Product Y. This design can be broadened to include multiple competing products too. In a highly competitive market, eBrain uses a more sophisticated approach – a discrete choice study (see case study) – to assess the impact of multiple prices on consumer demand.
Sometimes, consumers cannot tell you whether they are likely to buy your product without understanding the value they would receive from it. A trade-off survey approach, such as a conjoint or discrete choice model, can be designed that allows consumers to trade-off between price and product features. A conjoint design asks consumers to rank order or rate hypothetical products. Each product varies in price 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 high speed internet access on a mobile phone is worth an additional $10 in the price of the phone, while a walkie-talkie feature is only worth $2.
Consumers also use the price of a consumer electronics product as information about its quality. This can result in price/demand relationships that defy the rule of downward sloping demand when the price of a product rises. To illustrate, two DVD players may be exactly the same in features and quality, but one is priced at $29.99 and the other is $99.99. The $99.99 DVD player sells better because customers do not mind paying for what they assumed to be a better product.
A Price Sensitivity Analysis can be conducted to determine prices that are most consistent with the positioning of a product's quality. The approach determines what prices consumers consider 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, and the results are used to determine how price affects perceptions of the brand.
There are many ways you can use potential customers' feedback to help price your consumer electronics products. The choice of methodology depends on the situation, including the existence of cross-elastic products, the influence of product features, and the role of price in communicating quality.
| Events |
Register Now for a Free CEA/eBrain Webcast on Pricing! "Determining the Optimal Price for Your Product: How Much Will Your Customers Really Pay?" will teach you how to use consumer feedback to help guide pricing decisions for your consumer electronics product. The webcast will be on Thursday, June 21, 2007, 2-3pm ET / 11am-Noon PT. Click here to register for this free webcast. Please note: Registration ends Wednesday, June 20.
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