When a company has to determine the price of a new product or service, it has two choices. Either it can set a price based on gut-feeling, production costs and/or competitors’ prices, all of which are the most common traditional methods. Or it can ask the customer.
If you use the cost-plus or the competition-based method, you risk offering a price to the market that is far removed from what the customer is actually willing to pay. Production costs, for instance, may not accurately reflect the customer’s perceived value of your product or service, while competitors may not have done their homework very well so it could be folly to put your faith in their prices. Either way, setting a price “the old way” carries the risk of your alienating customers and/or causing revenue losses.
In the pricing projects we have worked on in the media industry, where the customers’ willingness-to-pay always determines prices, we typically achieve substantial margin improvements. In fact this has proven to be the most profitable and successful pricing strategy in all our price-optimization projects so far. The strategy also leads to more satisfied customers, improved customer relations and stronger brands.
But of course you cannot simply ask the customer how much he or she is willing to pay. Such an approach seldom brings you an honest answer. You must instead present the customer with a multitude of product or service offer combinations, all tagged with different prices and with varying payment intervals. Paying 9 euros a month, for instance, is perceived as being less expensive than having to shell out 108 euros for a full year. Additionally, the contractual time frame of the offering plays an important role in how it is evaluated by the customer. The sooner you are released from a contract, the less expensive the offering is perceived as being.
By systematically altering the terms of the various package combinations, all prices, cross-price elasticities and customer choices can be very precisely mapped out, assuming of course that the customers included in the study are representative of the marketplace.