Willingness to Pay and Reference Price

Take a look at this Yelp review

 went through a mess of salons to get some price ideas for mens haircut and I am sorry, I’ve been paying 10-15 dollars for a haircut for 22 years. I cannot and will not pay $80. That’s the price of a new video game! I called the salon and I got a price of $16 for mens! $1 more than my maximum?

ref-priceWhat do we see here? An illustration of the fact that,  as customers we do not walk around with a price we are willing to pay for every product and service. To a large extent this number is shaped by experience and what we have seen and trained to pay. That becomes our reference price.

Any price above the reference price – like the $16 vs. $15 – is seen as a pain or price increase that need to be reconciled. And you can see how this reviewer felt after paying $1 over his old reference price.

Reference price is not a fixed number, fortunately for all of us marketers. It is malleable – newer products, cost justifications, options, or extras – can be used to move it. If the customer is convinced they are seeing value for the extras they will happily move to the new higher reference price and will settle there until next movement. The same reviewer ends with,

I can truly say with a tremendous amount of confidence. I have found my PERMANENT salon.

Back to Willingness to Pay – the $80 price limit this reviewer quotes is his absolute reservation price. No amount of benefits, features, brand, customer service etc. can move this user to pay $80 for a haircut. His willingness to pay is somewhere close (tad below ) that number. You should know that this is just one customer and may be there are lot of them like him while there are many others who are more than willing to pay hundreds of dollars for a haircut (or the salon).

What do these two parameters mean to you as a marketer or entrepreneur?

First stop asking questions like,

“Would you pay $3.99 for my product?”

Because customers do not know.

Second do not be afraid of raising prices, as long as you understand the effect of reference price and execute this change correctly.

Finally, if your product used to be free and you are considering pay model do not assume no one will be willing to pay that price. You need to find those who value it enough, target them and move their reference price sufficiently to get the price that is fair share of your value add.

How do you manage your pricing?

See also: Multi-version pricing at salons.

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