Careful what you ask for in WTP studies

In a seminal work titled “How the questions shape the answers” published in American Psychologist (1999), Norbert Schwarz describes how responses are influenced by question wordings, format and context. Schwarz writes,

“Self reports a fallible source of data and minor changes in question wording, question format or question context can result in major changes in the obtained results”

This is especially a more pronounced problem when it comes to survey questions that ask customers for their willingness to pay (WTP) for a product. When you directly ask a customer questions like:

  1. will you buy this product at  10?
  2. how much will you pay for product?  a) $4   b) $8   c) $10   d) $10    e)  $12
  3. will you buy this product if this were not offered free any more?

The researcher run the risk of getting answers that are not in any way  a true representation of what the customers will actually do. These kinds of questions assume that customers know how much they value the service and  customers are willing to disclose it. Another flaw in WTP studies is treating customer WTP as a fixed number in the minds of customers while it has been shown to be malleable (Thomas and Menon, Journal of Martket Research, 2006).

I saw a report from Forrester research on US customer WTP for online newpapers.  I admit I have not read the report but only their promotional blog post about it. The report claims 80% are not willing to pay for content From what I read I am not satisfied with study or its methods. The survey question was:

If the Web sites for the newspapers and magazines you read were no longer free, how would to prefer to pay for that content?

  1. Wouldn’t access them if I have to pay
  2. Subscription access to access all online content
  3. Subscription that combined print, web, and mobile device access
  4. Individual payment for each article read

The biggest flaw I find is anchoring – the question clearly reminds that the content has been free. The question  was too generic, asking  about newspapers and magazines you read and not about a specific newspaper or magazine. The respondents could be thinking of all newspapers, even those they read occasionally while answering this question.  There were no questions reminding respondents of value they get or to rank the online news sources by importance.   If the question had been,

If your most favorite newspaper cannot financially support the free online access, would you be willing to pay in one of the following ways?

  1. Subscription access to access all online content
  2. Subscription that combined print, web, and mobile device access
  3. Individual payment for each article read
  4. Wouldn’t access them if I have to pay

… the results would have completely different.

Based on their survey, Forrester  recommends:

  1. Publishers should continue to offer free, ad-supported products to the 80% of consumers who won’t pay for content online; and
  2. Publishers should offer consumers a choice of multichannel subscriptions, single-channel subscriptions, and micropayments for premium product access.

I do not agree. Even if we assume the 80% number is correct, does providing free provide higher profit than charging?  Do newspapers rally want higher reach (because of the Ad revenue)?

If a newspaper publisher really wants to find customer willingness to pay for content they need to do more targeted study of their readers,  use methods like Conjoint analysis to tease out the segments, how much customers in each value the product and focus on methods that help improve customer reference price before charging for content.

The net is the results are unreliable and Forrester’s recommendations are plain wrong.

Will The Customer With High Willingness To Pay Please Step Forward

Within any given customer segment, however  specifically defined it is, are individuals who ultimately are different from everyone else in the same segment. Demographics, psychographics, buying behavior  etc all go only so far. Every individual ultimately has unique preferences, interests and willingness to pay  – all of which are non-static and highly malleable. The challenge is in finding the exact willingness to pay of each customer at any given point in time but the opportunity for the marketer is to create product versions, promotions and messaging that nudges the customers with higher willingness to pay to step forward or those with lower willingness to pay to step backward. In either case the front row of customers will be those that are the  least price sensitive.

Here are three case studies of marketers nudging the higher willingness to pay customers to identify themselves:

  1. For their new animated movie Frog and the Princess, Disney is  holding two and half weeks’ worth of premium-priced screenings at single theaters in New York City and Los Angeles. Ticket prices? $20 to $50. Disney says it brought in $2.8 million in ticket sales from these premium priced tickets.
  2. Panera bread, a gourmet casual restaurant, introduced a premium priced sandwich for $16.99 while most of the menu items are priced at $10 or less.
  3. A coffee shop owner used to charge $1.60 for his regular cup of Joe. He introduced premium coffee  illy and serves it in white ceramic cup with illy logo (premium product and premium packaging) at a premium price of $3.00. Sales tripled after this move.

The net is, the marketer can either take the prices as exogenous, set by   competitors , dictated by costs etc. or take control of their pricing to maximize profit.

Pricing For Richistan

Richistan is the name of the book by The Wall Street Journal columnist Robert Frank. The book is about the lives of the wealthy and high propensity to consume. Frank says in that book,

Pricing for Richistan is like pushing an unlocked door – no pressure

Through @pricingclub I saw the USA Today news on $4000 sunglasses by Oakley.

“I could have seen something like this selling three years ago,” says John Horan, publisher of Sporting Goods Intelligence newsletter. “But conspicuous consumption is out.”

Conspicuous consumption is not all out. While marketers (like LVMH) targeted Richistan there were a few other segments which self selected themselves. They had high willingness to pay but not the wherewithal to pay.  Only these segments are now out. Since the economic downturn we do not know the population of Richistan. Their ranks may have shrunk but as it does I hypothesize that those who are left in it have increasingly low price sensitivity and are willing to splurge lot more than. So it makes sense to introduce super and ultra premium products like the $4000 sunglasses.

Oakley is producing just 200 pairs, thus making it exclusive and its stated target segment is “the guy who doesn’t blink at spending $300,000 on a car”. This is super narrow targeting, males of Richistan that can buy expensive cars without a thought. Compared to $300K price tag the $4K is going to look relatively small.

Another reason why this will help Oakley is the presence of $4K per pair sunglasses helps to improve customer reference price and make their $200-$500 prices look like a great deal.

Great marketing strategy. But, what is surprising to me from that story is not the price but the argument for the high price based on the cost.

About 80 layers of costly carbon fiber — a material more common to the aerospace and motor sports industries — are pressed into the frame. The ultracostly material and design make the frames more flexible and comfortable for athletes, says Neil Ferrier, Oakley’s advanced product development chief.

Another reason for the high price tag, Ferrier says, is the number of worker hours devoted to them. About 90 hours of machine time go into crafting each pair, he estimates.

Costs do not matter to customers and making a cost based justification makes sense only if a marketer expects push back.    So why bother even mentioning cost to produce?

Lowering Prices To Generate Sales?

Here is another CEO who clearly believes lowering prices does not automatically guarantee  sales increase: Macy’s Terry J. Lundgren.  In his inteview with The Wall Street Journal, Mr. Lundgren  said,

WSJ: Do you think about lowering your average selling price or changing your product blend, as some of your competitors have done?

Mr. Lundgren: Here’s the challenge. We have [a men’s pants brand], and they typically go out the door between $29.50 and $32.50, with all the coupons and everything.

What Mr.Lundgren refers to as “out the door price” is the “pocket price“, the net price after all discounts. The net effect of the discounts and coupons is price leakage that erodes profit, clearly Mr. Lundgren is driving Macy’s to focus on its price waterfall.

Mr.Lundgren’s management serve as the best case study so for on the three components of effective price management:

Knowing the value add to segments:

Our purchasers are women. She’s spending the same amounts but just shopping with a great deal of discretion. Value is the word, even if it’s at regular price. The intrinsic value of what she’s buying is very important.

Incremental analysis: How much should sales rise to compensate for loss in profit from price cuts? (Lundgren is on the direction but he is comparing top-line while he should be doing incremental math on lost profit. There is also numbers error as pointed out by the commenter.)

So we were getting tremendous sell-through at low price points and no margins. And I am not making my pants sales for last year, because my average sale dropped by 30%. It’s really hard to make the math work. I have to have 30% more transactions on this product to break even.

Customer Margin: Understanding that loss leaders are effective only if they help generate incremental profit from customers who are attracted to the stores by low prices of loss leaders.

We and the manufacturer together agreed to mark them (pants) down to $21.99 or something like that. Selling like hotcakes. Every other pants around them stopped selling.

Does your business practice effective price management?

Ethics Of Price Discrimination

Note to new readers: Do check out my other articles on versioning andprice discrimination. It would help me greatly if readers coming from Rutgers or New Jersey let me know how they found this article.

When I last visited Italy, I was walking along a street in Sienna that was lined up with stores selling  ceramic arts. It was a surprise to me see the prices vary from store to store (even two adjacent stores) for pieces that looked identical (to my untrained eye). Better yet, I saw no locals making  a purchase (makes sense) and there were some willing to haggle and for them the prices kept dropping. Different customers paid different prices. Is this price discrimination? Is this a model for a marketer to follow?

Price discrimination is charging different prices to different customers for the same product. Perfect price discrimination occurs when every customer is charged a price that is equal to their willingness to pay. Previously I talked about consumer surplus as “the size of the smile on face of customer after paying the price for the product” (definition source: Prof. Steve Tadelis). In perfect price discrimination no one leaves the store with a smile. Such a perfect pricing model does not exist except if we are willing to bend the ethics.

Pricing is about value capture – a product or service delivered creates certain value to the customer and price is the way for the marketer to get a share of the total value created. A same product will be of different value to different customers.  For example I talked about pricing for fluorescent and LED  bulbs. The value of a long lasting bulb that requires fewer replacement is higher for a customer who incurs a high changing cost vs. a home customer who has no such costs.  It is only fair that the same longer life bulb is priced differently to these customers.

The Wall Street Journal talked about rug sales and how different customers pay different prices:

Except for connoisseurs, the only thing most buyers know is what they “love.” A seller can size up a buyer and decide what he’s likely to pay. In business school, it’s called “price discrimination.” Mr. Hassankola has learned that lesson: He went to business school in Switzerland. When he finished, in 1991, he took a job in a Zurich rug warehouse.

This is not that different from the sales I saw in Sienna and other touristy places. Customers are charged different prices because of the information gap and not based on  value difference. The WSJ story later talks about a woman who dismissed the claim by the store owner that a particular rug was purchased by his grandfather, because she could tell that the rug looked newer. But most of us do not have an idea about the quality, age, workmanship or the public value of the rug we are purchasing. In other words, the prices are different not because of value difference but because of knowledge difference.

It is difficult for me to accept this practice as price discrimination. This may work in transactional situations, where a marketer makes just one sale to each customer but does not help if the marketer wants to build a long term relation with the customer. No one can succeed in a business that adds no or negative value to the customers.

As long as the price discrimination is based on economic value added it is justifiable, fair and ethical.

The Price We Pay

If we always made rational decisions that is based only on economic reasons the price we pay for products and services we buy should leave us feeling that these are worth more than it cost them. At the very least these two should match. The  difference we perceive, between what the product is really worth to us and the price we paid is called the consumer surplus. But the problem with this is we are not all economists or rational number crunchers.  I am going to exclude emotional decision making for this post and focus simply on our quantitative ability or the lack of it.

I do not mean our capabilities with numbers but our ability to assign a dollar figure to the value we derive from products and services. Imagine you have an hand held device that can read bar code and an LCD display. You read the bar codes of any product and it displays the value you will get. Then you look at the price and decide whether this leaves you a positive consumer surplus or not  and decide whether or not to buy it. The value we get is our Willingness to Pay. We should be willing to pay any price up that and not more than that.

Unfortunately we do not have a device and even if there is one the device must not only work differently  for each person since the value you get is different from mine and from everyone else but also work differently for the same person based on time and context.

There is no such device. So how do we know whether are not a product is worth the price we paid for it? We never will for sure. I have heard a simpler and better definition for consumer surplus, ” it is the size of the smile on our face after we buy the product”.  If we kick ourselves for buying at a price obviously it means we paid too much.

The story does not end there, there are complexities like reference price, how marketing can increase our willingness to pay, how lack of value information (with no magic barcode reader) can artificially suppress our willingness to pay. There are emotional purchases in which we convince ourselves of higher willingness to pay or adjust our willingness to pay post-purchase to assuage our concerns of overpaying.

Now you know why  microeconomics alone is not enough to define pricing strategies for marketers and the need for behavioral economics and behavioral pricing.  I look forward to writing a few articles in behavioral pricing in the coming weeks.