Well done. You’ve got a fabulous new idea for a product or service. It’s unique, it’s world beating. No one else has anything like it.
There’s just one thing to figure out before you launch it. What price to charge?
When launching something for which a market already exists you can use various techniques to understand how the value you deliver compares with other solutions, and can price based on that relative value. But you’re launching something completely different. How do you establish a price?
One tool is the Van Westendorp's Price Sensitivity Meter.
Peter van Westendorp was a Dutch economist, and he introduced this model in 1976. It works by asking potential customers four simple questions:
1. At what price would this be so cheap you question the quality?
2. At what price would you think this is a bargain?
3. At what price would it start to feel expensive?
4. At what price would it be so expensive you wouldn’t buy it?
Using the answers to each of these questions, you build a graph with four lines. This is done by adding the cumulative number of responses as price increases.
For example, let’s say that the answers to question 3 are: £2.00, £2.00, £2.50, £3.00, £3.00, £3.00 and £3.50. On your X-axis (the horizontal axis) you have prices: £1.00, £1.50, £2.00, £2.50, £3.00, £3.50. You count how many answers you got for each, and add them cumulatively as you go:
£1.00 - 0
£1.50 - 0
£2.00 - 2
£2.50 - 3 (because one person said £2.50, so add this to the previous 2 for £2.00)
£3.00 - 6 (because three people said £3.00, as add that to the 3 so far)
£3.50 - 7 (etc)
As well as these four lines, some versions of the model add two other lines which are the inverse of questions 2 and 3 (and are considered to be ‘not cheap’ and ‘not expensive’).
Image credit: Levasha - https://commons.wikimedia.org/wiki/File:VanWestendorp1.svg
The range between where Too Cheap and Not Cheap intersects to where Too Expensive and Not Expensive intersects is considered to be the range of acceptable prices.
Where the Expensive and Cheap lines intersect is called the Indifference Price Point - it’s neither one thing nor the other.
Where Too Cheap and Too Expensive intersect is often viewed as the optimum price.
In many respects, this is a fabulous pricing model. It seems analytical, so it gives you confidence that the price you are choosing has some reasoning behind it. It takes the views of many people, so it hopefully has some statistical significance. And it’s certainly better than a finger-in-the-air guess.
However, the model should be used carefully. Like all models, it has flaws.
One of the most important is this: there’s actually no theoretical basis for the model. It seems to make sense, and is almost certainly better than just guessing, but it was not developed following research into actual price sensitivity or proclivity to pay.
Another issue is the order in which the questions are asked. That order creates an anchor. Whatever the first question, the participant imagines a price, and from then all other prices that they suggest are based on that first price. One way to make the model work better is to randomise the order of questions for each participant.
The participants also have to have some reference for the price they suggest. Right now there’s no market for whatever you are selling - it’s brand new, right? What would participants of a Van Westendorp survey have said to Dyson when he asked about his new bagless vacuum cleaner? At the time vacuums cost around £70, and he launched the Dyson for £300. Would the model have suggested that as an optimum price? Probably not.
The issue there is that value is a complicated thing. In a survey about price, participants would have simply been considering what they pay for existing solutions. But once it was on the market, the Dyson was cool. It was new and interesting. A few people bought it and talked about it, and suddenly it was exclusive - ‘Have you seen the new Dyson? I’ve got one, you know.” It was the BMW or Mercedes of cleaning.
How do you factor that into this pricing model?
The further considerations are that the model does not consider volumes - in other words, it doesn’t consider price elasticity. It also only looks at price and not margin, and there might be a higher price than the model suggests which actually translates into lower volumes but does maximise margin.
Nevertheless, when launching a new product or service you need to have some idea of what the best price might be, and this model is worth considering as an input to that price decision. Just don’t treat what it says as gospel, treat it as a suggestion that needs to be balanced against other research and other models.