Article: Research As An Aid To Optimum Pricing
Don't read this article if you're the slave of cost-plus or follow-my-leader pricing. If you sincerely wish to optimise profit you will find out about the value the market puts on your product/service - and charge accordingly. We describe some of the ways research can help you establish what that value is.
Classic economic theory maintains that there is a causal relationship between price and demand: the higher the price the lower the demand and vice versa. This relationship is, however, only the crudest starting point to an understanding of industrial pricing today. For a start, the rules differ considerably according to whether the product is a commodity (grains, minerals, metals, etc.) or manufactured. Commodities within any one group are totally undifferentiated; they are classified according to a standard and their price depends upon supply and demand. Speculation about a shortage of the commodity or the belief that it is an investment hedge will have short term and maybe dramatic effects on the price. As the commodity becomes processed into cement, steel or rice feedstuffs, it gains value, and the sophistication of the processing method enables a premium price to be charged. As the design element of a product increases and the value of the raw material becomes less important, so pricing becomes more complex. The price for design skills is more difficult to pitch.
A product with a considerable element of design becomes "differentiated" from those with which it competes, and buyers are faced with the problems of placing a value on the various benefits on offer. Normally a differentiated product allows the seller to take advantage of the multiplicity of features and charge a higher price. This is not to say that the customer is insensitive to price - rather that he perceives differences in the choice of products available and selects one which best meets his needs.
Of course, design is only one factor which buyers evaluate when considering the price of a product. They will also attribute a value to after sales service, reliable delivery, speedy delivery, quality, longevity and the reputation of the manufacturer. The permutations of the many features and benefits within the product mix make it difficult to establish a price which accurately reflects the differences between one's own product and the competition's. In any case, it is not realistic to expect the customer to know all the benefits of a product when to study them may take a great deal of time, effort and therefore cost.
Commercial vehicles provide a good example of a differentiated product. They are an assembly of different components and offer a variety of features some of which are in conflict. Buyers claim that they seek reliability and economy from their trucks. They also want comfort for the driver, easily available parts, a comprehensive after sales service, high load carrying capacity, low cost servicing and an efficient engine. Combining power, good fuel economy and reliability is not easy. One would expect the buyer to be sophisticated in his approach to this expensive purchase and yet he frequently is not. He finds it impossible to weigh up individually each of the many factors so in practice he arrives at a synthesis based on the brand.
A strong brand has a halo of confidence. An own label strawberry jam sells at a few pence less than a national brand – even though a blind taste test may show consumers cannot tell the difference between them. The difference reflects the confidence in the well known brand. In industrial markets the same principles apply. A recent survey showed that a truck manufacturer's parts were considered to be more expensive than those of' competitors when in fact they were not. The manufacturers poor image caused respondents to malign the company – even on factors where it was demonstrably superior. Volvo’s "halo" enables it to charge more for its trucks, Raychem for its cable, IBM for its computers and so on.
The complexity of pricing decisions should not cause the marketer to shy away from the subject; on the contrary it should be a spur to a greater understanding. This can be achieved in two ways. First by applying historical knowledge. For example, plot the effect of past price changes on sales. Admittedly, other factors as well as price affect volume: e.g. advertising, salesmen's incentives, interest rates. But a graph showing one's own and competitors' prices against one's own company's sales will at least provide a guideline as to the level of price sensitivity.
The inadequacies of historical knowledge to show the effect of price on sales volume, can be offset by using market research. Three different research techniques could be employed - each with the same objective, of showing the price sensitivity of a product. These are:
1. Researching the effects of a past price increase. As long as the price increase is within the recent past it is possible to question a "buyer" to determine the reaction. Was less product purchased? Did the price increase jolt him into obtaining competitive quotes? (It is surprising how many professional buyers regularly deal with only one supplier and lose touch with competitors' prices). What proportion of purchases were switched to a cheaper supplier? Was the increase believed to be justified ? Was it passed on ?
2. Predictions based on a hypothetical price increase. This is the "what if?" approach. The buyer is asked what reactions would be to a specific price change. The obvious problem with this type of research is the credence which can be given to the answers, since at best they may simply not know how and at worst may attempt to mislead. Prompts could be:
Though all the individual prompts are leading, taken together they place price in context and provide the researcher with a benchmark against which the response can be judged. Another method of questioning is to present the buyer with a list of suppliers to the market and a set of prices against each. The buyer is then asked to apportion the requirement between the companies, having been told that deliveries, product quality, and sales service are all the same.
3. Trade-off questions. An extension of the "what if" method is to study the buying decision in general and then move on to focus on price specifically. How many people influence the buying decision? Who are they? What role do they play?, what specifically does each look for? There may, for example, be three people involved in the decision - the works manager could be the key decision maker and be interested in a quality product; the safety officer may be concerned with toxicity while the purchasing manager is interested in price and delivery. The more stringent the specification of the works manager and the safety officer, the less the buyer's opportunity to play the field in a search for bargain prices. This price research must take into consideration who is involved in the decision and what they look for.
Another type of trade-off questions seek to show the value of each element of the package which is for sale. The buyer is given a list of the features and benefits of the product and asked to rank them in order of importance or to attribute a weight (say a percentage) to indicate their relative value to him. The result can be used to show the price that buyers are prepared to pay for each feature/benefit of the package. Thus the research becomes a tool which can be used to manipulate the price of the product. If, for example, a particular product feature is expensive to manufacture and research shows that it commands a low value in the buyer's mind, value engineering could be instructed to modify that part and reduce the costs without the necessity of lowering the price.
The following example has a list which is read out and pushes the limits of people's memories. Most respondents coped with the question but, in an ideal world, the list would have been half the length.
Q. I will now read out a list of factors which some people have said are important in influencing their choice of supplier of electric motors. To measure how important you think they are I would like you to allocate 10 points across the different factors. The more important a factor, the more points you should give it. But the more points you give to one factor, the less there are to give to the others. First I will read out the list. read list. rotate order. tick start. total must add to 10. Now, how would you like to spend your 10 points?
It is possible to devise eight different types of envelope concepts from these variations, viz:
Each of these concepts could be presented to a respondent who would be asked to classify them into piles, correspondent to `very interesting' through to `not particularly interesting'. Having done this, the respondent is then asked to rank the concepts in each pile to show which is most appealing and least appealing. This type of questioning can work with products which have a relatively small number of concepts but it becomes extremely tedious for the respondent if there are many attributes and therefore many concepts. Twenty five to thirty concepts is about the maximum that should be attempted.
Q. I would like you to look through these cards on which you will see different styles of envelope. Place the cards into three piles which illustrate whether you think that for your company the envelopes would be:
Now would you take each pile in turn and sort them into an order so that the card on the top is the envelope style you think is best for your company and that on the bottom is the one you think is worst.
Conjoint analysis is suitable for testing products that have distinguishable features of service levels that can be clearly identified. Reliability in the result requires at least 100 interviews and, since respondents have to shuffle cards, they demand face to face interviews. This means they can be prohibitively expensive in many business to business situations.