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What is Price Sensitivity?
Price sensitivity describes the degree to which changes in the price of a product or service influence a consumer’s purchasing behavior. A price sensitive customer is one with a low tolerance for price fluctuations. When prices exceed their willingness to pay, they will either not buy the product or opt for a cheaper alternative.
Price sensitivity applies to every customer and market — no person or company on Earth would pay any price for a product. But buyers’ ‘acceptable price range’ varies based on several factors, including:
- How much they need (or think they need) the product
- Their purchasing power
- Competition in the market
- Similar products’ prices
- What they think the product is worth
External factors like economic conditions and industry trends also impact price sensitivity. In times of recession, consumers tend to become more price sensitive — they seek out cheaper alternatives and postpone non-essential purchases.
It’s worth mentioning there are plenty of anomalies when it comes to price sensitivity. Some people are naturally “tight-fisted” and will always go for the cheapest option, while others prioritize quality over cost.
- Price elasticity
- Price responsiveness
- Price tolerance
Importance of Measuring Price Sensitivity
Buyers’ price sensitivity directly impacts their willingness and ability to purchase or subscribe to your product. It’s directly tied to price optimization.
- Charging too far below your customers’ general willingness to pay leads to lost revenue and a lower return on investment (ROI).
- Charging more than they can or want to spend on your solution turns them toward your competitors and increases your churn rate.
Understanding the how and why of price sensitivity also helps your sales and marketing teams tailor their messaging and approach. They can better position your product in the market, highlight its unique value proposition, and address customers’ pain points in a way that helps them justify the cost in their heads.
From a competitive standpoint, the ability to speak to your customers’ apprehensions and price products within their willingness-to-pay threshold gives you a huge advantage. It sets you apart from other vendors in the market and creates an emotional connection with your target audience.
Unlike basic approaches to pricing like cost-plus pricing, working within the bounds of your customers’ price sensitivity also incentivizes operational efficiency. If charging more will tank your sales, your only option for improving profitability is finding ways to lower your costs and optimize margins.
Price Sensitivity Implications for Consumer Decision-Making
Understanding price sensitivity is crucial in predicting and influencing consumers’ purchasing decisions. If you don’t have an accurate picture of how much your customers are willing to pay, you have a very limited understanding of what they want and why.
- Price sensitivity impacts how customers perceive value, which has major implications for their decision-making process. It’s important to note, though, that perceived value is subjective — it’s influenced by factors like personal preferences, past experiences, and your brand reputation.
- Your market’s demand elasticity also determines the most effective pricing model. Generally, the more money a person or company has, the less they want to purchase a low-end product that requires frequent re-purchasing. Price sensitive customers usually won’t want to commit to a long-term contract or make large upfront payments.
- Low price sensitivity among wealthy customers may indicate a need for quote-based pricing. Buyers with varied budgets and unique requirements may be willing to pay more for tailored solutions.
Your buyers’ level of price sensitivity changes at different stages in the buying decision process.
- In the recognition stage, the buyer is less concerned with the price of products because they only know they have a problem, not necessarily how your product solves it.
- In the information-gathering stage, they find out what they want to buy and why they need it. They’ll put a dollar sign on the problem they want to solve, so they’ll become a bit price-conscious.
- In the evaluation stage, sensitivity reveals itself. They’re comparing your competitors, so they’re more price-conscious. You have to justify the price of your product compared to alternatives (or no action at all).
- Once they make a purchase, you’ve sold them on the financial risks of not taking action and the financial benefits of your product over others.
- For retention, your goal is to continuously deliver that value. Price sensitivity reduces over time when they see $X input returns a much larger value.
Relationship Between Price Sensitivity and Price Elasticity of Demand
On a macro level, economists and business leaders often measure price sensitivity using price elasticity of demand, which states that some consumers won’t pay more if a lower-priced option exists. For every product and service, there’s a threshold for how much a consumer is willing to pay. On a graph, that’s what price elasticity of demand indicates: the relationship between the percentage change in quantity and the percentage change in price.
Imagine you’re at your favorite coffee shop. They’ve just bumped up the price of your beloved latte by $2. Now, if this coffee shop is the only one around for miles, and you really need your caffeine fix, you might grumble, but you’ll still pay up. That’s inelastic demand — your need for that latte doesn’t change much, even if it’s pricier.
Now, if there’s another coffee shop next door, any tiny price hike might send you walking right to the competitor. That’s high elasticity; your loyalty to the latte isn’t strong enough to withstand the price increase.
Businesses want to find the sweet spot between these two — equilibrium pricing — where they sell the most lattes for the most money without scaring customers away. They use a pricing engine to find that number, watching how every penny change affects their sales numbers.
Sometimes, they find that even if they charge more and a few people skip their coffee, they still end up making more money because the extra charge from the die-hard latte lovers exceeds the loss. It’s a balancing act, playing into consumer behavior while keeping the business profitable.
Factors That Affect Price Sensitivity
Demand vs. Scarcity
According to the law of demand, a price increase results in a decrease in quantity demanded, assuming other market factors remain constant. Scarcity is the main factor that affects this law.
Customers are less sensitive to the price of products when:
- They need them, but so do a lot of other people.
- They can’t get them elsewhere.
On the contrary, low demand for a product will force prices to go down to make the product more attractive.
Price and Quality
When a product is innovative or high-end, consumers are less sensitive to its price. Examples of this include:
- The new iPhone vs. a two-year-old model
- A tailored suit vs. something off the rack
- A new, trendy restaurant vs. McDonald’s
- An apartment by the beach vs. one with a view of the dumpster
- Software with advanced features vs. limited tools
People generally understand that “you get what you pay for.” So, consumer demand doesn’t change when a product justifies its higher cost with something more important than money.
Expense Relative to Budget
Of course, not everyone can afford a higher-quality product. There will be a point where a product’s price becomes too much for some customers. Everyone would prefer the newest iPhone, but $1,000+ is a big ask for many of us.
If the product in question requires a significant upfront investment proportional to their overall budget, they’re much likelier to look closely at pricing before making a purchase decision.
If it’s directly tied to the bottom line, a product’s utility can be high enough to justify the purchase (thereby reducing price sensitivity).
For example, a SaaS tool could help a business owner sell more products, so the $60 monthly cost is worth it. The same justification is common when selling agency services like digital marketing.
The same goes for anything that’s more important than money to the buyer at that moment, like social status or time savings.
Unique value is really another word for product differentiation, which comes in many different flavors. The two basic categories are:
- Horizontal differentiation — Design, brand identity, perceived value, loyalty
- Vertical differentiation — Quality, features, technology, support
Unique value is somewhat objective and somewhat subjective. Everything from brand colors and aesthetics to perceived quality can affect purchasing behaviors. There’s no way to make everyone like your product, but those who do are more price insensitive.
Substitutes and Competition
A customer might prefer one product, but if they can buy something “close enough” for much less money, that’s likely what they’ll do.
This all ties back into a product’s differentiation and availability. In markets with lots of competition and similar products, consumers have more options to choose from. So, new market entrants need to take a competitive pricing approach.
Cost to Switch
Switching CRMs or buying a new car is expensive, not just in terms of money but time, effort, and aggravation. The more it costs to switch from one product to another (whether monetary or otherwise), the more sensitive to price changes a customer will be.
Even in industries with natural monopolies (e.g., aviation, oil & gas, telecom), the customers ultimately regulate the market.
As an example, gas prices have soared in the last couple of years. But they can’t continue to rise indefinitely — eventually, they’ll hit a tipping point, and enough customers will either switch to public transportation or more fuel-efficient vehicles to stop the upward trend. Or, they’ll stop buying it simply because they can’t afford it.
That’s why there’s no such thing as ‘perfectly elastic’ or ‘perfectly inelastic’ demand.
How to Measure Price Sensitivity
Measuring price sensitivity involves analyzing data from past sales or conducting surveys with potential buyers.
Some common methods for conducting a price sensitivity analysis include:
- Van Westendorp’s Price Sensitivity Meter uses a series of questions to determine consumers’ willingness to pay for a product (e.g., “At what point would you consider this product a bargain?”).
- The Gabor-Granger Technique (price laddering) involves asking potential buyers about their purchasing intent at different price points.
- A conjoint analysis measures how much value consumers place on specific product features and how that affects their willingness to pay.
- Brand-price tradeoff (BPTO) is a statistical technique that involves asking respondents to choose between two products at different price points and varying brand associations.
Examples of Price-Sensitive Products
B2B SaaS Tools
The typical company uses around 300 SaaS applications, so there’s definitely a willingness to buy. That doesn’t make B2B SaaS buyers price insensitive by any means. The SaaS industry is interesting because the relative value an app produces for its users is dramatically lower than its asking price.
This is a product of the Fourth Industrial Revolution. Rapid technological advancements have caused people to value apps that deliver millions in value at a few hundred dollars per month. So, the optimal price is sometimes as little as 0.0001% of the value the product provides.
In the SaaS world, companies use tiered pricing models (including a freemium tier) to serve their price sensitive customers. For their larger customers, they’ll use a combination of usage-based pricing, subscription tiers, and, for enterprise customers, custom quotes.
Software companies are at an advantage here — SaaS pricing is based on recurring revenue. Customers don’t have to worry about a price increase month-to-month — they’ll be billed for the same amount every month or year. That builds trust and encourages them to commit for the long haul.
At the enterprise level, price sensitivity is high because the cost of switching is high. Sales reps have to work hard to justify the price, which is part of the reason enterprise sales cycles typically last more than six months.
Oil and Gas
When gas prices increase, drivers may start to change their habits. They might drive less, carpool more, or switch to public transportation if the price hike is significant enough. This behavior reflects the high elasticity of demand for gasoline: small changes in price lead to noticeable changes in consumption.
That said, sensitivity varies depending on short-term or long-term perspective. In the short term, people still need to go to work and fulfill their daily routines, so they’ll grumble at the pump but fill up their tanks anyway. This makes the demand relatively inelastic in the short term.
Over time, persistently high prices may lead to lasting changes, such as purchasing fuel-efficient vehicles or relocating closer to work. These changes demonstrate higher elasticity.
Travelers often have flexibility in their travel dates, destinations, or even the necessity of the trip itself. If airlines raise their prices, many leisure travelers will immediately start looking for alternatives. They might choose different airlines, opt for indirect flights that are cheaper, or even decide to postpone or cancel their trips.
Business travelers may be less price-sensitive, as they often need to travel at specific times for meetings. However, with the rise of virtual meeting technology, even business travel has become more price-sensitive, as companies may substitute in-person meetings with virtual ones if the cost of flying becomes too prohibitive.
Market transparency and competitiveness also influence the high demand elasticity for airline tickets. With a few clicks, customers can compare prices across numerous airlines, which intensifies the sensitivity to price changes.
Grocery and Food Items
Grocery store items like food and household products are inherently price sensitive because of the massive array of options and high competition for shelf space. Consumers have a lot of choices and can easily compare prices, so stores need to offer competitive pricing to stay in business.
Not all grocery items are equally price-sensitive. Products like milk, bread, and eggs tend to be more elastic because they are staples that consumers buy regularly. They’re also perishable, so the vendor has a very limited window to move the product off the shelf.
Luxury or specialty products have more inelastic demand. Their buyers are willing to pay a premium for unique or high-quality products (for example, tanks anyway).
Using Price Sensitivity Data to Inform Pricing Strategy
Once you’ve conducted market research and gathered data on price sensitivity, how do you use that information to inform your pricing strategy?
Here are some key takeaways:
- Know your target market. Understanding your target audience’s price sensitivity is crucial. Conducting surveys or focus groups can help gather this information.
- Consider different pricing strategies. Depending on the product and its demand elasticity, you may want to consider different pricing models. This could include tiered pricing, volume discounts, or subscription-based pricing.
- Monitor market trends. Keep an eye on overall market trends and changes in consumer behavior. This will help you adjust your pricing strategy as needed.
- Constantly gather feedback. Don’t just rely on initial price sensitivity data – continue to gather customer feedback to know how your pricing affects their purchasing decisions.
- Use promos and discounts sparingly. While you might increase demand in the short term or create new purchase intent, you’ll devalue your product and condition customers to wait for discounts, which could hurt long-term profitability.
- Sell the costs of not using your product. If you use a sales methodology like MEDDIC or SPICED, you’ll learn your customers’ pain points early on. These are the things you can drive home when you’re trying to overcome price sensitivity objections.
People Also Ask
What does it mean to reduce price sensitivity?
Reducing price sensitivity means finding ways to decrease the impact of price changes on consumer behavior. You can achieve this through discounts, promotions, tiered pricing models, or highlighting your product’s unique value and benefits that justify its price.
How do you mitigate or reduce price sensitivity?
Product differentiation, effective marketing and sales strategies, and a sense of urgency are ways to reduce price sensitivity without changing the product. Feature development and product improvements can help you justify higher prices or attract less sensitive customers.