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The aim of this chapter is to focus on tools to measure price sensitivity of the customer.
In other words, we will be trying to elicit the Willingness to pay of the customer. While
doing that we will also be able to estimate demand.
The specific objectives are
1. Understand the use of statistical tools and techniques to measure price sensitivity
2. Understand the use of statistical tools and techniques to estimate demand.
5.2. Introduction
Market researchers face two challenges as they provide market intelligence for managers.
First, they must meet managers objectives with useful, valid results. Second, they have
to communicate those results effectively. Failure on either of these two points is fatal.
Many managers have limited experience with statistics and can be skeptical of or
intimidated by advanced methods like the ones discussed here. Unfortunately simpler
ones can be unrealistic or useless. In an ideal world, researchers could accurately
measure price sensitivity by manipulating prices in test markets and measuring changes
in demand. While scanner technology has made this sort of analysis more feasible than
ever before for many categories of consumer goods, these real world experiments face
crippling hurdles. Market forces do not remain constant for the duration of the
experiment: macroeconomic forces can alter demand; competitors change their prices
and /or promotions; buyers stock up to take advantage of lower prices; new products are
introduced. Therefore the challenge before any researcher is to manage a real world
scenario in an experimental condition. The challenge is in sacrificing realism in favor of
control.
In the background of such need and challenge researchers have from time to time
suggested various methods for pricing research. Basically these methods can be
categorized into two basic categories viz., Historical Data Modeling; and
Purchase
Simulations. While each method throws up their unique challenges and methodological
problems, it is important for the manager to choose the method that is most suitable to
him for the problem at hand. For example, if the manager wishes to study the pricing
behavior of an existing product, for which a lot of past data is available, historical data
modeling might be the best but for new products, it is not possible to use this method.
Let us now focus a bit more on each of the methods.
5.3.
How does one use historical data to know price sensitivity? From a method perspective,
it is quite simple. We observe the price data over large periods and relate it to the
quantity purchased. Both these variables can be obtained from the retailers computer.
Based on this we can estimate the price sensitivity of the customer. For example, P&G
connects its main computer to each of the retailer computers. Whenever a customer
purchases a product of P&G, the transaction data is uploaded to P&Gs main computer.
These transaction data then is collected over a long period of time (anything between 2 to
4 years). A simple regression analysis will tell us the price-quantity relationship.
The above example shows the limitations of this method. Firstly, the basic assumption of
it is only price that leads to purchase of a specific quantity may not be true. Again, this
method does not take in the customer variances that may influence price sensitivity. For
example, are women more price sensitive then men? Do purchase occasions influence
price sensitivity? Some companies take care of this problem by tying up with the
retailers loyalty programme. When a customer keys in the loyalty card details, the data
can be used to profile customers on their price sensitivity. Infact, some companies even
sponsor the loyalty programme of the retailer to get such data.Thirdly, this method
cannot be used for new products. One has to distinguish between new brands of existing
products and new to the market products. For example, one can use the Historical Data
Modeling for new brands of soap or detergent. But for new to the market products like
Sonys AIBO, this method cannot be used. Finally, this method relies on the fact that the
past is a good reflection of the future. So, while the method can be used to evaluate
past pricing decisions, one needs to understand current consumer behavior to decide
future pricing!
5.4.
Purchase Simulations:
This involves the creation of artificial market simulations. The main advantage of this
method is that it is more controllable than the other method. Also, the context of the
pricing variable is also taken into account. This means that customers respond to price of
a product in a certain context of time, space, brand etc. So, in case we are able to create
the context, the responses are more meaningful. In the historical data modeling, this rich
data gets lost simply because it cannot be captured. However, this would also mean that
we need to create an artificial setting for obtaining price information. This might make
the entire study artificial, if the researcher is not careful!
Basically Price Simulations have two kinds of measures, the first being explicit measures
where the respondents are questioned directly. Typically, we use the Price Ladder,
Rotated Monadic Designs and Van Westendrop Price Sensitivity Measurement as the
explicit measures. In the explicit measures, the customer is given a description of the
product and then asked about their willingness to pay. These methods are simple to
implement but data quality is suspect. Customers generally overestimate their
willingness to pay!
In the second kind of simulation, called the derived measures, the specific technique used
is the conjoint analysis. Here the respondents are questioned indirectly. The context of
the pricing decision by the customer is taken into account here and price is viewed as a
part of the entire evaluation of a product. The obvious advantage is the richness of data,
the disadvantage being the increased cost and complexty of the research.
Therefore, the utility of the above two measures depends on the cost, complexity, output,
quality and context in which the studies are made. Since price simulations are widely
used even by companies not having sufficient IT infrastructure, subsequent discussions
will elaborate some more on this method.
Tell me more
Example of the Price Ladder
Step 1: Give details of a product on a placard as follows
o The Rotated Monadic Design: One problem that is there in the Price
ladder method is called maturity. What this means is that once a
respondent is exposed to one price, this would influence his response to any
future price combination that is shown to him, which would inturn
contaminate the data. To avoid this problem, one can use the rotated
monadic design. Here the respondents are divided into groups and each
group is shown one price and their purchase likelihood is observed. The
advantage of this method over the price ladder method is that the data
quality here is not as contaminated since context effects are eliminated.
Each group is given only one price and the relationship between the group
and price comfortable with can be found out. However since each group is
exposed to one price the number of such groups needs to be high and
therefore the sample size needs to be much higher than that required for the
price ladder. The disadvantages with the price ladder like translating
purchase preference scale to actual behavior and being product specific still
persists. Like the price ladder method this is easy to execute. The cost
however is higher than that of the price ladder.
Tell me more
Example:
Step 1: Give details of a product on a placard as follows, to a group of respondents having
income of $ 4000- -- to $5000 per month
Consider the following washing machine specifications
Manufacturer : Samsung
Type: Automatic
Capacity : 4 Kg
Warranty : 1 year
Step 2: Now ask the respondent the following question
How likely would you be to purchase this washing machine for $. 300/1.
2.
3.
4.
Manufacturer : BPL
Type: Automatic
Capacity : 4 Kg
Warranty : 1 year
How likely would you be to purchase this washing machine for $. 400
1. Definitely would not purchase
The steps of this method are as follows. First, give the respondent details of
the product on a placard. The 2nd step is to ask him four questions
6. Not
As indicated, this is a much richer output than the other methods. Now let us
focus on the derived measures
Derived or Implicit Measures : The major statistical tool that is used in this is the
Conjoint Analysis. Conjoint Analysis is a simple yet powerful tool, which provides
results that are easy for managers to embrace and understand. It is perhaps one of the
fastest growing and one of the most widely used market research techniques today.
The decision to buy is based on a complex mix of factors; the buyer is faced with the
need to trade-off desirable and less desirable product features (for example high
performance vs. high price). Conjoint Measurement can model this decision-making
process in order to single out those product features which most strongly influence the
purchase decision, and identify purchasing thresholds (for example price steps) or the
optimal price for the product or service. The greatest advantage of conjoint analysis is
that it can help answer questions about hypothetical scenarios for example, What is
my main competitor cuts his price by 10%? This application of conjoint measurement
offers management and marketing departments a reliable guide for decision-making.
A precondition for the proper use of conjoint measurement is that the product/service
has definable characteristics which are relevant to the purchase decision, at least one
of which can be varied. Furthermore, conjoint measurement can only work well if the
product or service options can be explained in clear and unambiguous terms and
realistic images, enabling the respondent to make clear choices. The same size
required is also very large (always >75) When there is too much heterogeneity then
the sample size should be much more (around 300). This becomes especially
important if a behavioral segmentation of the respondents is required. Essentially there
are 3 types of conjoint analysis. These are:
Adaptive Conjoint: Here the respondents are shown a subset of product
attributes, which they trade off against one another. New tradeoffs are based on
previous answers. This makes the task easy, even if there are a large number of
attributes since the respondents consider 2-3 attributes at a time. The cost of this
method is moderately high and the complexity of the design and analytical is also
moderately high. The richness of output is high since accessing alternative product
versions. The Market-simulator allows a wide range of what-if scenarios. The
quality is a little suspect since it consistently underestimates the importance of
price in the model.
Full Profile Conjoint: Respondents are shown complete products, which include
all attributes. The respondent can evaluate this as a single concept or can treat it
like an adaptive conjoint. The complexity and costs of this method is very high
and the output of this method is also very high.
Choice Based Conjoint: The Respondents are shown multiple packages of
features of the same product. This method directly measures choice, not purchase
consideration or preference. The process allows the respondents to choose none
of the above. The cost and complexity of this method is the highest since the
sample size is the highest. The output of this is also the best.
5.5.
v. Working Prototype
vi. Fully functional product
b. How realistic is the Context?
i. How do consumers make the purchase decision for the product?
ii. How do they best understand product cost? Is it based on total cost
or monthly payments?
iii. What are the alternatives that compete with the product? Is it a
standalone product or is it a component of a larger product (like a
car stereo)?
5.6.
Table 5.1: The Rating of various methods of price sensitivity study based on
choice criteria
1best to 6Worst
Cost
Complexity
Richness of
Output
Data Quality
Price Ladder
Rotated
Method
5.7.
hypothetical situations. It may be difficult for the consumer to respond honestly and
realistically in hypothetical situations. The reliability of such data is, therefore,
suspected. To overcome this, the seller of a product introduces variations and
actually tries it out in a representative market, and gathers information on the
behavior of the consumers. These are called market experiments, wherein a product
is tested out in a representative market and the results are projected onto the
population. This method is very effective when one wants to gather information on
elasticity. This is a high-cost technique and a highly risky one also, because the
situation cannot be controlled fully. Another variant of the technique is the concept
of consumer clinics. The consumers are asked to act in a simulated situation,
wherein they are given some amount of money and made to indulge in buying, and
their behavior is observed. This again suffers from the drawback of surveys, that is,
the consumer may not be responding in a realistic manner. However, the context in
which the consumer is placed when in a consumer clinic is less removed from
reality than consumer surveys.
publications or with the government, in its publication. In India, one can depend on
the publications of the Centre for Monitoring Indian Economy, the Confederation of
Indian Industries, and other such bodies. A set of techniques, which uses this
historical data and enables us to estimate the demand relationships, falls under the
broad subject area of econometrics. The principal econometric technique
estimation is regression analysis.
5.8.
How does this work? We can estimate the parameters from past data. Once we have
estimated the parameters we can insert the value of the variables and get the
demand.
How do we interpret these estimates? Suppose the estimates turned out to be as
follows:
QD=215 *1.1 n1+ 2n2+0.5 n3+0.005n4+2.5n5+1.5n6
What meaning do we attribute to these? The value of each estimate, which is also a
coefficient, gives the amount by which Q D will change for a unit change in the
respective variable, given that all other variables remain unchanged. In calculus
terminology, the coefficients are nothing but partial derivatives of the demand
function. This means that each additional unit of every independent variable has a
constant effect or impact on the dependent variable, regardless of the level at which
the independent variables are. For example, in our equation, the impact of unit
change in income Y on Q D will be 2.5, regardless of the level of Y, be it 50 or 5,000.
This is how we would interpret the coefficient of a linear equation, which is also the
slope and is constant throughout.
5.9.
Summary
Price Sensitivity Measures form the backbone of any marketing strategy. An idea of
the measure will help the manager to plan and price his products. The researcher
too is very interested in this because it will enable him to measure the elusive
willingness to pay aspect of the consumer. This chapter reviews the methods
available and their pros and cons. It is for the manager to choose among the various
methods depending on their objectives, cost constraints and time. The chapter also
focuses on the regression method of estimating demand.
Annexure 5.1.
Price Sensitivity Measure by the Van Westendrop MethodAn Empirical Example
Summary of Study Features: A survey was done in Bhubaneswar to find the willingness to pay. The study tried to
come as close as possible to the notion of willingness to pay:
1. Our questions were brand specific and for brands the respondents had purchased in the past.
2. To the extent that it was possible, we matched product and brand cues used in the questioning to
those present in the choice context (e.g., through the use of actual photographs of the products
tested).
3. The questioning took place during a purchase occasion to maximize the number of contextual cues
and to ensure the presence of normally available shopping knowledge.
Product Category Selection: The product categories for the survey were chosen so that they would represent high or
low (but not medium) levels of each of involvement. I have chosen detergents and Washing in the high and low
involvement respectively.
Selection, Instrument and Interview Procedure: The interviews all took place in one hypermarket in Bhubaneswar,
the Bapuji Nagar Market. It was selected because it is the busiest market and both the products are available there.
The objective of our respondent selection was to interview a representative sample of regular purchasers of the
stores in this area. As soon as an interviewer became available he or she had to solicit the third person that entered
the store for participation in the interview. The interview was simply introduced as part of a study on consumer
products. To qualify for the interview, purchasers had to pass a filter questions: they had to normally do their
shopping themselves and they are the decision making power for the products. 275 purchasers were interviewed in
the months of January and February 2002. Because I expected to find different types of purchasers at different times
of the day and the week, the interviews were scheduled such that we covered each relevant time slot (morning,
midday, evening; beginning of the week, normal weekday and weekend).
Products Tested
1. Product 1: A detergent of the following details
a. Manufacturer: Hindustan Lever Limited
b. Color: Green
c. Texture: Flaky
d. Packaging: Plastic Pouch
2. Product 2: Washing Machine with the following details
Manufacturer: BPL
Type: Automatic
Capacity: 4 Kg
Warranty: 1 year
10
15
20
25
30
35
40
45
50
55
60
65
70
75
80
85
90
Total
60
26
25
32
35
42
50
27
32
34
28
42
68
21
19
275
19
36
65
45
50
31
16
275
275
Chart 5.1
VWPSM For Detergents
120
Too Cheap
100
%
80
Too Expensive
60
40
20
Expensive
0
Bargain
Price
Analysis
Detergents: As can be seen from Chart 5.1 the optimal price for a new detergent is Rs. 50. In any case the price
should lie between Rs.40 (lower bound) and Rs. 65 (upper bound). This means any price below Rs. 40 will affect the
brands credibility in terms of quality and any price above Rs. 65 will overprice the brand. Now it is left to the
managers perspective as to how he prices the detergent.
2.
Past Data