What Is Price Sensitivity?

One of the biggest challenges any business can face is pricing its products or services properly. If prices are too high, customers might take their business to a competitor; set prices too low, and profits can lag. To set prices that maximize profits while retaining customer loyalty, businesses rely on an important concept: price sensitivity.

In this article, we'll explore how price sensitivity builds on other pricing models, its influence on sales and profit, and strategies for managing its impact to keep customers coming back.

• What is price sensitivity?
• The impact of price sensitivity on sales
• Factors influencing price sensitivity
• How to measure price sensitivity
• Strategies to manage price sensitivity
• Real-world examples of price sensitivity

Price sensitivity measures how consumers respond to price changes in goods or services. Customers with low price sensitivity will purchase a product or service at almost any reasonable price. Conversely, customers with high price sensitivity will react to steeper prices by choosing not to make a purchase — and may take their business to a rival company.

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At a high level, price sensitivity's impact on sales is simple: If customers are sensitive to price, they will likely be less inclined to purchase a product they consider too expensive. When a customer has a specific price perception of a product, and the actual cost exceeds that amount, they may either walk away or buy less of that item.

Software as a Service (SaaS) offerings are a good example, as they are often sold based on the number of seats. Price sensitivity can influence how many seats a customer decides to purchase. They might view the software as top-notch and essential for their business, but the high price may lead them to choose fewer seats.

By gauging price sensitivity, a company can understand its ideal customers. For example, the process might reveal that buyers in a certain segment will continue to purchase from the business even as prices climb. It may also show which type of customer is likely to balk at higher prices. This exercise can help a company form a solid pricing structure — one that maximizes revenue without alienating its valued customers.

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A host of factors can influence price sensitivity. Let's look at a few common ones:

If the market has many competitors offering functionally identical products, such as soft drinks or toothpaste, consumer price sensitivity will be high. This means that if your business offers a lemon-lime drink that competes with other well-known brands, pricing the beverage above competitors will likely trigger resistance from consumers, who will question why this lesser-known product is more expensive.

On the other hand, when your product is in a highly differentiated market, price sensitivity may be lower. For example, consumers may exhibit significantly less price sensitivity when purchasing recreational sports equipment, such as golf clubs or hockey skates. A consumer might view a higher price positively because there are measurable differences in quality, such as clubs that help you hit the ball farther.

Customer needs also influence price sensitivity. If a product is a "nice to have" item, and there are readily available substitutes (even if they're not a perfect solution to a problem or need), then you can expect higher price sensitivity. However, if a customer needs specific software to run their manufacturing business, price sensitivity will be lower, since they need the software to operate. Another example of this is prescription medications. When a medicine lacks generic versions, patients have no alternatives.

Think about frequent flyer miles and other perks offered by airlines. Customers who have accumulated miles with an airline might be more likely to accept higher ticket prices due to their long-term investment in the brand, which yields real, measurable benefits. Additionally, if they have experienced exceptional customer service, they may develop an emotional connection to the brand that will endure higher prices.

This factor is often found in software. Business decision-makers seeking a software solution for customer service or the employee experience might struggle to understand market prices, for example. That's because many publishers won't readily make that information available. In this case, price sensitivity can be low because the customer lacks context. Without an easily accessible price comparison, there is no basis for knowing what is too high or too low.

Price elasticity measures how changes in price affect supply and demand. With price elasticity, companies can use a simple formula to estimate how sales change with an increase or decrease in price. However, while price elasticity is a powerful tool for understanding product pricing, it depends on steady economic conditions, a stable competitive landscape, and reliable data. The formula won't be effective if any of these factors are absent. This is why companies often turn to price sensitivity to determine optimal pricing.

One way to think of it is as follows: price elasticity takes on the seller's viewpoint, while price sensitivity takes the buyer's perspective. If the price elasticity formula is unsuitable for a particular scenario, price sensitivity can provide much-needed context. For example, buyers in one segment may be more sensitive to price changes than those in another segment, or a competitor may offer a superior product. By gathering data on price sensitivity, businesses can develop a more nuanced pricing strategy for their products.

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Measuring price sensitivity can be challenging. Unlike price elasticity, there's no formula for generating a concrete result. Rather, business leaders must analyze many data sources before arriving at an answer. Here are a few sources of information that can provide valuable context:

• Account data: A high-quality customer relationship management (CRM) tool shines in this area. Business leaders can mine their CRM for win-loss data, extracting information supplied by prospects who ultimately didn't pan out. Did a prospect tell a salesperson that they found a cheaper alternative? Or was their decision based on some other factor, such as an existing personal relationship or features that your product lacks? While that can be crucial information, it will only surface if that data is structured for easy analysis. As we move into the era of artificial intelligence, new tools will make retrieving and understanding this data easier.
• Surveys: When in doubt, ask. Surveys can provide actionable insights to guide pricing, even with a simple question like, "What price would you consider buying this product?"
• Conjoint analysis: This builds on surveys by gathering information from prospective customers about a set of attributes: features, functions, and benefits. This can help companies deeply explore consumer motivations and preferences, which can then inform price sensitivity. However, this method can be complex or may not suit certain markets, such as new product categories that consumers are unfamiliar with.
• Van Westendorp price sensitivity meter: Developed in 1976 by Dutch economist Peter van Westendorp , this technique typically asks consumers four questions to measure price preferences. These questions cover a range of scenarios, including when a product is priced too high or too low to consider and which prices are considered bargains or pricey but not too much so.
• Gabor-Granger pricing study: The Gabor-Granger method identifies the highest price customers are willing to pay for a new product or service. It gives a range of prices for an item and then asks customers to rate them as "definitely buy" or "probably buy." By randomly presenting a range of prices, market researchers can determine a variable that will help them create a demand chart and revenue curve. This approach is typically applied to products that customers already recognize.

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Once a business understands customers' price sensitivity, it can implement well-defined strategies to optimize product pricing for profitability. Data provided by a CRM can inform those strategies. For example, insights drawn from win/loss data and transcripts of unsuccessful interactions can help a business determine which strategy to pursue. Here are some common strategies:

• Pricing by segment: This strategy sets different prices for various customer groups. Say your research has shown that customers in the Northeastern United States are very sensitive to price. To account for that sensitivity, you can adopt a strategy that offers a lower price to Boston consumers while setting a higher price for Los Angeles or Seattle.
• Dynamic pricing: Simply put, prices are driven by market demand. Dynamic pricing is effective when your product or service has windows of high demand. In this case, high demand reduces price sensitivity, and pricing can increase accordingly. For example, ticketing for popular concerts or sporting events often moves ticketing companies to boost prices. However, businesses would be wise to exercise caution, as raising prices too much could lead to a backlash.
• Product differentiation: This strategy distinguishes products or services from competitors. It is often employed in the SaaS world, but it's also used in the automobile industry and other markets. Software is commonly offered in multiple pricing packages: a basic, low-cost (perhaps even free) version with a few features, a mid-range option with more functionality, and an upper-tier choice with a wide range of features.
• Bundling: Packaging multiple products and services at a discounted rate mitigates price sensitivity concerns. For example, if you're selling a physical product, you can manage high price sensitivity by including something of extra value. This could be a preventive maintenance plan or a higher level of customer service.

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Price sensitivity exists in almost any market (except for luxury goods or custom services or products). Here are a few examples that will help explain the concept:

• Fuel: Gasoline is a classic example of a product with high price sensitivity. It is functionally the same no matter which filling station you go to. A station with higher prices than the competitor across the street will soon see its profits dip. Price sensitivity in this market is so pronounced that developers have released apps that flag stations by the lowest price.
• Software in an established market: Take collaboration platforms commonly used by companies for employee communication and project management. If you're launching a new platform to compete with the established players, price sensitivity will affect your pricing. In cases like this, the high level of price sensitivity might make penetration pricing an option.
• Food and household goods: Common non-luxury goods are subject to high levels of price sensitivity. Since they are widely available and are materially similar, if not identical — think laundry detergent or milk — consumers will show sensitivity to significant price differences.

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Understanding and responding to the challenges of price sensitivity can mean the difference between rising profits and serious trouble. An example of this can be found in the fierce competition between mobile phone carriers. One carrier recognized that customers were becoming increasingly price-sensitive about data plans for streaming, among other features. By simplifying its plans and offering some features free of charge, it soon saw a significant spike in contracts.

Thankfully, that kind of responsiveness to price sensitivity can be replicated across various markets. To compete, your business must take the necessary steps to understand how price sensitivity affects it. Once you know the limits of what customers are willing to pay, you'll open a clear path toward greater sales and higher profits.

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