Pricing is an important issue that needs to be considered early and often in startup companies.
But when it comes time to hit the ground with it, many entrepreneurs make a critical mistake: conducting a willingness to pay survey.
The survey may be easy to do and appears to provide information that will help your business make pricing decisions. However, beneath a willingness to pay (WTP) survey are three assumptions, all false, that will cost you money.
Bad Assumption #1: Customers will tell me the truthThe first assumption made in a WTP survey is that you will get valid information. Simply put, that customers will give you an honest answer. But why would they? Savvy respondents know that the survey is directed at pricing. They will see it not as willingness to pay, but "want to pay." Your customers will tell you how much they would like to pay for your product. Personally, I would love to pay $20 for a new 42" HDTV. I won't give that answer on your survey, though, because I want you to take my data point seriously and not throw it out. But I may tell you $350. More often than not, respondents will offer a price that is in the ballpark of value, but significantly below the real figure. The first reason they do this is to lower the eventual price of your item for their own benefit.
Bad Assumption #2: Willingness to pay surveys give me a price ceilingThe other reason customers give bad answers to WTP questions is that they cannot fully understand the value you are delivering. This leads us to our second false assumption: WTP responses will provide a price ceiling, above which they will not pay for my product, and below which I can make margin / volume tradeoffs.
The reality is that customers often do not understand the value you are delivering. Some may need to see what your product will look like, watch it in action, or hear from others why they found it so powerful. Without a solid understanding of the value delivered (what the product can do for me), responses drift toward the price of substitutes available today.
Take the 2007 iPhone launch, for example. If Apple had conducted a WTP survey, they likely would have heard numbers around $150-200 as customers gravitated toward a "typical" smartphone price. But Apple's phone delivered much more value -- the market just couldn't understand it. When initial sales were slower than expected, did they drop the price to match the market's WTP figure? No. Instead, they launched a major awareness campaign, showing customers how it is used and how it is so much more valuable (and cool, to pull on a psychological driver) than what they have today. Then they lowered the price slightly to $400 -- still a massive premium over the alternatives. I assume I don't need to tell you how that decision turned out.
Bad Assumption #3: Customers will consider my product in a vacuumThe third fallacy inherent in a WTP question is that customers are making their purchase decisions in isolation: I either buy your product for $50 or I do nothing. However, there are a litany of options available to them, all of which factor into a decision on whether or not to purchase your product. The WTP question does not take these options into account. Without considering these alternatives, the respondent is providing an answer that is not in touch with market realities.
Entrepreneurs need to understand what customers are doing now, and why this product would deliver value. Let's say you are selling a kitchen appliance to consumers. Are we chopping an onion more finely? More quickly? More easily? What is your customer doing now to address this pain point? What other value drivers are in play here? Is there a learning curve to your new product? Is kitchen space a constraint for the consumer -- either in product use or in storage? If so, which customer segments does this affect (unlikely to be a concern for all customers across all segments)? The answers to these questions, unlike a WTP question, consider what is actually happening when customers consider buying your product. They provide inputs that remove biases and allow you to make proactive pricing decisions that consider the options, issues and solutions customers experience today.The better approach: understanding valueAs I began to discuss in the previous example, research that goes toward the understanding of customer value can avoid many of the pitfalls of WTP surveys. To be clear, there is no doubt that some customers will buy your product at $10 and some will buy it at $50. But it is not some mystical "willingness to pay" factor that is driving it. There are reasons, and they are called value drivers. Understand them and you will be able to better segment and size your potential market, drive even more people to buy at the $10 price point, and perhaps get some of the $50 buyers to buy your product for $70 instead.
The truth is that a customer should be "willing to pay" up to the incremental value you are adding above their current choice at the current price. But they probably don't know what that is (and you may not either, but don't worry, we will help in our next post on quantifying value.)
You need to tell them what they should be paying, not ask them. Instead of WTP, ask what your customers care about, and what their biggest challenges are. Think about how you can help them achieve these goals. Understand why some would buy the product and some would not without considering any price points at all. With that information, you can better understand how to effectively manage your pricing decisions to maximize your profits.
So don't ask your customers for their "willingness to pay." Instead, do your homework and ask them about their value drivers. Then tell them what they should pay and why, and you'll be on a happy road to higher profitability.
The post originally appeared on the MIT Entrepreneurship Review. It is written by Jim Schuchart, an MBA candidate at MIT Sloan who previously spent five years as a consultant at Monitor Group.