Price sensitivity is the degree to which the price of a product affects consumers’ purchasing behaviors. Generally speaking, it’s how demand changes with the change in the cost of products.
In economics, price sensitivity is commonly measured using the price elasticity of demand, or the measure of the change in demand based on its price change. For example, some consumers are not willing to pay a few extra cents per gallon for gasoline, especially if a lower-priced station is nearby.
When companies and product manufacturers study and analyze price sensitivity, they can make sound decisions about products and services.
What is price sensitivity?
Price sensitivity is a measurement that calculates how much the price of an item affects the consumer’s purchasing behavior. Low price sensitivity can indicate customers are highly motivated to buy the product no matter the cost, while high price sensitivity can indicate price increases might discourage customers from buying.If the price of an item or service is high, a customer might choose to go with another brand, especially if other options are available. Often, if the product is less accessible, a consumer might be open to paying a higher price for it. When companies calculate price sensitivity, they usually present it as a percentage that quantifies what their business might gain or lose based on certain criteria.
Why is price sensitivity important?
Analyzing price sensitivity can help companies and manufacturers accurately price their products and align their pricing with their customer base. Specifically, price sensitivity helps businesses better understand their:
- Product’s value: Accurately assessing price sensitivity allows businesses to determine the value of their product within a market and how much consumers are willing to spend to acquire it.
- Price of goods: Price sensitivity can help manufacturers decide on the price of a product before they make it. This might help them determine the quality or quantity of goods and raw materials they use to manufacture the product.
- Customers: Determining price sensitivity can depend on several factors like demand and income. By researching a product’s market, a business can gather valuable insights into their prospective customers.
Factors that affect price sensitivity
A combination of things can influence a product’s price sensitivity, ranging from availability to income levels. Here are some of the most common factors that can affect price sensitivity and why it’s important to consider each of them:
1. Demand- Demand is how much a customer or group of customers might need or want a product. This variable can vary situationally, but demand might be higher for regular purchases such as gas, food or entertainment. The higher the demand for something, the higher price customers may be willing to pay.To calculate price sensitivity from demand, a company might look at the change in demand compared to the change in price. If the price increases at a higher rate than the demand does, customers might consider other brands, indicating high price sensitivity. Customer surveys might also provide you with information about how much demand actually exists for a product.
2. Competition-Competitive pricing is when companies in similar industries offer similar products or services to the same customer base. This can often affect the demand and price of products.For example, if every local store sells a comparable hair product, the one with the lower price might sell more to customers who have a high price sensitivity. This can change over time as different companies adjust their strategies and may enter and exit certain markets depending on sales. If there is less competition, you may see lower price sensitivity, and your company may consider slightly raising the price of a product.
3. Location and income-A customer’s location and income can make them more sensitive to price. This means if certain products are suddenly more expensive, customers may purchase the cheaper brand that’s more affordable.Companies might consider variable pricing to provide appropriate pricing to customers in different locations. Selling high-quality, expensive products in locations where income levels are high might be effective consistently since individuals might not be as sensitive to prices and price changes.
4. Exclusivity- While exclusive products can create higher prices, sometimes the customer sensitivity to pricing may remain low. Customers may be more likely to pay higher prices based on the limited availability of certain products.For example, a sneaker company may manufacture only 100 pairs of shoes in a particular style. They may charge more for this limited-edition than their normal shoe prices because of this exclusivity, but still make sales to customers with low price sensitivity.Given that price sensitivity varies from person to person, it’s important to consider how exclusivity and higher rates might make a product less appealing to some markets while having an overall positive impact on brand reputation.
5. Quality- Product quality may refer to the materials from which a company manufactures a product, the craftsmanship of a product’s assembly or the level of experience a service provider might offer. Companies may determine whether the quality of a product could encourage more people to buy, even if it’s a little more expensive.Similarly to exclusive products, the impact of quality might vary based on location and markets. People who are more sensitive to price might be more likely to sacrifice quality than others.
Calculating price sensitivity
Price elasticity
Price elasticity is the possibility of a change in relation to other factors, such as demand. For example, to calculate price elasticity of demand, the formula would divide the percentage of increased demand by the price change:PED = $% change in quantity demanded / % change in priceThe resulting price elasticity of demand figure, or PED, can show how much demand actually affects the price. With this formula, a company may calculate price elasticity for several factors to get a more comprehensive understanding of customer behavior.Using this method can ensure that if a company increases its price, it’s in relation to one of these factors, like product demand or exclusivity. This is helpful for determining the change up to a certain point, but other price sensitivity methods may still be more effective with customer input for a particular market.
Laddering
Laddering is a method that helps companies understand why a customer may buy a certain product or service. It can help immediately identify if the price is a factor in their purchase.To figure this out, companies may survey customers to share what their likelihood is of buying a product at a certain price on a scale of 1-10. For example, they may ask if customers would buy a new welcome mat for $100. If the response is lower, the survey may include qualifying questions for customers as well, such as if quality or exclusivity might change their minds. This type of customer feedback can help businesses determine how much price sensitivity might affect their sales.
FAQs
What is a Price Sensitive Market?
A price-sensitive market refers to a market where the price of a product or service significantly affects demand or supply. In such a market, small changes in price can lead to large shifts in consumer behavior, sales volume, or even investor activity. These markets are particularly sensitive to pricing strategies and fluctuations.
Why is price sensitivity important for businesses?
Understanding price sensitivity is crucial for businesses as it helps them:
- Set competitive pricing: Businesses can price their products appropriately based on market demand.
- Maximize revenue: By adjusting prices, companies can increase sales volume or maximize profit margins.
- Market segmentation: Identifying customer segments that are more price-sensitive helps target pricing strategies effectively.
- Product positioning: Price sensitivity influences how a product is positioned in the market (premium vs. budget-friendly).
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