Price depends on options & context

Newswise — Researchers from Concordia University and Northwestern University published a new Journal of Marketing study that presents the Comparative Method of Valuation as a more accurate way to measure customers’ willingness to pay for a product or service.

The study, forthcoming in the Journal of Marketing, is titled “Measuring Willingness to Pay: A Comparative Method of Valuation” and is authored by Sharlene He, Eric T. Anderson, and Derek D. Rucker.

At the grocery store, a customer may be willing to pay $18 for a bottle of Riesling when comparing it to a $15 bottle of Chardonnay. However, if that customer learns that the Chardonnay is on sale for $12, they may not be willing to pay $18 for the Riesling. Another customer may only be willing to pay $14 for the Riesling after comparing it to the alternative of not buying anything (i.e., keeping their money).

Whether selling consumer packaged goods, durable goods, or services, marketers have always confronted a critical question: What will a customer pay for the market offering? As He explains, “If a marketer charges too little relative to what customers are willing to pay, they risk missing out on profits that could otherwise have been earned. And if a marketer charges too much, an otherwise excellent product or service may fail to generate sufficient demand in the market.” Because understanding how much customers are willing to pay for a product or service carries immense practical implications, marketers have sought measurement and analytical tools to capture customers’ willingness to pay (WTP)—a metric that helps them understand the maximum price they can charge for a product or service.

This new study reveals limitations in existing methods of measuring WTP and cautions that these methods can provide vague and/or inaccurate results. For example, the open-ended question often asked in surveys or focus groups (“How much are you willing to pay for X?”) makes no mention, nor offers the respondent any guidance, as to the relevant comparisons or the relevant context. Another popular method, choice-based conjoint analysis, does present possible comparisons but does not capture what the most relevant comparison is for a respondent.

The new methodology—Comparative Method of Valuation (CMV)— integrates comparison and/or context and produces greater accuracy and insight. “Context can affect WTP by changing how a customer values a product relative to a comparison or by changing what the relevant comparison is altogether,” says Anderson. For example, WTP for a new car model may vary depending on whether the customer is upgrading to this model (comparison: old model), switching from a different model (comparison: other model), or buying a car for the first time (comparison: no car). This means that a valid WTP methodology must be able to not only capture a comparison, but also different potential comparisons. However, existing methods often taken an agnostic stance on this matter.

While most researchers would likely agree that WTP can vary with the situation, the study reveals how situational factors can affect WTP via two distinct comparative mechanisms.

• The situation can directly influence a customer’s valuation relative to a given comparative option. For example, consider a beachside vendor selling two brands of beer – Corona and Miller Lite – and some non-alcoholic beverages. The customer wants an alcoholic drink and their preferred option among the alternatives is Miller Lite (priced at $5). However, if the customer has an enjoyment goal, they may value Corona more than Miller Lite, and their WTP for Corona would be more than $5. But if they have a diet goal, they may value Corona less than Miller Lite and their WTP for Corona would be less than $5.
• The situation can indirectly impact WTP through a change in the comparative option. Taking the previous example, if the customer moves from the beach to the hotel bar, Miller Lite is priced at $8 a bottle but their preferred option may now be a $20 cocktail. In this case, the customer’s WTP for Corona would be determined in comparison to the cocktail instead of Miller Lite. Thus, the situation affects WTP via the indirect pathway; that is, through a change in the comparative option.

Without capturing the specific comparison relevant in a given situation, existing methods inherently contain substantial ambiguity as to what is being measured. Moreover, existing methods cannot delineate the two distinct pathways through which a situational factor may affect WTP. Rucker says that “CMV offers more precise measurement of WTP and is able to capture the direct and indirect mechanisms through which situational factors affect WTP.”

CMV allows marketers to move from attempting to measure WTP without comparisons and context to measuring WTP in a manner that integrates these critical factors. The researchers offer guidance as to how marketers can improve their measurement of WTP and obtain more insight about customers’ WTP. Moreover, their studies demonstrate how to apply CMV to solve common managerial problems. They show how CMV can be applied to price a premium version of a product relative to a basic version and how to use CMV to evaluate whether more or less of an attribute (e.g., warranty) should be offered.