Set the price too high and you may fail to get any customers. Set your price too low and you might get a lot of demand, but you’re leaving money on the table. Neither outcome is ideal, and marketers have long been tasked with determining consumers’ “willingness to pay” (WTP)—the maximum price a customer will spend to acquire a product or service.
“At its core, this is a classic problem,” says Derek Rucker, a marketing professor at Kellogg. “In fact, it’s one of the oldest and most important problems we face as marketers.”
But when Rucker and fellow Kellogg marketing professor Eric Anderson, along with Kellogg alumna Sharlene He, now a faculty member at Concordia University, dug into the literature, they found that the prevailing consensus on how to conceptualize WTP was in reality unclear and missing. critical ingredients.
Moreover, most of the existing methods of measuring WTP had serious drawbacks. “Current methods don’t consider context and competition as well as they should,” says Rucker. “This means that it is possible that merchants are making business decisions based on inaccurate estimates of willingness to pay.”
So Rucker, Anderson and He tried to find a better approach to measuring WTP. In a new paper appearing in Marketing Magazinedo just that, introducing what they call the Comparative Method of Valuation, or CMV, and validating it across thirteen studies.
Better tool
Over the decades, various approaches to measuring WTP have been developed. But all have limitations in their ability to capture willingness to pay based on phenomena that marketing scholars know to be true.
Previous research has often found differences in people’s WTP in different settings—for example, people are willing to pay more for a beer in a hotel bar compared to a vendor on the beach. However, many studies have measured WTP simply by asking people how much money they would spend on a product, without providing details about the situation in which it is purchased or the alternatives available. “In this simple example, you can see the problem,” says Eric Anderson, “You might pay over $10 for your favorite beer at a fancy hotel bar, but only $5 for the same beer from a vendor in beach. This difference in WTP may be perfectly reasonable and due to what alternatives are available. Simply asking consumers what they are willing to pay misses a critical aspect of the measurement, which is the comparisons consumers are considering.”
Most approaches to measuring WTP present customers with a product or service in isolation, as if their choice is to either buy it or go home empty-handed. While there are certainly some shopping situations where consumers will choose to walk away with nothing, more often than not the question is “this or that” rather than “this or nothing.”
Rucker learned this lesson firsthand when his teenage daughter needed a dress for her school’s homecoming dance. Not getting a dress was never an option – it was always an issue which dress.
Even approaches that consider alternatives do not always take into account the fact that most relevant The alternative will vary from one situation to another. Is this red dress for $75 the best comparison option? This blue one for $45? The one you already have in your closet?
To illustrate the importance of accounting for relative comparison, consider how it may differ between customer segments. A consumer considering a Disney Plus subscription will likely have a different comparison—and thus a different WTP—in mind if they are currently subscribed to Netflix versus if they currently have cable. The right comparison is fundamentally linked to a company’s intended target segment and positioning strategy.
Comparisons matter
Enter the Comparative Valuation Method.
CMV is based on another popular approach, known as the Becker-DeGroot-Marschak (BDM) method. With BDM, consumers are asked to provide a measure of their WTP for a target product—for example, a KitKat bar—and then see a random number. If this number is lower than or equal to Their WTP, they should buy the KitKat bar. If it’s higher, they get nothing.
This process has the advantage of keeping participants honest about how much they really deserve that Kit Kat—but it falls short for all the reasons described earlier.
So CMV takes this random lottery aspect of BDM, but then expands on it.
“What’s fundamentally different about our process is that instead of simply asking whether or not you would buy something, we want to first understand who the competition is,” He says. “We want to ask, if you weren’t buying this product, what would you be buying? This will be the relevant comparison that shapes one’s WTP. We don’t assume that the answer is that they wouldn’t buy anything.”
In practice, this means introducing a few steps before the draw process begins. First, participants choose between several comparative options. If the target product is a KitKat, for example, participants will choose whether to compare it to M&Ms at $1.10, Reese’s at $1.05, and Snickers at $1.15. This setting guarantees that the target product is compared to a viable and realistic alternative for that consumer.
Participants then provide an initial estimate of WTP by answering the question, “What price for KitKat would make you equally happy to buy KitKat for that price or to buy M&M’s for $1.10?”
Then comes the drawing process where participants put their money where their mouth is. The distribution of all resulting WTP data, across a wide range of contexts, can therefore be used to inform pricing.
One advantage of CMV is that it allows marketers to see what alternatives consumers are considering. The methodology is also flexible and can be adapted to different situations. For example, if a marketer wants to understand WTP for KitKat in the limited context of a vending machine, they can only test it with other candy bars. if they want to understand it in the context of a grocery store overflowing with snack options, they can try it with other candies, as well as (say) apples and crackers.
Testing the Comparative Valuation Method
The researchers conducted over a dozen empirical studies to test the CMV as a tool and explore its managerial applications.
Their empirical studies took several years to run and involved nearly 3,000 participants — in person and through online platforms like Amazon Mechanical Turk. “We learned different things in each study,” he says. “Everyone approaches the problem in a different way.”
For example, in one study, researchers tested WTP for a premium version of Kraft Lunchables that included a beverage. In this case, the company was trying to convert existing Lunchables customers into consumers of the premium product. To that end, the researchers tested the premium version against three flavors of regular, non-alcoholic Lunchables, all priced at $1.36 (the price at Walmart at the time of the study). They also included a “do not buy” option, which was designed to identify consumers who were probably unlikely to purchase a Lunchable product and thus unrealistic customers. As Anderson notes, “One good thing is that we’ve done studies that reflect real situations and problems that marketers are trying to solve!”
Among consumers who chose one of the basic varieties, the average WTP for the premium version was $2.33, while in the no-purchase group, WTP was only $1.35—even lower than the price of regular Lunchables. Thanks to CMV’s ability to identify these different segments (i.e. “buy” and “non-buy” groups), researchers gained important insight into Why some consumers had much lower WTP than others. In other words, visibility into the comparative choice a consumer is considering makes it easier to identify the true WTP—in this case, $2.33—of realistic customers.
CMV also proved to be a useful method to explore situational factors such as gift giving or to assess how changing product warranty might affect people’s WTP for different brands of luxury refrigerators.
Notably, the researchers also conducted an experiment where they tested CMV against its predecessor, the BDM method. When the WTPs produced by these two methods were compared in a real test of purchasing behavior, CMV outperformed its predecessor. “To be clear,” he says, “it’s not that BDM isn’t useful, but we’ve refined this method to offer something more accurate.”
The researchers also demonstrated when CMV outperforms the combination, another popular method of estimating WTP. While conjoint is useful as an efficient way to explore WTP in many different settings, CMV is superior when there are clear comparative options.
Useful tool
CMV contributes to the growing academic literature on behavioral economics by elucidating how different situational goals or comparative options can directly or indirectly affect customers’ willingness to pay.
But it can also be immediately adopted by marketers. “As a marketer, you don’t just need to understand what your brand offers—you also need to understand who you’re competing against,” says Anderson. “We cannot become so commercial that we only focus on ourselves. We need to know what alternatives consumers have in mind.”
In future work, the researchers plan to expand their focus by investigating how a brand’s and competitors’ advertising affects customers’ willingness to pay for a product—a direction that should provide even more practical insights for marketers. All three authors expect to continue to share new findings about WTP with both students and MBA executives, who in turn can continue to test theories in real-world settings.
“We have by no means solved the problem where we can tell someone with 100 percent accuracy the right price for a product,” Anderson says. “But we’ve taken a step in the right direction by clarifying the definition of WTP and giving people a methodology that directly takes into account comparison and context to better approximate real-world market situations.”
