How much?

In his paper Overestimating Others’ Willingness to Pay marketing professor Shane Frederick warns that organisations are at risk of setting prices too high and overestimating demand for products because of a quirk of consumer behaviour. In a series of detailed experimental designs, he contends that he has identified a tendency for consumers to overestimate what others will pay for a product or service. In one test, which asked people to bid for goods and guess the median offer price, respondents overestimated by an average of 43%. He suggests that this tendency “may influence pricing and negotiations, which depend on accurate assessment of others’ valuations” and he implies that businesses may need to reappraise how they price new products.

“Businesses and individuals need to accurately predict the economic valuations of others,” says Frederick. “Firms must decide how to price new products… parties negotiating the terms of an offer must guess the other side’s reservation price, and so on. Whatever its basis, the bias explored here may be pertinent to real-world decision making.”

But is it pertinent for researchers engaged in pricing research? Experimental designs have an increasing contribution to make in challenging our assumptions about pricing dynamics. Many researchers are still grappling with the implications of behavioural economics, and some are formulating new techniques as a result. But we are not convinced Frederick’s paper makes the case for generalising his theory to consumer markets more widely. Nor does it undermine orthodox pricing research. The typical approach taken in most pricing research – understanding the price perceptions of individuals who are representative of the target market – is fundamentally correct.

It is difficult to see why it would be generally preferable to reference pricing from the observations of what individuals guess others might pay for a product rather than from the perspective of the target audience that the products are ultimately aimed at.

In the real world, pricing strategy is formulated after reviewing multiple sources of insight, both internal and external. Given sufficient time and resources, a rounded pricing strategy benefits from a complex process which combines marketing, finance, market research, sales data, tracking data, competitive intelligence and channel assessments. Market research, of course, is axiomatic to good decision making, but we should acknowledge the complex of business insight that feeds into the decision-making process.

Researchers are all too aware of the need to make evidence-based judgements which take account of potential bias and misrepresentation. Building in measures to capture overstatement and likely commitment and relevance to the product, as well as softer moderating factors such as brand and emotional engagement, are all part of the toolkit in pricing research studies. At the same time, we have seen many examples of marketers making questionable assumptions about target audiences, and overly optimistic assessments of potential market demand for new products. Of course, some product ideas feed on an inertia created by a mix of interests and prejudices of individuals or organisations rather than what the evidence suggests.

On the other hand, there are many cases of research underestimating actual demand for products, particularly new products. When Motorola’s first mobile phone was launched, sales far outweighed the original estimates indicated by the research. New product launches and new market categories are much more difficult to predict, and we should recognise our limitations when estimating optimum pricing and demand.

Frederick makes a very credible point when he speculates that “a lifetime of selective exposure to paying customers engenders the idea that others are freer with money”. Individuals responsible for planning new products need to take particular care that they are not being overly influenced by their own prejudices and experiences of the products they like when framing new products. It is precisely for this reason that the assessment of price sensitivity needs to be firmly rooted to the objectivity of a truly random and representative target audience.

Defining the target audience and aligning it to appropriate offerings is not an easy task, but it is essential if the research findings are to be relied upon. We would argue that a well ordered multiple-phase programme of research to define audiences and test product concepts is necessary before testing price perceptions.

Neil Cary is a director of Redshift Research UK and Lisa Bella vice president of Redshift Research North America. Read ShaneFrederick’s paper in full here.