A customer’s willingness to pay (WTP) is the maximum amount they’re willing to spend on a product or a service. It’s easier to understand their willingness to pay when we viewed it from one of the macroeconomic’s pillar concepts.
If you’ve ever been to economics class, you probably heard of the law of supply and demand. All things being equal, the law states that as the price of goods or services go up, the demand drops. In other words, producers want to charge high while customers want to pay little.
The middle ground between these two is where solutions are normally priced at. Willingness to pay directly measures how much a customer is willing to concede.
For businesses, understanding your market’s WTP is central to pricing your goods and services at that ideal level. Not mastering WTP can result in leaving money on the table or, even worse, pricing yourself out of the market.
In this article, we’ll explore the factors affecting willingness to pay. Moreover, we’ll look at some practical examples of WTP applied to better equip you with this important concept.
How Willing Are You To Pay For A Product/Service?
Ever wondered why some customers are willing to pay a premium for services when there are other cheaper options available? That shouldn’t be surprising. There are layers of reasons that influence a person’s buying decision other than price.
For example, brand image, prestige, and relationships may matter to them. Whereas, other customers with limited cash flow may be restricted to what their budget can afford.
With that said, willingness to pay varies from person to person. This difference is attributed to the overlying ad underlying context which can be divided into two: extrinsic and intrinsic factors.
- Extrinsic Factors
These details are observable, which means you don’t need to ask the buyer directly to determine. Extrinsic factors include the buyer’s age, gender, educational attainment, and home address. Their income also falls into this category.
All of these details play a part in influencing a person’s willingness to pay.
- Intrinsic Factors
Intrinsic details are the polar opposite of extrinsic factors and they’re commonly a person’s characteristics. You need to ask for the information directly from the buyer to identify them.
These factors include a person’s risk tolerance, propensity for prestige, passion and attention to brand image, among others. This can also impact a person’s willingness to pay.
The relationship between intrinsic and extrinsic factors measure’s a customer’s total willingness to pay.
Factors Affecting the Willingness to Pay (WTP)
A customer’s willingness to pay is not a fixed metric. This means there are elements that can further influence their WTP to rise or fall.
For instance, a surplus in supplies will only push customers to pay less amount for a product or service. Similarly, they may be forced to pay a premium if they have an urgent need for the service. For instance, when their heater breaks down with winter right around the corner.
These are all situational, but the factors can be broken down into 6 distinct categories which we’ll discuss below:
1. Economy Status
The economy is perhaps the biggest influencer to customers’ willingness to pay and also product and service pricing. When the economy performs positively, the WTP is more or less going to increase. However, recessions or other economic issues like high inflation can lead to a decrease in willingness to pay. This is often caused by people becoming more price-sensitive given their limited purchasing power.
For residential home service businesses, it’s important to consider general economic shifts when pricing your club memberships. Sensible customers will understand the ramifications of high subscription prices if they’re knowledgeable of basic economics.
2. Seasonality of Product/Services
Unlike other residential home services, roofing and HVAC businesses have strong seasonality to them. HVAC contractors experience peak seasons during the onset of summer and winter. It’s expected that such companies will experience a high willingness to pay from customers during these times.
By the end of the peak seasons, the spike in WTP will have subsided and prices (and demand) will go down. The same trend will repeat itself each year. Smart businesses take advantage of preventative maintenance clubs during shoulder seasons to drive revenue. This will allow you to stay on top of extreme fluctuations.
3. Price Points
You have to understand that you’re not any customer’s first purchase. Their long history of buying from different stores has enabled them to assess their spending budget. This is called a customer’s personal price point.
Every price they encounter internally signals them how to think about the price. Normally it’s impossible to account for your client’s personal price points. However, there’s a workaround to help you assess your customer’s personal price point. Try to examine how different touchpoints within your industry impact a customer’s buying decisions.
For instance, relational buyers who value empathetic competent convenience will have a higher willingness to pay and choose reasonably premium solutions. Whereas transactional shoppers with limited budgets will normally gravitate to lower prices. Knowing your market can help you create better pricing tiers.
4. Individual Circumstances
A customer’s willingness to pay is also going to be relative to their current circumstances. If they just had a windfall, they may be more willing to splurge on that new car or designer handbag. But if they’re going through tough times, they may be looking for the best deal possible on essential items.
Another example is the geographical distance from your business. If other residential home services can attend to their concerns faster than yours, they’ll choose that option.
5. Product Availability
Rarity is another factor that influences the value of a product or service. The less available a product is, the higher its selling price. If the perceived rarity of your services is high, you have more leverage to ask for higher prices.
The entire diamond market is founded in scarcity. While there are millions of diamonds available, diamond conglomerates purposely limit access to prop up prices. We’ve even seen high end luxury brands torch over $600,000 in goods to protect their market value.
6. Product Quality
The higher the quality of your product or service, the more your customers will be willing to pay. This is because they perceive a direct relationship between quality and price.
An example of this in the residential home service is solar panel installations. An off-grid system can help save your budget from a lifetime of electric bills. For this reason, solar panel installation comes with an expensive upfront price. This further increases when the installing company has a reputation to deliver high-quality services to customers.
On the other hand, customers who are looking for a low-cost option will be less willing to pay for quality. They may be happy with a lower-quality service that meets their needs and budget.
There’s no Exact Formula for Calculating WTP
If you’re looking for an exact formula to calculate willingness to pay, you won’t find any. Different people have different levels of willingness to pay. If you ask a group today about their WTP, you’ll likely get a different consensus from another group tomorrow.
There is no one-size-fits-all when it comes to calculating WTP. While there’s no exact formula, there are ways to assess the willingness to pay range. Here are three ways:
One of the most common truths in any industry is that most businesses will be competing for the lowest price. Competition tends to drive prices down. If you’re the only business in your market that offers the service, you can leverage it for a higher price.
However, in overly saturated markets like the home service industry, you can’t charge higher than average for an equal value. The only way to win the market is by creating your perfectly fair competitive advantage. This means selling at a reasonable premium with an irresistible value proposition.
Doing so will create demand for your services despite the price bump.
Just because the market for a certain industry is great doesn’t mean reception for your business will be as good. Your service offerings must still speak directly to your customers’ needs and preferences.
The features and benefits that your products and services pack must align with your clients’ advantages. If what you deliver can make your customer’s perceptual reality an actual reality, you increase their willingness to pay.
Customer research is about knowing what your customers truly care about. Otherwise, you’re just another home service provider with generic solutions.
Surveys are effective ways to gather information from customers like their preferences, perceived value, loyalty and other data points. All this information is a building block you can use to calculate your customers’ willingness to pay.
If you have the budget, focus groups can also be better but more expensive data gathering methods.
Ways of Influencing A Customer’s WTP
You want to induce a spike in your customer’s willingness to pay. That way you can charge a premium for your products and services. Now then how exactly do we do it?
Here are two ways:
Align Your Unique Sales Proposition to Your Market’s Needs
One of the biggest mistakes that companies make is they fail to articulate their unique sales proposition. This is the quality that makes customers choose your solution.
To do this, it’s important to answer the following questions:
- What makes your solutions better than others?
- Why should customers care about your solutions?
- How do your solutions address their underlying felt needs (money, energy and time)?
Your whole marketing and advertising campaign must revolve around your USP. Otherwise, your customers will be unaware how desirable your offers are. This helps create desire and convinces customers to increase their willingness to pay for your solutions.
Increase Your Brand Awareness and Social Proof
Even if generic businesses and household names sold the same quality service, people will still normally choose the premium option. The thing is that brand awareness plays a significant part in a person’s willingness to pay.
The key to being able to sell premiums is building your brand image and brand recognition. The more recognizable you are, the more important you become. One way to do this is to establish social proof through your projects. Demonstrate impeccable quality in your goods and services and you create social proof.
Aligning value proposition with great marketing and service that boosts your brand awareness and social proof, you propel customers’ WTP.
Example of Willingness to Pay
Consider the willingness to pay for a high-end geothermal heat pump for luxury homes. While most people understand the importance of heaters, not everyone is aware of geothermal pumps. More importantly, no one would normally pay $25,000+ for a heater.
A customer who is familiar with your brand and had a good previous experience will evaluate you differently than others. They will be more willing to pay a premium for your high-end heater than those who aren’t aware.
The only way you can reach the high-end homeowners is by increasing your brand awareness through marketing. Focusing your message on your value proposition will enable you to speak to your ideal customers. High-end buyers who normally yearn for identity, purpose, and adventure will easily gravitate to your offer.
Unlike reaching out to cold audiences with a premium product they don’t understand, you become the bearer of their desires. This makes the process of converting leads to prospects and then customers smoother since their willingness to pay increases.
When you master how to increase your customer’s willingness to pay, selling premium services becomes a breeze. If you need expert guidance in this matter, Wizard of Sales® can help you. It begins when you book a call.