One of the biggest differences between successful and struggling businesses comes down to one question: has price sensitive is your customer?
It seems like common sense, but I didn’t fully understand what caused price sensitivity until recently. Here are some of the main factors that I’ve seen contribute to price sensitivity (or lack there of):
- How visible is your fee to your customer?
Is your fee one of just a few expenses that your customer has to manage or is it one of several dozen? Does your fee have it’s own line item in your customer’s financial reporting, or is your fee non-transparently tucked into another larger category? The more visible your fee is to your customer, the more price sensitive they will be.
- What percentage of your customer’s budget is your fee?
Does your fee represent a small part of a large budget or does your fee represent a large part of a small budget? The larger the proportion of your customer’s budget you take, the more sensitive your customer (regardless of the actual size of the budget).
- Is your product or service seen as an expense or an investment?
For most people, buying a house is very visible and expensive, but people see it as an investment, so they are relatively less price sensitive. Buying a car is more like an expense, and people tend to be much more price sensitive when shopping for cars.
Competition definitely has an impact on price sensitivity (the more providers that offer what you do, the more downward pricing pressure you will feel), but from what I’ve seen – this impact is muted compared to the three bullets above. There are some very crowded industries where customers still lack price sensitivity (e.g. medical expenses).
A very price sensitive customer almost always makes for a very difficult business. But, if you find yourself with sensitive customers, it’s not the end of the world.
The best way to deal with price sensitivity? Pricing power.
Businesses that have pricing power can charge a premium for their product and services despite their customer being price sensitive.
Buying a new computer? Apple will charge you 2x the price of a Dell because they have the pricing power to do so. Apple has made investments in brand, technology, usability and style that gets otherwise price sensitive consumers to fork over $2k for the newest, slimmest, and most stylish laptop computer.
Buying a vacuum cleaner? Dyson will charge you 3x the cost of the average vacuum. However, before you shy away from their outrageous prices, just think of how impressed your guests will be when they see that fancy new cordless vacuum hanging on the wall like a work of art.
Some other examples of product categories where customers have varying price sensitivity:
Toothpaste – high price sensitivity- but Colgate has created pricing power through branding and advertising.
Jewelry – high price sensitivity – but Tiffany has created pricing power through decades of advertising and that signature little blue box.
Most Medical Expenses – low price sensitivity – the expense is usually paid by insurance (not very visible to customer); no need for most doctors or dentists to create pricing power.
Home insurance – low price sensitivity – for most people the cost is rolled into their mortgage payment (not visible) and it’s a small part of a large budget (their monthly mortgage budget).
It can also be very interesting and potentially catastrophic when customers transition from being relatively un-price sensitive to very price sensitive. With the push for increased transparency in pricing, the online ad industry (all the way from agency to publisher) is going through this transition right now. It’s only a matter of time before all fees become fully transparent and companies who have always relied on customers who lack price sensitivity will have to find a way to create pricing power.
As Warren Buffet says – only when the tide goes out do you find out who is not wearing a bathing suit.