Willingness to Pay – Definition, Meaning and Calculation

Willingness to pay or WTP is the maximum amount of money a consumer is inclined or willing to spend on a commodity. This amount can never be expressed in exact numbers as all the consumers will never have the same willingness to pay.

In other words, the willingness to pay keeps on fluctuating depending on certain factors. So, it is generally measured as a range. Willingness to pay gives an idea of the aggregate demand for a particular period.

What is Willingness to Pay?

Definition – Willingness to pay or WTP is defined as the maximum price that a consumer is willing to pay on a commodity or product or service. The concept of WTP helps economists figure out the aggregate consumer demand. Businesses use the information regarding consumer demand to set the price points for their products.

The OECD(Organization for Economic Co-operation and Development), defines willingness to pay as-

The stated price that an individual would accept to pay for avoiding the loss or the diminution of an environmental service.

This quite often gets mistaken for willingness to accept, which applies to the sellers. It is the price that sellers are willing to charge from the consumers for their commodities. The sellers will find a medium between their WTA and the consumers’ WTP when pricing a product.

The sellers will try to fix an attractive price that will encourage more consumers to buy their commodities. However, an exchange occurs only when the willingness to pay aligns with the sellers’ willingness to accept.

Difference between Willingness to Pay and Willingness to Accept

Willingness to accept is the minimum amount at which sellers sell their commodity. Contrary to this, the Willingness to Pay is the maximum price consumers would pay to buy the item.

Factors Affecting Willingness to Pay WTP

The maximum price your customers are willing to pay for your product or service is affected by the following factors-

1. Economic Condition

Economic condition drives the willingness to pay to a large extent. If the financial situation is good, willingness to pay will increase.

However, if the condition worsens due to industry problems or recession, the consumers’ willingness to pay will fall. It is always a better idea to monitor these market shifts while pricing the products.

2. Seasonality and Trendiness

Willingness to pay keeps fluctuating for the products that have a seasonal nature like Halloween costumes or Christmas décor. Depending on the market behavior, the pattern of fluctuations can be monitored and tracked.

Monitoring the behavior may be a bit of a challenge in the case of trendiness. Therefore, it is crucial to look for the trends by keeping the industry updates in check.

3. Brand Image

Brand image is likely to influence the price consumers are willing to pay for a commodity. If a brand is famous, consumers’ WTP will be more for its products.

FMCG’s generally keep the price point below average or average to attract more customers. This is because, in the case of consumables, people get many alternatives to choose from.

4. Consumers’ Price Preferences

Different consumers have different price preferences, depending on their background. This means that willingness to pay cannot be uniform across the board.

A high-income consumer may have more willingness to pay for a premium commodity than a low-income consumer.

5. Consumers’ Circumstantial Needs

Willingness to pay also pins on what their existing circumstances are. These precise needs can be anything ranging from personal aims to geographical location.

With a change in the consumer’s geographical location, their willingness to pay will also see a drastic change. Similarly, if their personal goals change, their WTP will rise or fall accordingly.

6. Product’s Supply

If the supply of a product is low or is not abundantly available in the market, willingness to pay for it will rise. This means that the value of that product starts rising for the consumers.

While pricing such products, the sellers should not increase the price so much to become unaffordable.

7. Product’s Quality

A product’s quality directly impacts the willingness to pay. The better the quality, the more will be the WTP and vice versa.

How to calculate Willingness to Pay? Four ways to measure WTP

1. Market Data Analysis & Business Metrics

In market data analysis, how the market will behave is projected using the data on previous years’ demand.

Sales data used for carrying out market data analysis include:

Store Scanner Data? based on previous years’ records of sales.

Panel Data? based on the data of the purchases recorded by the appointed customer panel.

This type of analysis helps in analyzing the consumers’ shopping behavior. However, appointing a customer panel can turn out to be expensive. Also, it cannot be easy to find out the data if the product is new.

2. Direct Surveys

Direct surveys can be either customer surveys or experts’ judgments.

Customer Surveys- These surveys require the direct involvement of the customers, who have to answer questions regarding their willingness to pay.

These surveys provide immediate outcomes, which may or may not truly express the consumers’ buying behavior.

Experts’ Judgments- Experts in the fields of marketing and sales analyze the competitive environment. This kind of survey takes less time and is cheap.

However, when the target audience widens, the experts’ judgments may not remain valid. This is because it becomes difficult to stay up-to-date with the changing customers’ needs.

3. Experiments

Experiments can be either field experiments or lab experiments.

Field Experiment- This kind of experiment involves groundwork like observing the consumers’ buying behavior in stores or malls. Even though field experiments are time-consuming and costly, they help form a better picture of the consumers’ behavior patterns while shopping.

Lab Experiment- This experiment is conducted in a simulation instead of a real place to judge the consumers’ buying behavior. Lab experiments provide immediate results, but they can be highly biased and subjective.

4. Indirect Surveys

In the case of indirect surveys, consumers are offered different alternatives to a product. They are then asked to rank them according to their priorities.

Such surveys yield more accurate results than direct surveys, which include customer surveys and experts’ judgments. Moreover, these results provide a deeper knowledge of the needs of the consumers. This information can be leveraged to tweak the product.

However, indirect surveys, too, fail to provide a true image of consumers’ buying behavior.

How Does Willingness to Pay Affect Businesses?

The maximum amount of money that your customers would pay for your product or service i.e. WTP would affect different aspects of your business such as-

1. Market Demand

Willingness to pay helps businesses gauge the products that are likely to be a hit in the market. The more the demand for that product, the more would be the willingness to pay. In other words, they can understand the market demand for their products by measuring WTP.

2. Pricing Strategy

Businesses can design their pricing strategy based on the consumers’ willingness to pay. The data gathered from the surveys can help them charge different prices for their products’ features from different target audiences.

3. Product Development

Surveying the target market to know the willingness to pay can help businesses understand which features or products they should improve. In other words, WTP helps in product development which in turn assists in the growth of the business.

How to influence Willingness To Pay?

Different factors that would increase the willingness to pay of the customer base of your brand are-

1. Know your value proposition

It is one of the key factors that make your product better than the competitors and compel your audiences to opt for your product or services. It should drive your marketing to connect and convince your audiences that your product is worth spending their money on.

2. Optimize brand awareness

Customers like to pay a premium price for the products or services of the big brands. Therefore, your brand must have good recognition in the target market. Optimized brand awareness should be aligned with the values that you offer to your audiences and it would influence WTP productively.

3. Use influencer marketing & social proof

To optimize the credibility of your brand messaging, companies should use the power of influencer marketing and social proof. They are quite effective in shaping customer perceptions in your favor that will ultimately help in influencing the willingness to pay of target customers.

Examples of Willingness to Pay

Amazon Prime

The survey of a set of Amazon Prime subscribers revealed that their age and yearly income hugely affected their willingness to pay. People with a higher salary package had a greater willingness to pay as compared to those with a lower compensation package.

Noticing the rising willingness to pay, Amazon Prime increased the price point of its monthly subscription twice. This increased their revenue exponentially. The first increase helped them capture almost all the age groups. However, with the second increase, they were able to target those who came under the higher income group.

Spotify

Spotify can cash in on its subscribers’ increasing willingness to pay. A survey indicated that the price of the standard plan offered by Spotify matches its subscribers’ aggregate willingness to pay.

However, there is scope for it to introduce tiered pricing for its different monthly subscription plans. Those who want a 5-user plan are willing to pay $3 more than what Spotify is currently charging. This means that it can gain a lot by raising the price of its Family plan.

Shopify

This eCommerce store provider is known for doing some great jobs in optimizing their customer’s WTP. Their pricing tiers grow approximately at the same rate as their customers’ loyalty to the brand.

They offer a $29 basic, $79 premium, and $299 enterprise tier for customers and while breaking down their WTP as per their gross merchant volume (the number of sales they made in one year), it seems they are moving ahead on the right track.

Conclusion!

On the concluding note, it is obvious that being aware of what your customers are willing to pay is inevitable for building an effective, competitive, and conversion-driven pricing strategy.

How important do you consider the willingness to pay of target customers in deciding the right pricing plan?