Willingness to Pay: What is it and how to measure WTP?
Acquisition & Growth
June 15, 2021
Without a well-defined WTP, you can't charge for your product optimally.
The idea of Willingness To Pay is simple; it's the maximum amount of money your customers are willing to pay for your tool or services.
Don't let the plainness of the term deceive you, however. Because of where the Saas industry is heading - a fully commoditized market, with numerous players fighting over more demanding and less paying customers - the awareness of WTP is fundamental to your SaaS business.
Every year the revenue growth rate of SaaS companies decreases. Once the market moves towards commodities, it creates more pressure on profitability. Without understanding willingness-to-pay, you can' fully unleash your pricing potential.
In fact, without a well-defined WTP, you can't charge for your product optimally. You will either turn off potential users because the price is too high, or you will waste the revenue and growth potential (and potentially sink your company) because it's too cheap. SaaS is all about value creation and division.
If you don't want to be in either of these groups, you need to define the Willingness to Pay of your client base and then build the product around it. In the end, what matters is how much value you provide in exchange for what money. Let's see how to define the second part of this equation.
In this article, you will learn:
- What are the different methods of learning the WTP?
- What are their advantages and disadvantages?
- What is the best WTP methodology for your business?
How to measure WTP, method 1: ask your clients
If you want to know how much your potential clients are willing to pay for your services, you can simply ask them this question during sales calls and increase the proposed price with every next one (or every next couple of calls). The idea is beautiful in its simplicity, as it doesn't require much time or effort. However, it works well only under particular circumstances.
Asking for the Willingness to Pay directly is an excellent start for small businesses that are just trying to figure out their pricing strategy and mostly rely on outbound sales. You can consider the WTP question as part of the general market research you conduct among your buying personas to understand your business environment better.
The downside of this method, and an ultimate reason you shouldn't use it in the further stages of your business growth, is the risk of price anchoring your customers. Once you establish a certain pricing point in the client's mind, it won't be easy to ask for more if the price you've proposed turns out to be too little.
An important note: you're not supposed to ask: "how much would you pay for this or that." This type of question might provoke your client to be wondering whether price X is good or not. You want to offer your clients gradually increased prices until you meet the spot where they say, "that's too expensive." You shouldn't be asking questions, but instead, observe the reaction after telling them that "the price is X."
Also, there is a cool analysis done by OpenView Partners based on the data from public SaaS companies. They calculated the average revenue per customer depending on the customers served. It's not perfect but allows you to get the essential information if you're in the pricing corridor or your pricing is off. Very useful if you have a mid-market/enterprise-level solution and still try to price it well.
How to measure WTP, method 2: value analysis
This one is quick, effortless, and requires you to do nothing but just simple math. Think of how much value does your tool provides to your users. In a sense: how much time does it save your average customer, and how much is this time worth. Then take 10-15% from this amount as what your users are supposed to be paying you.
For instance, if my tool saves you ten working hours every month, and your working hour is worth $50, I'm effectively saving you a total worth of $500 every month. By a rule of thumb presented by Kyle Poyar in his ebook here, it's fair if I charge you $50-$75 a month.
Someone may say it's a POOMA/FMA type of metric (google the acronym or see the video), but according to the tacit knowledge of pricing experts, you can use the following matrix for that.
How to measure WTP, method 3: Van Westendorp framework
The Price Sensitivity Meter (PSM) made by Peter Van Westendorp in 1976 is another method to determine price preferences. It also includes customer interviews. As such, it has the advantages and disadvantages of the first method - it's easy and quick in the making but exposes you to potential price anchoring.
These are the four questions that you ask your customers:
- What price of the product would you consider so expensive that you would not consider buying it? (Too expensive)
- What cost of the product would you think so low that you would feel the quality couldn't be very good? (Too cheap)
- What price of the product would you consider so expensive to consider buying it, but you would have to give some thought to do so? (Expensive/High Side)
- What price of the product would you consider a bargain—an excellent buy for the money? (Cheap/Good Value)
After you collect the answers, you need to plot the numbers to a line graph, where the x-axis stands for the price and the y-axis for the number of respondents, as presented on the chart from a real case study.
How to measure WTP, method 4: conjoint analysis
Conjoint analysis is the creme de la creme method of determining Willingness to Pay. Its purpose is to understand how much the user values different attributes that make up a product; does he or she consider them necessary or not. It attempts to capture the complexity of our choices, all small decisions that lead us to choose this or that.
The ultimate idea behind that methodology is that we evaluate products' characteristics differently, and we match those evaluations with our preferences before any buying decision.
To measure the WTP through conjoint analysis, you need to break down your SaaS into features and then identify customer preferences by presenting different sets of those features to them. Respondents have to choose between potential product concepts formed through the combination of features.
The power of conjoint analysis lies within its versatility: businesses of all industries can use it, no matter the size, development stage, or competitiveness in the market. As the survey is anonymous, you cannot price ladder your potential customers. However, to conduct it properly, you need a large sample group and a proper knowledge of the methodology itself.
What we have learned
- If you just started a SaaS company, and are doing general research on your product's potential, test the pricing on your clients until they start mentioning it's too high
- If you want to estimate the Willingness to Pay real quick, go for the value-based method
- If you want to have precise information on the Willingness to Pay with optimal effort, run a van Westendorp methodology
- If you're going to have the most accurate WTP, invest time and money in Conjoint analysis