expectations that can he utilized at key points in the software development process where design decisions are at stake. Price sensitivity measurement (PSM) ...
Incorporating Price Sensitivity Measurement Into the Software Engineering Process' Robert Harmon', David Raffo', Stuart Fa& 'Portland State University, School of Business, Portland, OR 97207, USA 2Universityof Oregon, Department of Computer Science, Eugene, OR 97403, USA Abstract. Software developers typically make critical design decisions without uuderstanding how the market will value the fiual product in terms of the price that customers are willing to pay. Market research techniques that rely on simulated purchase situations, laboratory experiments, and actual purchase behavior are often dismissed as too expensive, too time consuming, or too impractical. What is needed is a quick and cost-effective method for assessing customers' price expectations that can he utilized at key points in the software development process where design decisions are at stake. Price sensitivity measurement (PSM) research provides product developers with the capability to quickly assess the range of acceptable prices, indifference points, and optimum pricing points for any given software configuration. 1,lNTRODUCTlON Marketers have long acknowledged that the pricing decision is one of the most difficult in the technology development and commercialization process. This is particularly true for new software products where product attributes are complex and difficult to define during the initial stages of development. Yet, software developers need to know early in the design process what the economic implications of key design decisions will be. Knowledge about the price expectations of potential customers for particular software features, configurations, and capabilities is needed to guide these decisions. Therefore, it is critical that software developers integrate insights from customer value analysis and price sensitivity analysis into the design process. This study presents an application of the price-sensitivity measurement (PSM) methodology to the Value-Based Software Engineering (VBSE) process [14]. The software development team needed customer-based pricing input in order to decide on which of two software modules to develop first. The PSM method was used to provide an estimate of the prices potential buyers would be willing to pay for each module.
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11. PRICE SENSITIVITY
Marketing researchers have directed considerable attention to studying the effects of pricing on purchase behavior [18][19][31][32][34][36][39], and more recently on the factors affecting price sensitivity [40][27][22]. Price sensitivity is defined as the highest price that a customer
' This uork was sponsored by the Vationill Sricncc Foundation grant LEC99057P.9 10 the SuRwarc Engincermg Rewarrh Center under the Small FIN Collaboratne R&D program
would agree to pay for the desired product [35].' Economists call this the reservation price. The obverse is also true. The lower bound on price sensitivity is the lowest price a customer would pay without questioning the quality of the product [47]. Price sensitivity research assumes that purchase decisions are motivated by perceived economic value, or utility, which buyers seek to maximize. This, in turn, is affected by the knowledge of alternatives (such as substitutes or reference products), product differentiation, brand preferences, advertising, and segment membership (customer type, demographics, and attitudes). If a buyer picks product A over product B, then s h e sees more utility or value in A than in B. Price is assumed to influence choice because it is an indicator of what the buyer must give up to attain that utility [33]. For new products, marketers are particularly interested in the innovator's price sensitivity since it is a major determinant of the product's market acceptance [17]. lnnovators are, by definition, the first to buy the product as it is introduced to the market. Eliciting a favorable price reaction from the innovators is important to generate earlystage sales and to energize the diffusion process as innovators influence the decisions of later buyers [41][20].
A . Price Sensitivity Measurement The Law of Demand posits a basic relationship in economic theov-the quantity demanded of a product in a given time period is inversely related to its price. Therefore, marketers of new products have a keen interest in setting a price that will maximize demand for their product while ensuring a profitable business outcome. Understanding the price sensitivity of the buyer provides marketing decision makers with the foundation to develop accurate demand forecasts. The pricing decision is a key determinant of the financial success of the new product [22]. Early market demand forecasting models such as the Fourt and Woodlock's Pure Innovative Diffusion Model [I61 indirectly addressed price sensitivity by estimating the penetration rate of untapped market potential and potential sales as a fraction of all buyers to arrive at market demand over time for a new product. Bass [Z] extended the pure innovation approach to account for the innovation effect of early adopters on later adopters in the estimation of the sales curve. Subsequent research extended the generalized Bass Model by incorporating price changes and marketing mix changes into the sales forecasts [5][3][4][6]. Both the Fourt and Woodlock and Bass models are appropriate for forecasting overall sales of a new product for which there is no close substitutes in the marketplace [45][54]. These models attempt to predict how many
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customers will ultimately adopt a new product and the time period in which they act. However, these dynamic market demand forecasting models have limited application in price determination and they are relatively complex, time consuming, and expensive to implement. Extending the pioneering work of Gabor and Granger [I81 on the price-quality relationship, and Monroe [30][31] and Stoetzel [49] .on the psychological aspects of price, the PSM model, which was developed by Dutch economist Van Westendorp [55], was among the first efforts to incorporate a psychometric approach to price sensitivity measurement. Like the market demand models, the PSM model has been successfully applied to new and existing products and services [51]. It is also useful for estimating market demand [33]. At any given price one can calculate the proportion of buyers that would buy the product. However, the model’s primary strength is its focus on customer value, which, in tum, feeds directly to the pricing decision. The relative simplicity of the model enables quick and inexpensive implementation. The PSM model determines the limits of buyer resistance over a range of prices that relate to the product’s value perceptions. A key to these value perceptions is the buyer’s tendency to compare a product’s value with that of a reference product or with a “perceived normal” price for the product class. These value perceptions are market segment specific, and based on the buyer’s beliefs, attitudes, spending capabilities, and intentions. By anchoring their perceptions to a reference product or reference price, the buyer’s price sensitivity responses are comparative in nature and provide insights into the choice decision [15][29][30][37]. Since PSM is a point measurement, repeated applications of PSM over a number of time periods will provide insight into the longitudinal dynamics of the psychological pricing situation. B. Perceptions of Value Perception refers to the way that individuals organize and give meaning to sensory data. Perception, therefore, alludes to a decision process that is based on experience and uses discriminatory cues to classify incoming stimuli [46]. Marketing stimuli such as communications about the price of a new product serve to initiate a perceptual judgment about the reasonableness of the price. Product developers and marketers are keenly interested in these perceptual judgments since the price that a new product can command may determine if a product is to he developed, influence its design, and impact its marketing strategy. The experiential nature of value perceptions underlies price sensitivity assessments. Perceptual judgments of price are characterized by the following factors: The judgment focuses on perceived value that balances benefit against price. Every judgment of price is relative to the knowledge of other prices and value of other products. 9 A normal or “standard” price exists for every level of benefit in every product category. This standard price functions as an “anchoring” point for judging prices [ S I .
C. The Value Equation Perceived value can be defined in terms of the relationship between perceived benefits received and the perceived price of acquiring the product or service that delivers those benefits. The Value Equation depicts the dynamics of this relationship. Buyers will make judgments about price and benefits and choose products and services that maximize perceived value [25]. Perceived Benefit (1) Perceived Value
= Perceived Price
Where: Perceived benefit: The summation of physical and intangible product attributes that are available &om use of the product and influence its perceived quality. Perceived price: The perceived total cost to the buyer including purchase price, start-up costs, and post-purchase costs [33]. Buyers judge the appropriateness of a given price based
on three perceived value scenarios. The bargain experience applies when the price of a product is less than the perceived normal price (or reference price) and the quality is similar. Buyers will perceive that they are getting a good deal and may be motivated to buy more of the product [52]. The price-quality experience suggests that price is an important indicator of quality when it is difficult or impossible to judge quality in any other way [ZI]. The general case here is buyers tend to perceive higher prices to he indicative of higher quality in the absence ofrelevant benefit cues [10][12][28]. Finally, the price threshold experience refers to the observation that price elasticity is not a smooth As price passes through continuum [33][44]. specific price levels, or thresholds, demand can shiA dramatically. These thresholds tend to be associated with consumers’ perceptions conceming the relative value of the product vs. the reference product or “normal” price. The basic question here is-how will a price change affect the quantity demanded and profits and at what point will demand drop off precipitously?
D.Value Thresholds The PSM methodology defines the upper and lower threshold limits of the range of acceptable prices. The price where consumers would doubt the quality of the product and would substitute another brand demarcates the lower threshold. The upper threshold is the price that the consumer would regard as too high, prompting substitution for a lower
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priced product or canceling purchase activities altogether. Therefore, these boundary limits may be defined as the points where the cognitive responses to the perceived value inherent in the benefidprice ratio of the value equation become sufficiently stressed that buyers are compelled to change their attitudes, purchase intentions, and behaviors. At the upper threshold the price is too high relative to the benefit and thereby contributes to a low perception of product value. Within the range of acceptahle prices, a lower price will generally lead to an increase in perceived value since price is falling relative to benefit. However, at the lower threshold, a sufticiently lower price will elicit lower perceived value as buyers start to question their initial perceptions of the product’s benefits. Social psychological theory offers an explanation of the underlying constructs for the pricerthreshold effect [46]. Sherif and Hovland [42] and Sherif, Sherif and-Nebergall 1431 in their work on social judgment theory found that individuals form acceptance or rejection latitudes (ranges) around attitudinal frames of reference. The frame of reference is formed through experience and represents prior value assessments, experiences, emotions, and interests that are pertinent to the purchase decision. It actsto set the stage for cognitive-response judgments, either accepting or rejecting the communication, as the new information is contrasted with the initial attitudes. Communications that are perceptually close to the existing frame of reference are within the latitude of acceptance on the attitude continuum and likely to be assimilated. The buyer will view the price communication favorably. Conversely,. pricing information that is sufficiently distant from the existing frame of reference (either too high or too low) will suffer from a contrast effect and fall into a latitude .of rejection. The contrast effects start to take hold and increase in intensity at both the lower and upper thresholds of the latitude of acceptance where the transition occurs to the respective latitudes of rejection. Correspondingly. cognitive response theory [37][53] has consistently found that message recipients generate more support argumentation when a new communication is perceived to be in agreement with existing attitudes. Conversely, more counterarguments are generaLed when a .new communication is inconsistent with existing attitudes. A high level of support argumentation leads to message acceptance and more favorable attitudes and purchase intentions. A high level of counter-argumentation will elicit negative attitudes and result in message rejection [23][13][24]. Therefore, the research on social judgment theory and the cognitive response process provide strong support that the attitude change process is the primary psychometric mechanism that underlies the PSM method. Prices that closely match a buyer’s value expectations will generate support argumentation and fall within the latitude : acceptance. Prices that sufficiently contrast with~thebuyer’s expectations, as being too high or too low, will generate enough -counter-argl;mentatjon to fall into the appropriate
latitude of rejection by traversing the corresponding upper or lower price threshold. 111. THE PSM METHOD
The PSM method features a product scenario that serves as the stimulus to communicate the essential elements of the product’s total value for each pricing situation. Care is taken to ensure that the graphicdepiction and written scenario elements portray the essential features, advantages, and benefits that make up the product’s value proposition that is to be tested. A pricing scale is developed that encompasses the relevant range of market prices that a consumer could reasonably expect for the product class [ S I . The PSM question inventory consists of four items that are presented to the subject after they are exposed to product scenario and the relevant pricing scale. The questions are: 41. At which price on the scale do you consider the product to be Q2. At which price on the scale do. you.consider the product to be exDensive? 4 3 . At which price on the scale do you consider the product to be too exDensive so that you would never consider buying it? 44. At which price on the scale do you consider the product to he too cheaD so that you would question its quality?
m?
A . The Indifference Price
- ,
First, the cumulative distributions for the cheap (Ql) and expensive (42) questions are plotted. The point at which they intersect indicates the indifference price (IDP): The IDP is the point in the price range where an equal number of people perceive the product to be cheap or as expensive 1551. An inverse relationship exists between indifference and price consciousness. A low-level of indifference indicates a high level of price consciousness. Conversely, a high indifference point indicates a low level of price consciousness: The IDP is thought to reflect the normal price in the market or the price of an important market leader.
E. The Optimum Pricing Point A similar process is used in graphing the response to the too-expensive (43) and too-cheap (44) questions. The point where their cumulative distribution lines intersect is the optimum pricingpoinf (OPP). The OPP is the point at which an equal number of respondents see the brand as too cheap and too expensive. The corresponding price at this point evokes lowest level resistance against that price in terms of -being too low or too high [ S I .
C. The IDP and OPP Relationship The relationship between the 1DP and OPP contrasts perceptions of the normal market price with the price that has the least resistance. An OPP that is close to the IDP indicates less price consciousness since the optimum price and the
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indifference price are similar. This is the most common outcome across a wide range of products. However, the greater the separation between IDP and OPP, the more stress there is in the pricing situation [ S S ] . Stress can occur below or above the IDP. In the first instance, when the OPP is to the left, a lower OPP indicates that a number of customers have a high level of price consciousness and that they would prefer a lower price. They are more likely to consider switching to another supplier. This situation often occurs after a major price increase when newer customers perceive the product's higher price as more normal, but longer-term customers are more sensitive to the increase in price. Conversely, an OPP that is higher than IDP, and below the upper threshold of rejection, indicates that some customers may he willing to accept a price increase. In any case, a high degree of stress may be indicative that price may have important potential as a segmentation variable for classifying customers into high and low-price segments.
D.Marginal Pricing Points The marginal pricing points form the upper and lower thresholds for the latitude of acceptance. Price levels between these points are more or less acceptable to most buyers. The intersection of the expensive (42) and too-cheap (44) distributions is the point ofmarginal cheapness (PMC). This is the inflection point at which the proportion of respondents that view the product as too cheap start to increase rapidly. Prices below this threshold are viewed as being sufficiently low that customers will start to question product quality and move into the latitude ofrejection. The intersection of too expensive (43) and cheap (QI) distributions is the point of marginal expensiveness (PME). The PME is the upper threshold of the latitude of acceptance beyond which potential buyers will fall into the upper latitude of rejection. Prices above this threshold will cause perceived1
value to fall sufficiently that buyers will switch to -other products. The PME is the inflection point where the increasing price elasticity of demand is sufficient to cause demand to fall rapidly. 1V. PSM IN THE VBSE PROCESS The Value-Based Software Engineering (VBSE) process aligns software development with customer requirements and strategic business objectives [38][ 141. VBSE seeks to improve the development process by incorporating customer value measurements to guide product line development. Understanding the relevant customer-value drivers unifies domain engineering and application engineering within a common framework. As such, this approach to product-line engineering builds on the quality function deployment (QFD) work of Hauser and Clawing [ 2 6 ] , Akio [I], and Taguchi [SO]; the customer value work of Belk [7][8], Stemthal [48], and Harmon and Laird [ZS]; and the software development process modeling of Campbell, et al. [9] and Cuka and Weiss [Ill. Within the VBSE process (Table I), developers gain insights into customer value requirements, value drivers, and the economics of the potential product at the front end of the process with the customer value assessment (Phase 1). This initial value assessment is further refined with economic and PSM analysis as the product design strategy is being devised (Phase Ill). Further refinement in the product family's price sensitivity profile is achieved in Phase 1V as the architecture and product family requirements are verified. Another PSM check is recommended as an input to the final marketing plan development prior to commercialization in Phase V. In all three measurement instances representative customer panels provide the value profiles through a personal .interview process
TABLl
Markcling Devclopmenl-Markcling, Distribution, Customcr Scrvicc Product Srratcey Prioritize sattwarc rcquircmcnts Initial cortlcconomic analwis lnilinl Value Perception-I"PSM Assessment Fnmilv Architeclural D n i e s and Verification * Architectural rctluiremcnts Product family &atform rcquircmcnts Product family v ~ l u e - 2 ' ~ PSM aswsment Build Family Instance Low-lcvcl dcsicn Coding Prototypc tcsting Pre-productionleammercislilalion ~ a l u e - 3PSM ~ assermen1 Sourcc: Adapted from iulk, Harmon. and Raffo [14].
Phase 111
-. -.. -. -
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C. The PSM Questions The PSM method is implemented by presenting the subject with a product scenario that represents the total value of the product. Subjects are then asked the four PSM questions that are keyed to a price scale. The pricing scale represents an extended range of feasible market prices for the product class. For this study, the scales low point was $50 and the high point was $900. The pricing-scale amounts are for the total purchase price of the product inclusive of firstyear support costs but not other recumng expenses. Two product scenarios were developed, one for the labor-tracking module and one for the purchasing module. In order to ensure that the product description accurately presented the appropriate value proposition to be tested, each scenario was content verified with the company’s design team and marketing group. After reading the appropriate product scenario, each subject responded to the four PSM questions that assessed the points where the total price of the product was perceived to be cheup (Ql), expensive (Q2), too expensive (Q3), and too cheup (44)on the pricing scale.
V. METHODOLOGY
The focus of the study is to measure the price sensitivity and relevant range of prices for a new software product. The software is a thin-client, hand-held, personal digital assistant (PDA) device version of a project management software suite that is targeted toward the construction industry? The goal for the PDA software development project was to enable contractors in the field to have readwrite access to the project management database. The initial versions of the product would focus on job costing and feature two application modules: one for tracking labor hours (labor-tracking module) and the second for tracking materials, vendors, and subcontractors (purchasing module). A . Subjects The subjects were 96 small-to-medium sized contractors recruited from the software company’s customer base. All subjects were direct users of the server-based software product that operated on a personal computer network. 40 respondents evaluated the labor-tracking solution and 56 evaluated the purchasing solution.
VI. RESULTS
B. Procedure
The results of the PSM analyses are reported in Table 2. Figures 1 and 2 graphically present the cumulative distributions for the PSM questions for each product configuration. Recall that the purpose of the PSM analysis in this study is to provide insights into which software module should be developed and introduced to the market first. The company intended to develop both modules, but decision makers were keen to determine their pricing flexibility in each instance since both modules would require approximately the same amount of time and financial resources to develop. Therefore, the question is to determine which module would have the greatest potential retum within the given time horizon.
Subjects in each group were provided with a brief presentation that fully described the new mobile software application. The presentation included PDA screen shots with simulated functionality. Data could be entered, updated, and graphically represented on the PDA emulator. They were then given a survey instrument and asked to respond to a series of QFD’-like questions that included product-use situation questions, product-feature questions, a customervalue driver inventory, and a series of price-oriented questions that included the PSM inventoly that is the focus of this study. Both groups were asked identical questions except for the product questions that were application specific.
..
Mobile. ADplicatioh ~
.
IDP -
%
~
~
.OPP
- ~ %
~
PMC Y.
PME Y.
PrieeRange $115
0.695
$150
-0.133
Labohtracking module
$460 12%
$380 6%
$360
$475
8%
11%
Purehaslag module
$355 15%
$375
$300 10%
$450 10%
8%
~
Stress
Factor
The identity ofthe company and exact description ofthe praduct are being withheld due to the proprietary name ofthe product research.
’’
’ Quality function deployment (QFD) questions map customer value expectations and other customer requirements such as product features, advantages and bcnetits.
‘The PSM questions were presented in the classical order (551. No order effect w% 320
found in a pretest of this issue for this study.
-Cheap (QI) -Expensive(92) -TOO
Expensive((
-T m Cheap (Q4)
’
IOPP PMC PME
Price
FIGURE 1: PSM Results for the Labor-TrackingModule
1 00
0 90
C 070 0
a
8
060
B
050
Expensive (Q2)
040
T m Expensive(Q3)
I c
0
-Tm
Cheap (Q4)
020
0 10 0 00
Price PMC
PME
FIGURE 2 PSM Results for the Purchasing Module
A. Price Thresholds and the Accepfable Pricing Range The comparison of the upper and lower pricing thresholds and the range of acceptable prices can yield useful information concerning the pricing options for each product module. The range of acceptable prices, the difference between the PME and PMC, is $115 for the labor-tracking module and $150 for the purchasing module. The tighter
range for the labor-tracking module may indicate clearer value expectations for the labor-tracking module as well as increased price consciousness. At the upper end of the pricing range, the PME for the labor-tracking module at $475 is $25 higher than that for the purchasing module. Recall that prices higher than the PME are in the latitude of rejection where the numbers of
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relatively flat slope of the too expensive (43)distribution within this range provides further evidence for this conclusion.
customers that find the price unacceptable increase rapidly. On the low end of the range of acceptable prices is the PMC. Prices that fall below this threshold are in the lower latitude of rejection where customers question the benefit of the product because they perceive the price to be too low. For the labor-tracking module this threshold is at $360. For the purchasing module it is $300. In terms of the price thresholds, the PSM profile for the labor-tracking module is more attractive. Its upper price threshold (PME) is at a higher price, as is the PMC. The tighter pricing range indicates a higher level of agreement about perceived value than for the purchasing product. It appears on the surface that customers will pay more for the labor-tracking module.
VU. DISCUSSION AND CONCLUSION
B. IDP and OPP . The IDP for the labor-tracking module in Figure 1 is $460, which is $105 greater than that of the purchasing module ($355) in Figure 2. The IDP occurs at the intersection of Q1 “cheap” and 4 2 “expensive” cumulative distributions. The IDP represents an approximation for the perceived “market price” for each product module. The OPP occurs at the intersection of 43 “too cheap” and Q4 “too expensive” distributions. The OPP is $380 for the labortracking module and $375 for the purchasing module. The . comparison of the IDPs and OPPs indicates perceived pricing expectations that are higher for the labor-tracking module. The low proportion of respondents at the IDP price for both the labor-tracking (12%) and purchasing (15%) modules indicate a high level of price consciousness for both modules, although slightly less so for the purchasing module. C. Pricing stress In a pricing stress situation, some consumers perceive the market price to be too high relative to the perceived value of the product. The difference between the OPP and the IDP provides the basis for estimating the degree of pricing stress. The OPP for the labor-tracking module is $80 less than the u)P, indicating that a number of respondents would prefer a cheaper price. They may not be willing to pay the “normal” IDP market price and are likely to search for altematives if the price increases from the OPP. Indeed the proportion of respondents that view the product as “too expensive” doubles from the OPP (6%) to the IDP (12%). The amount of stress in this relationship can be calculated by dividing the difference between OPP and IDP by the range of acceptable prices (PME-PMC = $115). The stress comprises 69.5% of the range of acceptable prices indicating a high degree of price sensitivity. For the purchasing module, the OPP is $20 greater than the IDP. This result indicates that a small proportion of buyers would accept a higher price. Difference analysis produces a stress factor of -0.133 or 13.3 percent of the acceptable pricing range on the right, or upper, side of the IDP.~The relatively low stress does not indicate a high degree of price sensitivity on the high side of the range. The
The decision on which software application module to develop first will be greatly influenced by the perceived value and forecasted price of each product. Estimates of price points coupled with the product-cost economics provide important insights for future profit potential. In the current analysis, the preponderance of the PSM results would lead one to conclude that the labor-tracking module should be developed first. It will provide the fastest financial retum potential. All of the relevant pricing points are higher as is the upper threshold of the acceptable pricing range. Moreover, the range of acceptable prices is tighter indicating stronger perceptions of value and a more stable view of the benefiuprice relationship. The greater price sensitivity indicated for the labor-tracking module is troublesome only if the product’s cost economics indicate - that a high price outside the range of acceptable prices is necessary. Although PSM analysis has been widely used and documented by market researchers since the technique was first developed by economist Van Westendorp at The Hague thirty years ago, little attention bas been given to the psychological constructs that underlie its methodology. Going back to the original work, this paper has laid the groundwork for a social psychological explanation of price sensitivity in terms of perceived value and value thresholds. Social judgment theory with its latitudes of acceptance and rejection and the corresponding cognitive response theory with its support and counter-argumentation concepts, firmly place price sensitivity measurement withm the discussion of attitude change theory. Future research should be directed at increasing the understanding of the underlying constructs of price sensitivity and the factors that influence its measurement. Additional research is needed on price sensitiyity as a segmentation variable, price-benefits tradeoffs, linkages to intentions and actual behaviors, and the impact of situational variables such as task, time, and psycho-physiological states. REFERENCES [I]
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