What is willingness to pay (WTP) and how to calculate it
One of the most powerful yet overlooked growth levers in SaaS is pricing strategy. Get it right and your revenue can soar. It’s not easy though, which is why so many companies set a price when they launch a product and then focus their attention on peddling, rather than improving, their chosen rate.
Profitwell found companies spend just 6 hours on their pricing strategy. The most successful companies, on the other hand, review their pricing quarterly and update it every six months.
A big part of setting and evolving that strategy is understanding who is willing to pay for your product, how much different people are willing to pay, and why. This is summarised in the aptly named metric “willingness to pay” (WTP).
Below, we cover the factors that impact a customer’s WTP, how to calculate it, and how to increase it.
What is willingness to pay?
Willingness to pay is the maximum price that a customer is willing to pay for a product or service.
By calculating and tracking willingness to pay as a metric, you can optimize your pricing plan and your product localization to ultimately achieve optimum revenue for your business. 💰
This can massively vary from customer to customer, which means finding the price point that fits within the WTP threshold of large enough proportions of the customer base, while also delivering the most revenue to your business. It’s a balancing act. Oh, and it’s not a one-time calculation either - willingness to pay is an ongoing metric that SaaS businesses need to keep track of.
We’ll talk more about the factors that impact a customer’s WTP - and how you could increase it - further down.
How WTP and market demand impact your product
The importance of understanding your customers’ willingness to pay is huge because it impacts your three central growth strategies: product, go-to-market, and revenue delivery.
Working out the ‘sweet spot’ for your pricing will help you sell to more people without undervaluing your product. Understanding which parts of your product most affect willingness to pay can help you make the product more appealing. Both help you position yourself more effectively in the market.
Customer segmentation is important here. What are the commonalities between people who are willing to pay the most for your solution? How can you cater to those who are interested in aspects of your product, but only at a lower price point? This is where tiers and plans come into play.
Your product roadmap can also be steered by your learnings here. Do you want to prioritize creating a version of your product that appeals to a handful of prospects with a high willingness to pay threshold, or a version that opens the door to lots of prospects wanting a lower price point?
To answer these kinds of questions you need to investigate WTP on a continuous basis. People change, as does the market.
So, what exactly can affect your customers’ willingness to pay?
Five factors that impact your customers’ willingness to pay
It doesn’t come down entirely to individual opinion, external factors impact your customers’ willingness to pay too.
Let’s take a look at the main five:
1. State of the economy
Economic uncertainty has a huge impact on willingness to pay, which is something we certainly saw during the pandemic. Countless businesses were forced to cut down on paying for tools that were considered nice-to-have, and focused only on the essentials to keep their business going.
When the economy is thriving, you’re more likely to see people trying out products and companies they don’t usually use. They’re willing to both experiment and spend more. This generally has a positive impact on their willingness to pay.
2. Seasonal and market trends
Just like the fashion industry, SaaS has its seasons and trends - and this is just another thing that will affect your customers’ willingness to pay throughout the year. We’ve got our four quarters, and big events like Black Friday and the rest of Cyber Weekend, as well as generic end-of-quarter discounting, which will have an impact on consumers’ buying behavior and habits.
No matter how timeless your product might be, it can’t compete with the ebbs and flows of software trends grabbing the attention of your target market.
3. Your customer’s location
Circumstances are different between individuals, but on a larger basis: between locations around the world.
Geography can have an impact on how your customers view the software you’re selling. If you’re selling, or looking to sell into more markets, you’ll need to research the target locations in terms of currency and economy, but also culture.
This is where pricing localization steps in - namely true localization, which takes into account willingness to pay across different regions. Research the conventions and the competitive landscape of each and every possible market, factoring in the cost of living and inflation in these areas to get a real idea of your customers’ willingness to pay.
4. Competitive value and differentiation
As per the scarcity effect, the rarer something of interest is, the more value it is seen to have. The higher the perceived value, the more people will be willing to pay. How unique is your offering?
This is where competitor analysis can help. How can you develop and position your product or brand to be different from your competitors? Creating a slight niche for your business can move you a level up ⬆️. This could for instance be creating a version of a familiar product but designing specifically to solve the pain points and support the ways of working in a particular industry.
5. The quality of your product
How your customers perceive the quality of your product is a huge factor too. There’s no such thing as a successful product without high customer satisfaction.
There are different ways to showcase the quality of your product pre-sales. Case studies, customer testimonials, and familiar logos offer social proof. Giving customers access for free lets them see for themselves whether your claims are true. And that’s the clincher really – making sure they are true, that you live up to, if not exceed the expectations you set in your marketing and sales messaging.
How to calculate willingness to pay
Given its complexity, there is no specific formula to calculate willingness to pay.
Working it out requires research - in-depth market and customer research. This can come in the form of:
- Sending out surveys and polls
- Client research through your sales and success teams, or outsourced
- Encouraging testimonials and reviews
- Customer satisfaction emails
- Tracking and reviewing how customers use your product with tools like Mixpanel or Hotjar
- Investigating both commercial and public sources of market research
- Analyzing your existing customer data
Reach out to existing and prospective customers with incentives for any participation, like money or vouchers, and use all the data and feedback to complete Mission WTP.
Piecing it all together will help you arrive at an informed anchor-point to steer your product pricing strategy. It might come in the form of a single number, a range of $$$, or as a tiered model. Whichever you go for, the research and calculations put towards your pricing strategy will result in a boost in retention and increased acquisition because you are making sure the customers you’re targeting are getting the service they expect for the amount they are willing to pay.
How to increase your customer’s willingness to pay
There are a number of ways you can influence your customer’s WTP, but it takes real effort. Here are three approaches:
1. Perfect your value proposition
Take a look at your messaging. If you can’t clearly and simply articulate your value proposition and what sets you apart from your competitors, you cannot expect your target audience to pick up on or understand.
Your customers want to know what your product is, how it can help them, how much it costs and what exactly they can expect in return - and they want all this information yesterday.
The clarity in your messaging is key, anything less is a missed opportunity.
2. Raise brand awareness
It’s not all about presenting the value of your product, though. The brand itself can be just as influential in a customers’ buying decision.
As much as they make a song and dance of new products and features with reveal events and the likes, a lot of the appeal comes from the brand itself. People have a lot of respect for Apple, and apply that to their buying decisions.
Building brand awareness comes down to a powerful marketing strategy; one that ultimately creates a competitive advantage for your business regardless of how exactly your features stack up against a competing product.
Invest in different channels and content types, including SEO and social media, as well as partnerships with larger or better-known brands, to get people to see and talk about you.
3. Get involved with influencer marketing
We know that social media can be an essential tool for a lot of businesses, and we all know that word of mouth is an equally important method of building credibility. So, what do you get if you combine them?
Influencer marketing can be a powerful strategy. Partnering with influencers in your field who then talk about your brand or product on their platform drives awareness but also links their credibility to your name.
One example is Setapp. They created a strong social proof campaign in which Jason Staczek, a film composer, introduces himself, his career, and how he makes the most of Setapp. See the full video here.
Other metrics to consider
Your customers’ willingness to pay is a metric that reveals a lot about the health of your business, but it doesn’t give you the whole picture.
Here are just a few of the other key metrics you should keep on top of across different functions:
- Win rate: The generated leads or opps your sales team closes over a certain period of time.
- Sales qualified leads (SQLs): The number of leads deemed ready to speak to a sales rep.
- Deal velocity: The time it takes a lead to travel through the sales cycle before it is “closed-won”.
- Closed won/lost: The ratio of won Vs. lost deals, either by team or individual sales representative.
- Net promoter score (NPS): A feedback survey with a scoring system that lets you know how likely a customer it to recommend your product or service.
- Customer satisfaction (CSAT) score: Analysing data from feedback surveys to measure how satisfied customers are with their experience of your product or service.
- Response time: Keeping on top of how long your support team take to respond to emails from customers.
- Marketing qualified leads: The number of leads generated by your marketing efforts that fit your ideal customer profile.
- MQL to SQL: The number of marketing qualified leads that go on to be qualified by a sales team.
- Lead to customer: The number of leads that go on to be paying customers.
- Demo requests/talk to sales: The number of people from marketing channels who request either a demo of your product or speak to a sales rep.
- Customer churn: The calculation of the rate at which your customers are cancelling their subscriptions.
- Monthly recurring revenue (MRR): All your recurring revenue on a monthly basis (inclusive of upgrades and downgrades).
- Renewal rate: The percentage of customers that renew after their subscription ends.
- Customer lifetime value (CLV): How much revenue the average customer will bring in during their subscription to your product.
To find out more about the SaaS metrics that count across your teams, head to our ultimate guide.