With consumers feeling the pinch, marketers need to prioritise strategies that convince consumers their product is worth paying for, argues Dr Grace Kite, econometrician and founder of magic numbers.
Navigating inflation and the threat of recession
This article is part of a series of articles from the WARC Guide to navigating inflation and the threat of recession.
New research shows it’s possible to measure changing price sensitivity as a response to marketing. It’s true. Willingness to pay a high price is something that marketers can change.
The evidence shows that if you consistently air good quality advertising and invest in your brand, you build up associations that mean people buy it just because it’s easy to think of, or out of habit. Some will buy it without checking the price, others might check prices but still decide the product is worth paying more for.
It’s not an easy win. Even with great creative and a good budget, willingness to pay might only change to some extent, and only with some people. Even so, the money magnitudes involved mean that this effect may well be the biggest business benefit of advertising.
And right now, as the cost of ingredients, components, and especially energy is increasing rapidly, many businesses are being forced to increase prices. Willingness to pay and how to bolster it should be at the forefront of marketers’ thinking.
Branded products sell for more even if they are the same or worse quality
The simplest and clearest evidence that marketing affects willingness to pay is on display on supermarket shelves and comparison websites everywhere. Own label products which aren’t specifically marketed sell for less than those that are.
The chart above shows a pattern which is visible across many categories. In it, all 3 branded products sell for more than double the price of own label, and the strongest brand in the category sells for nearly 5 times as much.
Of course, the products themselves may be of differing quality, and some may genuinely be worth paying more for. In the example, Fever Tree and London Essence are cases in point, both make more effort on ingredients than the others.
So why does Fever Tree come out top? Why do they enjoy the highest price premium over own label? It’s in part because they communicate their higher quality in advertising which always bears the tagline “If ¾ of your drink is the mixer, mix with the best”. But it’s also because they invest in their brand via beer garden umbrellas in country pubs, drinks mats, and training for bar staff that ensures the bottle is served alongside every lovely gin and tonic, and always with the label facing outwards.
Schweppes is an interesting example here too. Even though it’s a well-established brand that many would recognise, it hasn’t done any advertising for years, does deep price promotions often, and is available at a very low price point in Lidl. It is an example where willingness to pay has moved in the wrong direction as marketers’ choices taught shoppers there’s no reason to buy it at full price.
It’s possible to measure changing price sensitivity as a response to marketing
Economists measure price sensitivity using a measure called price elasticity. That’s the percentage change in sales you can expect for a 1% increase in price.
Price elasticity is always negative – when price goes up, people inevitably buy less. But if you want to increase price, it matters a lot whether the price elasticity is a little bit negative, say -0.1%, or a lot negative, say -2%. If it’s the former you can charge a high price without losing too many sales, but if it’s the latter you have to keep prices low or risk losing all your customers.
The chart above is a simplified real-world example where both the advertising and the evaluation work was good enough to see a change in price elasticity. The orange line was the starting position, with each orange dot representing price and sales in a single week before the advertising. The green line and green blobs show the same picture after sustained and successful advertising.
In the right-hand portion of the chart, it’s clear that after the successful advertising more people bought the product at, or close to, full price than before. And along the green line the slope is shallower, showing a diminished response to all kinds of changes in price.
This example came from econometrics done by magic numbers, but we aren’t the only clever economists looking at this issue:
- A study from 2016 by Prof Berk Ataman and team considered seven years of data for 350 brands in 39 categories and found that advertising led to lower price elasticity. The effect was stronger for niche brands and in complex or more expensive categories.
- Research published in 2009 study in the Journal of Quantitative Market Economics showed that in 2880 purchases of toothpaste, toothbrush, detergent, ketchup, exposure to TV advertising increased willingness to pay higher prices.
The Schweppes type story – where willingness to pay is eroded by too many promotions and not enough investment can also be visible in econometrics if it’s done well. In the example below, the brand was sold to a new owner whose relationships with retailers were weaker.
The new owners were less able to withstand pressure from retailer account managers to go on deal more often and as a result consumers began to expect to be able to buy this product for a lower price.
The result was a movement in willingness to pay in the wrong direction and much fewer sales at full price than before.
Willingness to pay is the biggest money benefit of good marketing and especially important now
Whether or not you can increase price is a big deal. In a recent study by McKinsey, the finding was that the average S&P 1500 company would get a full 8% more profit if they could increase their prices by 1%.
This effect is likely to be the biggest money benefit of advertising for most businesses. If lower sensitivity to price allows you to increase price by 1%, the 8% resulting profit boost will, in most cases, outstrip the profit earned directly from advertising. A good norm for the direct effect of advertising is 10% of revenue1, and most advertisers’ profit margin is substantially less than 80%.
Right now, investing into willingness to pay is even more important than usual. The current crunch in household budgets is challenging consumers’ loyalty to their regular purchases even as costs of production are increasing in many businesses. Kantar’s latest reports show that shoppers are maintaining their weekly budgets but making ends meet by switching to lower priced alternatives.
Marketers that want to survive the coming shakedown need to look through their toolkits with a new lens and prioritise strategies that convince consumers their product is worth paying for.
1. This is the average % of revenue contributed by advertising in the IPA and magic numbers’ ARC21 database of 343 econometric evaluations of advertising.
Read more articles from the WARC Guide to navigating inflation and the threat of recession.
Managing brand and product portfolios in a recession: How to find growth
Building brand equity in an economic downturn: Five tactics beyond numbers
Raising prices? How advertising strengthens your brand’s pricing power
Berk Ataman, Koen Pauwels, Shuba Srinivasan and Marc Vanhuele
Özyeğin University / Northeastern University / BU Questrom School of Business / HEC Paris
Bain & Company’s advice on how companies should prepare for a recession
Pricing thoughtfully: Four lessons to ensure your brand survives the cost-of-living crisis
Advertising in recessionary times
Brand innovation in inflationary times: How to reduce pricing vulnerability