The Gabor-Granger method is a popular approach for demand-oriented pricing. It helps determine the optimal price point by surveying customers about their willingness to pay and fitting a logistic model to predict purchase probabilities. Let's walk through the steps of using this method with a concrete example.

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Step-by-Step Example

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Customer Survey:

We conducted a survey with 26 customers, asking about their likelihood to purchase a product at different price points (4, 6, 8, 10, 12 Euro) using a Likert scale (1-5). Here’s the summarized survey data:

We averaged the 26 responses to obtain a probability vector and fit a logistic model to these probabilities: (0.32, 0.31, 0.21, 0.05, 0.04).

Now we fit a logit model.

Logistic Model:

The logistic regression model is fitted as follows:

In this example:

• max = 0.33
• β0​ = 8.3
• β1​ = -0.97

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Calculating Optimal Price

Given the fixed cost of 5000 Euro, marginal cost of 3 Euro per unit, and a total market of 10'000 customers, we aim to find the price that maximizes profits.
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1. Calculate Revenue and Profit for Different Prices:
   • Revenue = Price * Quantity Sold
   • Profit = Revenue - (Fixed Cost + Marginal Cost * Quantity Sold)
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2. Fit the Logistic Model to Predict Quantity Sold:
   • Probability of purchase at different prices is computed using the logistic model.
   • Expected Quantity Sold = Probability * Total Market Size.

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Calculating Profit

Now, we determine the price that maximizes revenue or profit. Assume fixed costs are €5'000, marginal costs are €3 per unit, and the total market size is 10'000 customers.

The profit calculation involves determining the total revenue and total cost for each price point.

The formulas used are:

• Units Sold: Units Sold = Market Size × Probability of Purchase
• Total Revenue: Total Revenue = Units Sold × Price
• Total Cost: Total Cost = Fixed Costs + (Units Sold × Marginal Cost)
• Profit: Profit = Total Revenue − Total Cost

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The optimal price that maximizes profit is €7.5, yielding a profit of €5'928.79.

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Graph of Likelihood of Purchase:

To visualize the logistic curve for purchase probability:

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Python code used for graph:
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Disadvantages of the Gabor-Granger Method

The Gabor-Granger method is a valuable tool for determining optimal pricing based on customer willingness to pay. However, it has several limitations and drawbacks that businesses should consider:

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Survey Bias

• Explanation: Customer responses in surveys may not always reflect their actual purchasing behavior. Factors such as social desirability bias, hypothetical bias, or simply the difference between stated intention and real action can lead to inaccurate data.
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• Impact: This can result in pricing decisions that do not align with actual market conditions, potentially leading to suboptimal revenue or profit outcomes.

Limited to Specific Price Points

• Explanation: The Gabor-Granger method relies on predefined price points presented to respondents. This means it can miss intermediate prices or other pricing nuances that could be more effective.
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• Impact: Businesses may not capture the full range of customer willingness to pay, potentially overlooking optimal price points that fall between the tested values.

Static Nature

• Explanation: The method does not account for dynamic market conditions, such as seasonal demand fluctuations, competitor price changes, or evolving customer preferences.
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• Impact: Pricing strategies based solely on this method might be less responsive to market changes, making them less effective over time.

Assumes Rational Decision-Making

• Explanation: The Gabor-Granger method assumes that customers make rational decisions based solely on price and their stated willingness to pay. In reality, purchasing decisions are influenced by a variety of factors, including brand loyalty, product features, marketing efforts, and emotional responses.
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• Impact: This simplification can lead to an incomplete understanding of customer behavior, potentially resulting in pricing strategies that do not fully align with how customers actually make purchase decisions.

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Conclusion

While the Gabor-Granger method is a useful tool for demand-oriented pricing, it is essential to be aware of its limitations. Businesses should consider these disadvantages and potentially supplement the method with other pricing strategies and market research techniques to develop a more comprehensive and effective pricing strategy.