What is Price Optimisation?

Posted by Moira McCormick on January 31, 2017
Moira McCormick
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Price optimisation is the process of finding that pricing sweet spot, or maximising price against the customers willingness to pay.  Companies up and down the supply chain, both in B2B and B2C settings, rightly dedicate a massive amount of time towards price optimisation to ensure that their products will sell quickly at the right price while still making a decent profit.

If an item is priced too high, it may not sell at all, while if the price is reduced too much, the business will not make a profit.  Businesses use a price optimisation formula based on the overall demand for their product, their level of competition, and (in the case of manufacturers) the cost of manufacturing their goods. 

Finding the perfect balance between profit and value is essentially what price optimisation is all about, and because the relative values of goods and services constantly change, this is a never-ending task for most businesses.

To assist in this vital process, software companies have developed price optimisation software packages to handle the complex calculations required. The pricing software can be tailored to meet the needs of both B2C or B2B companies.

 

Pricing Has A Big Data Problem

 

How Price Optimisation Models Work

Price Optimisation Models are mathematical programs that calculate how demand varies at different price levels. The resulting data is then combined with information on costs and stock levels to recommend prices that will improve profits.

Price optimisation can be used to tailor pricing for customer segments by simulating how targeted customers will respond to price changes with data-driven scenarios. Given the complexity of pricing thousands of items in highly dynamic market conditions, the results help to forecast demand, develop pricing and promotion strategies, control stock levels and improve customer satisfaction.

For example, a supermarket may carry six different types of tinned tomatoes. While each of these brands may be similar in terms of overall quality, manufacturers will set their price optimisation based on their image with consumers.

A few of the tinned tomatoes on supermarket shelves may be 20 to 30% more than the generic brands, while the value brands are constantly dropping their prices in order to remain the least expensive.

For price optimisation the pricing manager will:

  1. Select the preferred optimisation model and determine desired goals.
  2. Collect historical data, including product volumes, the company's prices and promotions, competitors' prices, market conditions, product availability, seasonal conditions and fixed and variable cost details.
  3. Clarify the business's value proposition and set strategic rules to guide the price optimisation process.
  4. Load, run and revise the model.
  5. Establish decision-making processes that incorporate the results.
  6. Monitor results and upgrade data input to continuously improve pricing accuracy.

 

Next Generation Price Analytics

 

Price Optimisation Models help businesses determine initial pricing, promotional pricing and discount pricing:

Initial price optimisation works well for companies with a secure base of long life-cycle products, e.g. supermarkets, chemists, office supply stores and commodities manufacturers.

Promotional price optimisation helps set temporary prices to boost sales of items with long life-cycles - newly introduced products, products bundled together in special promotions and loss leaders.

Discount price optimisation helps businesses selling short lifecycle products subject to fashion trends and seasonality such as airlines, hotels, clothing stores.

 

Win-Win Outcomes

Few decisions have as large an impact on the success of your business as optimising prices. Your prices influence how many customers actually purchase your products, how your product is perceived, the types of customers you attract - and sales revenue. This all has a direct effect on your profit margins.

Every pricing decision you make should offer a win-win outcome where your customers get good value for their money and your business makes a healthy profit. So, start a review of your pricing strategy without delay – and consider investing in price optimisation software to maximise your profits.

 

Please Stop Confusing Your Customers With Your Pricing

 

Related Posts

Your Priority Should be Profitable Growth Not Higher Prices

Why Do Companies Price Discriminate

Top 6 Yield Management Tips

 

Sources

The Strategy and Tactics of Pricing, Tom Nagle and John Hogan, 2016

Pricing with Confidence: 10 ways to stop leaving money on the table, Reed K. Holden and Mark Burton, 2014

Pricing Strategy: Tactics and strategies for pricing with confidence, Warren D Hamilton 2014

Pricing Optimization: Striking the Right Balance for Margin Advantage: NAW Institute for Distribution Excellence and Texas A&M University’s Industrial Distribution Program, 2009

Pricing and Revenue Optimization by Dr. Robert L. Phillips, 2005

The Art of Pricing: How to Find the Hidden Profits to Grow Your Business by Rafi Mohammed, 2005

Topics: Price Optimisation

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