Price Optimization Models

Price setting can make or break any business. After all, making a wrong guess can lead to the loss of hundreds (or even thousands) of potential customers. However, you also need to be careful as copying competitors’ prices can start a price war.

A successful price optimization strategy is about finding that sweet spot between lucrative and attractive. It is about a balance, the lack of which can have a significant influence on sales, profit margins, customer satisfaction, and attainable growth goals.

Obviously, finding the optimal price point is not simple. It will require conducting a thorough analysis of historical data, as well as taking a closer look at customer behavior. Still, it is far from impossible, particularly if you have a strong understanding of pricing concepts and the right tools for the job.

The following guide is here to help. Each one of its sections examines key price optimization concepts. You need to study them carefully to understand what’s necessary to take your business to the next level.

What Is a Price Optimization Model?

A price optimization model is a mathematical program that determines how demand for a given product or service varies at different price points based on data analysis. Next, it combines its findings with information on inventory levels and costs to suggest prices that are most likely to improve profit margins.

To put it another way, price optimization models can be used to create an optimal pricing strategy for different customer segments. It can do so by simulating how targeted customers will respond to various price changes based on customer and market data.

Price Optimization Models & Pricing Strategy Models

It is worth noting that a pricing strategy and price optimization are two different things.

Pricing is the amount of money you charge for a product or service. A pricing strategy model is a process of determining what that amount ought to be.

Each strategy has its upsides, downsides, and best-use cases, all of which depend on the business or industry. Here are some of the most commonly used pricing strategy models:

• dynamic pricing
• captive product pricing
• penetration pricing
• even-odd pricing
• loss leader pricing
• psychological pricing
• bundle pricing
• price skimming
• demand pricing
• hourly pricing
• freemium pricing
• cost-plus pricing
• competition pricing

Price optimization, on the other hand, is the process of finding the optimal price for a product or service, and it is a crucial part of any solid pricing strategy.

How Can Price Optimization Models Help You?

Portfolio Pricing

THE PROBLEM ➨ Business owners need to consider the interrelations between different items when changing prices. If you change the price of one product, you need to adjust the prices of other products in the same category. It might also be challenging to determine which items require price changes in the first place.

THE SOLUTION ➨ To maximize revenue and sales volume on a portfolio level, you need an optimization model that will take into account the price elasticity of a given product and its cross-elasticity with similar products. If you choose the right price optimization solution, it will provide you with optimal and dynamic pricing recommendations across selected products.

Prices of Individual Products

THE PROBLEM ➨ Prices do not exist in a vacuum. Setting prices is not supposed to be based on one’s business goals alone. Instead, to find the optimal prices for products, businesses need to analyze a number of key variables, including price elasticity.

In a nutshell, price elasticity is the relationship between price and sales volume. The higher the elasticity of a product or service, the more its price will influence sales volume. You might find it difficult to maximize profits without knowing which products are more elastic than others.

THE SOLUTION ➨ With the help of pricing optimization models, you can simulate the behavior of targeted customers. You can easily determine which products customers will buy, and how different price points can impact buyers’ purchase decisions. With that knowledge, you can make precise predictions regarding revenue, profit margins, and sales volumes.

Price Partitioning

THE PROBLEM ➨ It is hard to predict whether the target customer will perceive the price of a product as justified. Conversely, it is easy to set a price that is either too low or too high. In both scenarios, the potential profit is lost.

THE SOLUTION ➨ Buyers will perceive products that have similar value and features in clusters. They are willing to pay a very specific minimum, average, and maximum price for products that represent each cluster.

Pricing optimization software can group products from the same category into such clusters. As a result, you can easily determine which cluster a specific product belongs to and what its optimal price is.

Finding the “Magic” Price Points

THE PROBLEM ➨ As mentioned above, customers put similar items into clusters with very specific price thresholds. By opting for a price point that is between the minimum and maximum price threshold, you can maximize sales and increase revenue. If you do not take such patterns into account, you end up with suboptimal sales and lose out on potential profits.

THE SOLUTION ➨ With price optimization software, you can identify optimal price points with ease. In consequence, you can maximize sales by offering attractive and competitive prices for all your products.

Outplaying Competitors

THE PROBLEM ➨ To neutralize your competitors or benefit from their weaknesses, you need to set the right prices for your products. In such a situation, it might be close to impossible to determine what the initial price of a product should be, given the high dynamics of pricing and the sheer number of product categories that you have to take into consideration.

THE SOLUTION ➨ To outplay competition, you need to understand what the category leader is doing. At which price levels are customers most willing to buy the leader’s products? At a promotional discount price? At a premium price?

Customers will pay the same price for products with similar features. For that reason, the category leader’s pricing serves as the benchmark from which you can build an optimal pricing strategy.

With price optimization solutions, you can check what a given product category’s optimal price points are and what discounts can help you maximize profits based on market data, including competitors’ pricing.

Promotional Pressure

THE PROBLEM ➨ Promotional pressure has increased in recent years. Brands and retailers alike often start price promotion wars, which leads to lost sales and decreased market share.

THE SOLUTION ➨ To evaluate what promotional pressure would be optimal for a given product category, you need to analyze the share of the sold volume per purchase across the entire category.

With price optimization software, you will be able to do just that. What is more, the software will highlight each product that has optimal promotional pressure, as well as each discounted product that is overselling. In consequence, making difficult pricing decisions should become a whole lot easier.

Advantages of Price Optimization Models

Invest in Guaranteed Consistency

When using pricing optimization software, you do not have to worry about whether your prices are consistent. Inconsistencies in pricing tend to stem from things like differences between similar items, such as color or size. Price optimization models take such things into account, helping you to make consistent pricing decisions based on relevant and accurate market and customer data.

Stop Guessing

You get to take the guesswork out of price setting. You no longer need to make random predictions and hope that you made the right choice. Instead, with the help of machine learning technology and data-driven scenarios, you can adjust prices across a number of different channels with ease and accuracy.

Automate Tedious Tasks

You are given an opportunity to automate the entire process of developing price strategies, ranging from market research to quantitative data analysis. Doing so removes the need for manual work and prevents the occurrence of human error. As a consequence, you will not be making incorrect predictions, which could have a negative impact on profit margins and customer loyalty.

Speed Up the Process of Making Decisions

Due to the aforementioned automation, the rate at which you can make reasonable pricing decisions increases. You can respond to competitors’ actions much faster, no matter whether you compete with local office supply stores or international commodities manufacturers.

Reap Financial Benefits

You are provided with the means to achieve various business goals, whether it be increasing sales or the number of conversions. For instance, you get to increase the price of a product without losing existing customers or settle for a promotional price without leaving money on the table.

How to Use Price Optimization Models

Finding a fair price for a product or service begins with understanding who you are trying to sell to. In other words, you need to understand what the needs and expectations of your potential customers are. On top of that, you have to consider the latest industry trends and the market that you want to target.

Here is how you can do it step by step:

Obtain Relevant Data

Price optimization is not supposed to be a guessing game. To do it right, you need accurate and relevant data. In general, it takes both quantitative and qualitative data to determine how much customers are willing to pay for a product or service.

• Quantitive data can be counted, measured, and given a numerical value.
  
  It might include information on psychographics, inventory, supply, demand, demographics, historical market specifics, churn rate, sales metrics, price sensitivity, and product features.
  
• Qualitative data is information that cannot be given a numerical value. It can be collected from customer surveys and expressed using data visualization tools like concept maps, word clouds, timelines, and infographics.
  
  It can be helpful when it comes to finding out what a brand’s perceived value is, measuring the effectiveness of different sales tactics and loyalty programs, and gathering opinions on newly introduced products and pricing.

Set Goals and Define Constraints

The vast majority of companies interested in price optimization are focused on increasing revenue. However, greater profits are just one of many goals that can be achieved with optimized prices. You could also aim to increase customer loyalty or attract a certain number of new customers.

Before you begin the process of optimizing prices, set measurable goals and determine what constraints you will have to deal with. For instance, if you want to boost sales, write down the number of sales that you would be satisfied with, as well as the time frame in which you want to hit that number.

Next, determine what is likely to prevent you from reaching that goal. For example, if you decide to set promotional prices for a number of products, you do not want to end up losing out on potential profits.

Focus on Perceived Value

The price of a product has to align with its perceived value. If you want to sell a piece of software, you are likely to charge for its specific features. On the other hand, if you want to sell a physical product, you are likely to charge per unit.

Finding a product’s perceived value is crucial for price optimization. In order to determine it, conduct customer surveys to identify the best features of what you offer. After that, experiment with different ways to charge for them until you find the best price.

Create Different Pricing Tiers

Next, you could come up with different pricing tiers. Each tier should address the needs of a specific customer segment or align with the product’s perceived value.

To illustrate, Netflix has three different price tiers. The lowest one addresses the needs of one-person households. You can watch on just one screen at the same time, and download movies and TV series on just one device.

The highest tier is most likely to resonate with a multi-person household. In such a household, multiple family members are likely to want to use Netflix at the same time. For that reason, that specific tier allows you to watch on up to four screens at the same time, and download movies and TV series on up to four devices.

If such a pricing strategy does not make sense for what you are selling, you might be able to start selling bundles. You could also create sales sections that address the needs of various customer segments.

Monitor Pricing

Last but not least, set up a way to gather market and customer data. By doing so, you can make sure that the value you are offering aligns with target customers’ pricing expectations and needs.

If relevant data shows that it is time to make some adjustments to different prices, do not be afraid to reevaluate the pricing strategy that you had followed thus far. Just remember not to change prices too often or too quickly. Doing so is likely to frustrate existing customers and have a negative impact on sales figures.

In Conclusion

Your company can improve its sales in quite a few different ways while keeping healthy profit margins. However, no matter what you decide to do, you will need to make use of at least some price optimization processes to see it through.

Luckily, our price management software can take care of that. By using machine learning and artificial intelligence, it can accurately predict the outcome of any decision related to price changes and promotional activity. As a result, it is guaranteed to aid you in achieving the most challenging business goals.