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Price Optimization 2018-11-14T07:46:30+00:00

## Prize Optimization

The price optimization is a mathematical exercise whose purpose is to find the price that delivers the maximum profit.

High volume businesses often use price optimization, since they can use mathematical models. In a smaller level, price optimization might mean that a retailer makes A/B testing to see how much premium they can have upwards from the monitored market pricing.

## Overview

Have you ever wondered how companies find that perfect price that they can charge their customers? How do they find out the maximum price they can ask a customer to pay for?

Price optimization is basically a strategy used by companies where they acquire data and use variety of other things to find out how sensitive customers are to changes in prices. Companies can then figure out how much they can charge to get as much as profit they can.

### Principles

Companies tend to spend considerable amount of time and money to ensure that they have the sweet spot between getting maximum profit and customer satisfaction so that their product or services are sold quickly in the market. Price optimization is something that is heavily used across the board whether it’s a B2C or B2B company.

Consider this – if an item has been priced too high, customers will choose to ignore it and move towards the competition. And if the price is too low, not only will it tarnish the brand image but will also result in low profits or even in losses.

With price optimization companies consider the total demand of their product, what is the competition that they face and if it’s a manufacturer, they will consider the cost of making their goods.

It is incredibly important to have a price that is right between the value you are offering and the profit you want to earn. This is what price optimization is and since the value offered by goods and services often fluctuates, it’s important to have the right price.

## How does it work?

Using a combination of mathematical formulas and variety of software, companies can come up with the information of how demand will be different at different price levels. The data that is accumulated is then used with the information of costs and how much inventory the company has to come up with the ideal price.

One of the best ways to use price optimization is to create different prices for different customer segments. This is done through simulating how the customers will react to different price changes using the data and information at hand.

Conventionally, price optimization begins with customer segmentation. Companies start out by dividing their customers into variety of groups or segments according to their reaction to different prices. With this information, the pricing managers will then start to see how they can meet company goals while ensuring customers are also happy with the prices.

Considering the fact that there are hundreds and thousands of prices in the market and all have different underlying reasons for why they are set, price optimization tools help a company to come at the perfect price using forecast of demand, inventory levels and information about customer satisfaction.

### Example

The best examples of price optimization at work will be seen in supermarkets where you will find variety of prices for the same kind of products. For instance, you will find eight different brands of Apple jam which will be priced differently. Why is that? Because the manufacturers behind these jams have used price optimization to make their product more feasible to their customers.

Some of the jams will charged more than others as they would be selling something more or unique from generic brands.  Some brands sell at a cheaper price, because of the way the companies market them (for example private label brands).

### Benefits

With price optimization companies can determine three things – promotional pricing, initial pricing and discount pricing.

As the term itself suggests, promotional pricing is when a company creates short term price to attract customers and increase sales. On special events and public holidays shops tend to use promotional pricing compared to long term pricing strategies.

Companies use initial pricing, which is another price optimization tactic, when they’re selling long term cycle products. These companies are for example supermarkets, drug manufacturers etc.

Companies quickly unload their inventories to the market by discount pricing. Airline tickets, summer discounts on clothes or U.S Black Friday sale are the best examples of seasonal changes.

## Price Optimization software

Since it’s hard to factor in variety of things when it comes to optimizing prices, there are many software companies that are offering software packages. These can easily handle the complex data calculations that pricing managers need to do.

These software packages help retailers optimize prices in real time – meaning these packages allow better operational efficiency.  These packages meet each company’s requirements with tweaking. For retailers they will be tinkered differently compared to B2B companies. Since these companies have much more and complicated data to work with.

Companies that have a large number of products also use software packages. Consider Johnson & Johnson or Procter & Gamble as they have hundreds of products in numerous categories. For them these software packages are a blessing since they can handle the complexity of big data and easily help pricing managers with price optimization.

Price optimization is about the company’s profits and its customers. An ideal situation where both are winners. Optimizing prices is what makes or breaks a business. Customers always want the best price, so doing it properly is important.

It’s the price in the end that finalizes the decision. The decision is also supported by how customers perceive your products or services and if they are in sale or not. This is all connected directly to the company’s profit.

## Strategy card

Strategic importance (retail) 90
Strategic importance (ecommerce) 85
Ease of use 70
Practical implementation 77