Price Analytics

Dr. Keerti Jain

NIIT University, Neemrana
The moment you make a mistake in pricing, you are
eating into your reputation or your profits

-Katharine Paine
Pricing is one of the most powerful levers for
improving profitability
 Price Analytics

• Pricing Analytics enables companies, across all industries, to dramatically

improve profitability & market share by defining optimal prices & pricing
strategy.
• Pricing Solutions leverages data to understand what drives your customers’
buying decisions and integrates this knowledge to meet your pricing needs.
• Where it all comes together Advanced analytics aimed at customer and
business outcomes are at the core of modern pricing and profitability
management, price leveraging, and trade spend effectiveness.
 What is the Matter, Now?
• Research shows that price management initiatives can increase a company’s margins
by 2 to 7 percent in 12 months—yielding an ROI between 200 and 350 percent.
• But many companies aren’t able to unlock this potential, often because they’re
building on a poor foundation in analytics.
• Don’t have the appropriate level of visibility into the true profitability of their
complex channels, product portfolios, and customers.
• As a result, they frequently revert to gut instincts and more traditional guidelines for
critical decision making that can lead to missed opportunities, exposure to
unnecessary risk, and falling margins.
 Why Price Analytics?

• Analytics can lead the way on pricing and customer profitability Facing growing
complexity.
• A multi-channel business environment, companies need to be able to answer
fundamental business questions— such as “Who is my most profitable
customer?” and “What is my most profitable product or region?”
• Combine pricing with analytics, and one can create a mechanism that functions
as both a catalyst and a metrics engine for managing profitability.
• Pricing analytics can also help executives more clearly understand both the
internal and external factors affecting profitability at a granular level.
 Pricing Solutions Applies Analytics to:

• Optimize the Trade-Off Between Price, Volume and Profit

• Identify Quick Wins
• Develop High Impact Price Strategies
• Increase the Confidence of the Sales Force
 Benefits of Price Analytics
• Insight to drive decisions
• More effective business decisions on tightly defined issues, such as which customers to
focus on and which products to rationalize, using hard data rather than gut instincts.
• Automation tools that enable informed decision-making—for example, sales team
dashboards that show the impact of discounts on deal profitability.
• Improved agility in responding to a shifting competitive environment and market
conditions.
• Clear feedback loops so pricing teams can assess effectiveness and adjust as needed.
• The ability to run advanced scenario modelling to avoid costly mistakes or missed
opportunities—for example, the potential impact of a pricing change on demand and
profitability
Pricing Policy Depends
 Price Elasticity

• Given a demand curve, the price elasticity for demand is the percentage of
decrease in demand resulting from a 1 percent increase in price.
• When elasticity is larger than 1, demand is price elastic. When demand is
price elastic, a price cut will increase revenue.
• When elasticity is less than 1, demand is price inelastic. When demand is
price inelastic, a price cut will decrease revenue.
 Example of Price Elasticity
Following estimates of elasticity are obtained from the studies of economists:
• Salt: 0.1 (Very inelastic)
• Coffee: 0.25 (Inelastic)
• Legal fees: 0.4 (Inelastic)
• TV Sets: 1.2 (Slightly elastic)
• Restaurant meals: 2.3 (Elastic)
• Foreign travel: 4.0 (Very elastic) (1% of decrease in the cost of foreign travel,
can increase the 4% demand for foreign travel.)
 Demand

• Demand The relationship between the quantity of a good desired by people

in a market and the factors that affect that the quantity desired is referred
to as the demand for the product. We can express the demand for a
product in the form curves
• Factors that we expect to affect the demand for the good include:
· Population (n)
· Price of the good (p )
i

· Price of other goods (p )

j

· Income (y)
• Expectations of future prices
· Tastes (T)
 Forms of Demand Curves

• Linear Demand Curve (q=a-bp)

• Power Demand Curve (q=ap^b), a>0, b<0
 Linear Demand Curve

• The linear demand curve is of the form q=a-bp, where q is quantity

demanded and p is unit price.
• When the demand curve is linear the price elasticity is changing.
 Power Demand Curve

• The demand curve of the form q=ap^b, a>0, b<0. q is quantity demanded
and p is unit price.
• When the demand curve is power, the price elasticity is equal to –b.
 Estimation of price and demand

• Demand curves can be estimated using regression.

• When the price of each unit sold is same for all customers. The seller is using
linear pricing, which can be optimize by linear programming.
• When the price of each unit sold is not same. That is there price
discrimination exist. The seller is using non-linear pricing, which can be
optimize by non linear programming.
 Market Structure – Internal rivalry

Market structure and pricing decisions are closely

related. But how to define the market?

The degree to which the firm gets to choose price is

determined in large part by market structure

There are two extreme cases: perfect competition and

monopoly
Assessing and responding to a competitor’s price cut (depending
on the market structure)
 Perfect Competition
Conditions necessary:
Large numbers of buyers and sellers
Homogeneous product
Free entry and exit
Perfect information
 Perfect Competition
Demand curve for any given firm is horizontal. Price is
set by market at Pe

P P D
e e
D

Firm can sell as much or as little as desired at market

price, but nothing if they raise P.
 Monopoly
Conditions necessary
Single seller of product
No close substitutes
Significant barriers to entry
There are few examples of perfect competition and pure monopoly.
Most firms have a differentiated product, and there are substitutes.
 Pricing in Perfect Competition

Do not choose price.

Choose output quantity. TC includes opportunity cost of
capital invested.
What will be our profit (loss) from our output decision?
Should we produce now? (SR)
Should we stay in the industry? (LR)
 Costs at different levels of production

Cost per unit at different levels of production

 Pricing in a Monopoly

Profit maximization will be achieved by setting price so

that MC=MR.
It is not reached by setting price as “high as possible.”
Like any firm, the monopolist is constrained by their
demand curve.
One cannot choose both P and Q.
 Price Discrimination

Selling the same good to different people at different

prices
Conditions necessary:
Identifiable customer groups with differing price elasticities
Maintain separation of groups--prevent resale.
 Types of Price Discrimination
First degree
Identify and charge each customer what they are
willing to pay
Limit: D = MR, no consumer surplus.
Second degree
Quantity discounts. Volume purchases are given
lower prices. Need to measure goods and services
bought by consumers.
 Types of Price Discrimination

Third degree
Segment markets in some way. Charge all
in the segment the same prices.
Treat each segment as a separate market–
then do MR=MC in each
Use coupons as a price discrimination
mechanism?
 Price Bundling

Companies often bundle products in an attempt to get customers to purchase more products
than they would have without bundling
Examples
• Computer companies often bundle computers with printer, scanners and monitors.
• Automobile companies often bundle popular options such as navigation, satellite radio and
keyless entry.
• Microsoft office has been a highly successful bundling of software products such as Excel,
Word, Access and outlook etc.
 Pure Bundling

• If the seller only offers the customer a choice between purchasing all
product or nothing, the situation is called pure bundling.
Example:
Movie rental companies usually give the theatres a choice between renting an
assortment of some blockbuster movies and same not so popular movies, or
renting no movies at all.
 Mixed Bundling

• Mixed bundling means the seller offers a different price for each available
combination of products.
• Mixed Bundling is optimal.
 Pricing Strategy

• How does a company decide what price to

charge for its products and services?
• What is “the price” anyway? doesn’t price vary
across situations and over time?
• Some firms have to decide what to charge
different customers and in different situations
• They must decide whether discounts are to be
offered, to whom, when, and for what reason
 Why is Pricing Important?

In a company with average economics*,

• 1% increase in volume = 3.3% increase in profit
• 1% increase in price = 11.1% increase in profit
• Improvements in price typically have 3-4 times the effect on profit as
proportionate increases in volume.

*Based on average of 2,463 companies

 Price vs. Nonprice Competition

• In price competition, a seller regularly offers products

priced as low as possible and accompanied by a minimum
of services
• In non price competition, a seller has stable prices and
stresses other aspects of marketing
• With value pricing, firms strive for more benefits at lower
costs to consumer
• With relationship pricing, customers have incentives to
be loyal-- get price incentive if you do more business with
one firm
 Nonprice Competition

• Some firms feel price is the main competitive tool, that customers always
want low prices
• Other firms are looking for ways to add value, thereby being able to avoid
low prices
• Sometimes prices have to be changed in response to competitive actions
• Many firms would prefer to engage in non price competition by building
brand equity and relationships with customers
 The Process: An Illustration
SELECT PRICING OBJECTIVE

SELECT METHOD OF DETERMINING THE BASE PRICE:

Cost-plus Price based on Price set in

pricing both demand relation to
and costs market alone

DESIGN APPROPRIATE STRATEGIES:

Price vs. nonprice Freight payments Leader pricing

competition One price vs. Everyday low vs.
Skimming vs. flexible price high-low pricing
penetration Psychological pricing Resale price
Discounts and allowances maintenance
 Steps for Determining Prices

• Establish Pricing Objectives

• Increase sales volume?
• Prestigious image?
• Increase market share?
 Steps for Determining Prices

• Study Costs
• Can you make a
profit?
• Can you reduce costs
without affecting
quality or image?
 Steps for Determining Prices

• Estimate Demand
• What do customers expect to pay?
• Prices usually are directly related to
demand.
 Steps for Determining Prices

• Decide on a Pricing
Strategy
• Price higher than the
competition because your
product is superior
• Price lower, then raise it once
your product is accepted
 Steps for Determining Prices

• Set Price
• Monitor and evaluate its effectiveness as conditions in
the market change
Pricing Strategies
Penetration Pricing
 Penetration Pricing

• Price set to ‘penetrate the market’

• ‘Low’ price to secure high volumes

• Typical in mass market products – chocolate bars, food stuffs, household goods, etc.

• Suitable for products with long anticipated life cycles

• May be useful if launching into a new market
Market Skimming
 Market Skimming

• High price, Low volumes

• Skim the profit from the market

• Suitable for products that have short life cycles or which will face competition at some point
in the future (e.g. after a patent runs out)

• Examples include: Playstation, jewellery, digital technology, new DVDs, etc.

 Market Skimming

Laptops and mobiles with latest

features
Plasma screen at
high prices but for how long?
Title: Thin-shaped television. Copyright: Getty Images,
available from Education Image Gallery
Value Pricing
 Value Pricing

• Price set in accordance with customer

perceptions about the value of the product /
service

• Examples include status products/exclusive

products
Companies may be able to set prices
according to perceived value.
Loss Leader
 Loss Leader

• Goods/services deliberately sold below cost to encourage sales elsewhere

• Typical in supermarkets, e.g. at Christmas, selling bottles of gin at £3 in the

hope that people will be attracted to the store and buy other things

• Purchases of other items more than covers ‘loss’ on item sold

• e.g. ‘Free’ mobile phone when taking on contract package
Psychological Pricing
 Psychological Pricing

• Used to play on consumer perceptions

• Classic example - $9.99 instead of $10.00!

• Odd-even: $5.95, $.79, $699 OR $12, $50

• Multiple Unit-3 for !1.00 better than $.34 each

 Psychological Pricing

• Odd-Even Pricing
• Odd numbers convey a bargain image -- $.79, $9.99, $699

• Even numbers convey a quality image -- $10, $50, $100

 Psychological Pricing
• Prestige Pricing – sets a higher than average price to suggest status
 Psychological Pricing
• Multiple-Unit Pricing – 3 for $.99
• Suggests a bargain and helps increase sales
volume.
• Better than selling the same items at $.33 each.
 Psychological Pricing

• Everyday Low Prices (EDLP) – set on a

consistent basis
Going Rate (Price Leadership)
 Going Rate (Price Leadership)

• In case of price leader, rivals have difficulty in competing on price – too high and they lose
market share, too low and the price leader would match price and force smaller rival out of
market

• May follow pricing leads of rivals especially where those rivals have a clear dominance of
market share

• Where competition is limited, ‘going rate’ pricing may be applicable – banks, petrol,
supermarkets, electrical goods – find very similar prices in all outlets
Tender Pricing
 Tender Pricing

• Many contracts awarded on a

tender basis

• Firm (or firms) submit their

price for carrying out the work

• Purchaser then chooses which

represents best value
A European consortium led by Airbus
recently won a contract to supply
refuelling services to the RAF – priced • Most government contracts
at £13 billion!
Price Discrimination
 Price Discrimination
• Charging a different price for the same
good/service in different markets

• Requires each market to be impenetrable

• Requires different price elasticity of

demand in each market
• Air/rail
• First class
Prices for rail travel differ for the same
journey at different times of the day • Business class
• Economy class
 Discounts and Allowances

• Cash Discounts – offered to buyers to encourage

them to pay their bills quickly.
• 2/10, net 30
• Quantity Discounts – offered for placing large orders
• Trade Discounts – the way manufacturers quote
prices to wholesalers and retailers.
Promotional Pricing -- Used with sales promotion

• Loss Leader Pricing – offering very popular

items for sale at below-cost prices
• Special-Event
• Back-to-school specials
• Dollar days
• Anniversary sales
• Rebates and Coupons
 Discounts and Allowances
• Seasonal Discount – offered outside the
customary buying season
 Discounts and Allowances

• Allowances – go directly to the buyer. Customers

are offered a price reduction if they sell back an old
model of the product they are purchasing
Destroyer Pricing/Predatory Pricing
 Destroyer/Predatory Pricing

• Deliberate price cutting or offer of ‘free

gifts/products’ to force rivals (normally
smaller and weaker) out of business or
prevent new entrants

• Anti-competitive and illegal if it can be

proved
Microsoft – have been accused of predatory
pricing strategies in offering ‘free’ software as
part of their operating system – Internet
Explorer and Windows Media Player - forcing • Typical of oligopoly with collusion
competitors like Netscape and Real Player out
of the market
 The Legality and Ethics of
Price Strategy
Unfair
UnfairTrade
TradePractices
Practices

Price
PriceFixing
Fixing

Issues
Issues Price
PriceDiscrimination
Discrimination
That
That Limit
Limit
Pricing
Pricing
Decisions
Decisions Predatory
PredatoryPricing
Pricing

70
Unfair Trade Practice Acts

Laws that prohibit wholesalers

and retailers from selling
below cost
Price Fixing

An agreement between two or

more firms on the
price they will charge
for a product (usually in oligopolistic
markets)
 Price Discrimination

The Robinson-Patman Act of 1936 (USA):

• Prohibits any firm from selling to two or more different buyers

at different prices if the result would lessen competition
 Robinson-Patman Act Defenses
Defenses
SellerDefenses
Seller

Market
Market
Cost
Cost Competition
Competition
Conditions
Conditions

74
Predatory Pricing
The practice of charging a
very low price for a product
with the intent of driving
competitors out of business or
out of a market.
 Discussion: Impact of Ethics on Pricing

• How should you price if your product is a life-saving drug?

• What are the ethical considerations?
• Customers have no choice
• Need to pay for the research
• When cheaper options doesn’t work
• Competition decides

76
 Some other pricing strategies

• These all involve the use of some numerical understanding….

Absorption/Full Cost Pricing
 Absorption/Full Cost Pricing
• Full Cost Pricing – attempting to set price to cover both fixed and variable
costs

• Absorption Cost Pricing – Price set to ‘absorb’ some of the fixed costs of
production
Marginal Cost Pricing
 Marginal Cost Pricing

• Marginal cost – the cost of producing ONE extra or ONE fewer item of production
• MC pricing – allows flexibility
• Particularly relevant in transport where fixed costs may be relatively high

• Allows variable pricing structure – e.g. on a flight from London to New York – providing the
cost of the extra passenger is covered, the price could be varied a good deal to attract
customers and fill the aircraft
 Marginal Cost Pricing

• Example:
Aircraft flying from Bristol to Edinburgh – Total Cost (including
normal profit) = £15,000 of which £13,000 is fixed cost*
Number of seats = 160, average price = £93.75
MC of each passenger = 2000/160 = £12.50
If flight not full, better to offer passengers chance of flying at
£12.50 and fill the seat than not fill it at all!
*All figures are estimates only
Contribution Pricing
 Contribution Pricing

• Contribution = Selling Price – Variable (direct costs)

• Prices set to ensure coverage of variable costs and a ‘contribution’ to the

fixed costs
• Similar in principle to marginal cost pricing
• Break-even analysis might be useful in such circumstances
Target Pricing
 Target Pricing

• Setting price to ‘target’ a specified profit level

• Estimates of the cost and potential revenue at different prices, and thus the
break-even have to be made, to determine the mark-up
• Mark-up = Profit/Cost x 100

• This strategy is used by many clothes retailers where they can add upto 60%
mark-up on the basic cost of the clothes. So even with a 50% sales offer they still
make a profit!
Cost-Plus Pricing
 Cost-Plus Pricing

• Calculation of the average cost (AC) plus a mark up

• AC = Total Cost/Output