This blog is a two-part Q&A series on pricing in Revenue Optimization. In part one, Wâtte will give you a closer look at why pricing matters and the right and wrong way to approach setting the optimal price for your product.
If you’d like to take a deeper dive into pricing, covering price elasticity, how to set your products’ optimum price, and the importance of data, stay tuned for part two. You can also watch our webinar, Price Optimization for Revenue Optimization to learn how to evaluate your pricing structure, examine ways to shift price, find inefficiencies in a pricing competitive landscape, and more.
We’d like to note that there are several ways to approach Pricing Strategy when it comes to Revenue Optimization. The following Q&A will provide you with valuable information regarding your strategy and revenue optimization but keep in mind there are no set numbers, tools, or answers that will magically guarantee a successful pricing strategy.
Q: What is pricing about and why does it matter?
Price is important because it heavily drives your revenue. If you sell an item for 50 cents more, with the same volume, you will obviously increase your revenue. When you have optimized your pricing, this isn’t so simple. When you set a price too high, volumes will drop, potentially increasing production costs as a result of small batches. If you set it too low your volume will increase but your profits are under pressure. This means your costs to produce the volume might become too high compared to revenue generated. You need to find the right price points to optimize your income stream and profitability. That's the relevance for pricing within Revenue Optimization.
Q: What are some best practices for pricing?
Find out who your main competitors are. What are the main competitive products? It's not the whole market. From there, look at the volume impact of various price points. Experiment with variation in price and monitor what happens in the market. Compare what happens with your price variations versus your main competitive products. That gives you the data to process to insights which helps you to understand where your optimal pricing ranges are. If you go below the cutoff point, your product will not sell more, but only lose margins (saturation). On the other hand, you must find out what an increase in your price would do. How does it really affect your sales volume? Conduct comparisons and do experiments. Increase and decrease your price and find out what happens. That helps you to find the real bandwidth from which you have to operate your price. From there you can find an optimum.
Q: What are the different approaches to pricing and price setting? Are there correct and incorrect ones?
There is no magic tool. It’s not like “this is the right price for your brand or for your product.” That's not how it works. It's all about valuing your brand image. Why can Versace market a T-shirt for 900 euros whilst other brands will typically never succeed at something like that? It's about the image that you have. It's about the design that you apply or the quality of the product that you have. That also sets your maneuvering space. You can say your brand is premium, but if the market doesn't believe it and if you don’t make the right premises to them, then you will not succeed. There's no magic formula stating the exact correct price. However, typically there is a bottom price. If you look at manufacturing costs and expected volumes, you can tell what the minimum price for your product would be, based on the cost for production and overheads. For example, you could say “this product should at minimum, bring us a €1 of income per unit. You can say that, but you risk salespeople saying, “If I need €1, I will start with €1.50 because then we make a decent profit.”
Today, this way of working has become abandoned. It's not so much about activity-based costing or cost price plus, anymore. It's way more about also bringing your brand equity into the equation. Asking “What is the value of your brand?” and from there see if it's reasonable. If you take phones for instance, the Apple iPhone X cost price is not related to the selling price at all. But they have a price buildup and a range attached to it, which gets the people who value these phones for what they can do and for how they are designed to buy it. But half a year later you see a huge drop in price. You skim off the market and at each price step you try to reach people that are in it. For example, you start at 1500 and you get 2% of potential buyers and then you drop to 1400, you get 10% more and you drop to 1300, you get 30% more. By doing so you gradually scrape off the top and sell your product to everyone in the market. It’s called price skimming and that approach is still used. This is a strategy that can work, but not for all products. You must be aware of what can happen, know your price (in)elasticities, and costs.
Q: What are the benefits to setting your price correctly and what are the downfalls of doing it in the wrong way?
The old way did not take into consideration all circumstances. Revenue Optimization focuses on selling your products at the right price, in the right channel, at the right moment. The right price could be translated as the maximum price that you can achieve. For example, if you are traveling to Poland by car and you're on the German highways, all of a sudden you are willing to pay €4 for a small bottle of water as long as you can buy it whilst on the highway. But the minute you are in a city at the supermarket, you would never pay that amount for such a small volume. So, that's the right price for the right place. That's important to understand and addresses the essence. That is what Revenue Optimization brings us. And of course, we all have applied this as out of home or food service was already adding to the product price because of the service costs etc. But now it can be done in a more effective way, also by others, for example convenience stores which makes it more and more apparent. Also, if you look at pricing for consumer goods, you see that it’s clearer for some products, as opposed to for example food items where you don't see it as much. There is also the effect of competition. Let’s say yesterday you had a promotion on laundry machines and tumble dryers. What happened was that Company X and Company Y were all following precisely this promoted price immediately. And today when the promotion is off, they immediately changed the price back. Companies are very aware of price related activities, as a lot consumers are price sensitive.
One thing that we saw during the Covid-19 crisis was change in coffee pricing. In the middle of May, all of a sudden we were overwhelmed by all sorts of coffee promotions. All the coffee brands, including private label, were all of the sudden putting a lot of attention around their brands because they realized that people during lock-down drink more coffee at home. The Food service channel revenue stream dried up but retail was selling larger volumes, so companies needed to ensure and stabilize market share, and it doesn't happen by itself. So, there were a lot of promotions and all to keep up share position. They were sometimes willing, sometimes forced to lower the average price, which is actually a bit odd as this was also the ideal opportunity to keep your price stable or increase it, because people had no other alternatives. On the other hand decreasing prices allows them to manage public opinion in these times, as it prevents them from being seen as a greedy vendor.
Today you’ve taken closer look at why pricing matters, and the right and wrong way to approach setting the optimal price for your product. It’s clear to see that as the marketing world moves forward, so does our understanding of the link between pricing and revenue growth. That being said, there’s no magic tool that will set the optimal price for you. You must value your brand’s image, compare and experiment with price variations, and know your competitors.
As we mentioned, you can check out part 2 of The Fundamentals of Pricing Strategy in Revenue Optimization Q&A to learn more about price elasticity, how to set your product’s optimum price, and the importance of data.
If you are still looking for more pricing content, check out our webinar--Price Optimization in Revenue Optimization where we covered price elasticities in periods of high demand and shortages, price shocks, finding your optimal price, and more. Access the recording of our Price Optimization for Revenue Optimization webinar below: