Price optimization is how a business determines the ideal price for the products or services it sells. The process involves understanding profit margins, the value of your goods in the market, and how much your customer is willing to pay. Successful companies determine the right price point by using data on their customers and market to maximize profits and value to the consumer. The ideal price considers the customers’ willingness to pay, the incremental margin on each purchase, and any capacity constraints.
Price optimization calculations come in many forms, including experimental, analytical, economic, and yield management models. You can even use computer algorithms to help you make decisions. Here are a few factors to consider as you set your prices for your goods and services, no matter which method you employ.
1. Collecting Data for Price Optimization
As with most significant business decisions, the company with the best information wins when it comes to pricing. Price optimization starts with accurate quantitative data about your customers and your products or services. In addition to a complete understanding of the product or service and its selling point, the process includes thoroughly evaluating other factors. As you set up your business systems, make sure you’re capturing all of this essential information about your enterprise:
- Consumer demographics, including age, gender, race, household income, and geography
- Inventory management and how it affects product availability
- Supply and demand economics of your industry
- History of the market for your service or goods
- Sales indicators for the long and short terms
- Price sensitivity of your consumers
- Churn rate, also known as customer attrition
Qualitative data is as necessary as quantitative, though it may be more challenging to collect. Businesses have a variety of choices for gathering this information.
One of the most popular is the customer survey. These tools are simple to administer, and you can find many resources available online to distribute your questions and compile the responses. Even small rewards for participation can help improve the number of responses you get from your clients. With a carefully designed survey, you can gather important information about how your customers:
- See your product or service as compared to your competitors
- Perceive the value of your products and services
- Feel about your sales approach, advertising, and the customer experience
- Rate your loyalty incentives, discounts, and promotions
- Evaluate the pricing of your products independently and in comparison to competitors
Good information, carefully analyzed, is the most solid foundation for optimizing prices. Once you have your quantitative and qualitative data collected and organized, you’re ready to use it to chart the course for your business future.
2. Setting Goals for Price Optimization
Price optimization requires setting goals. Most businesses set goals around the profit they want to realize, which is an essential factor. However, selecting the right price can also help you reach other targets related to customer retention, attracting new clients, and upselling. Research indicates that price is one of the leading factors in whether a buyer makes a purchase.
As you are thinking through the goals for your business, consider:
- How to increase the value of your product or service in the eyes of your customer
- Whether you have a minimum price point that you cannot go below
- How changing pricing will affect any sales quotas you have in place
- How modified pricing changes your discounts, promotions, and loyalty programs
Keep careful notes as you think through all this information the first time. The practice will save you time as you revisit your pricing in the future, and the records become a vital part of the operation of your company. Later on, you can return to your assessment and see how successful you were and what you might want to do differently. Your goals for optimization are as ever-evolving as your business, so don’t be afraid to revisit them often.
3. Using Value Metrics for Price Optimization
Value metrics describe how you price your product or service compared to the value that your customers assign to what they are buying. You define your metrics based on the nature of your business. You probably price goods per unit if you sell a product, whereas a service business might charge per project. To ensure you have the correct value metric, use the data you gathered to make an honest appraisal of how your customers value your goods or services. Once you understand that, you’re ready to determine how much you can realistically charge.
4. Setting Tiered Pricing
Tiered pricing lets you target a specific market segment and tailor your pricing to how that group values your goods or services. The data gathered during your research should help you identify the different populations in your data sets. For example, a software company may offer one pricing tier for individual users who only need one user license and another pricing tier for companies with hundreds of users. The business may have other levels for small companies, students, or nonprofit organizations within those groups.
5. Evaluating Price Optimization on an Ongoing Basis
Price optimization requires constant monitoring and evaluation, especially when something significant changes in your market or company. As your business grows and expands, you might enter new markets, gain new clients, and increase your market share. Those events require a careful evaluation of how they affect your pricing structure. A good rule of thumb is to evaluate annually, or at least every two years, to see where you might need to make changes to optimize.
6. Understanding the Role of Human Behavior in Price Optimization
While cold hard facts and data can guide your pricing strategy, if you are selling to humans, you can never ignore the role of psychology. For example, when you have multiple pricing options for customers to choose from, you want to find the correct number of choices to present. Too few choices may cause customers to walk away altogether, finding nothing that fits their budget. Too many options may lead to feelings of overwhelm, frustration, and confusion.
Price optimization is critical for your business’ success. After all, price is often the primary factor in whether a customer buys or walks away. Contact Benjamin Naderi today to learn more about optimizing the pricing structure for your business.