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Quantitative Consulting for Business

Price sensitivity and how to measure it

Dr. B o r  i s Va i l l a n t

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Profit-optimal price

Price

   D  e  m  a  n   d   /

   P  r  o   f   i   t

Demand

Profit

Pricing: The basics

Knowing how your customers will react to price changes is the heart of what we call„Pricing“.

● Methods for estimating the demand function

● Measuring effects of past price changes

● Market simulations based on market research /Conjoint analysis data

● Expert workshops

● The „Price elasticity“ e measures your customers'propensity to react to price changes

● A price increase by x % leads to a decrease in salesby e*x %

● The target function need not always be profit, butmost often it is

● Finding the profit-optimal price

● At the optimum, the following simple rule holds for 

the elasticity e:1/e = Operating margin

● Intuition is that low competitive pressure allows for high margins and vice versa

1

1

2

4

Demand curve

Price

   S  a   l  e  s

3

4

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Real prices and reference line

Product parameter 

   R  e  a   l   i  z  e   d  p  r   i  c  e  s

Transactions

Pricing: Estimating your price position using internal benchmarking

A lot can be learned about optimal pricing by comparing the prices or margins realized byyour sales force for a given product.

Benchmarking B2B-sales performance

● Comparison of realized margins for individualtransactions for a given product

● Establish reference profitability

● Modified approach using a reference profit line or 

reference price line

● ensure comparability across several productsby taking into account the main product andmarket parameters

● avoid use of profitability when necessary (notuniversally known, or under debate etc.). Thenthe benchmarking can be based on realizedprice levels.

See our article about constructingbenchmarking systems

1

1

Deviation analysis

Profit

   #   T  r  a  n  s  a  c   t   i  o  n  s

2

2

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Pricing: Estimating price elasticity in expert workshops

An approach to estimating price elasticity for a product is to have internal experts estimatedifferent scenarios for price change.

Market Share (%)

Market Share (%)

Market Share (%)

Market Share (%)

Price Scenario

Estimated effect on salesBasis

Profit-optimal price

Price

   D  e  m  a

  n   d   /   P  r  o   f   i   t

Demand

Profit

Market Share (%)

Car Z

Car Y

Car X

Workshopresult

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Pricing: Estimating price elasticity using conjoint analysis

Conjoint analysis is a popular market research tool to measure customers valuation of product components for new products relative to price.

Decomposition of the productinto its main value creatingcomponents

Measure the contribution of eachcomponent to the perceivedcustomer value

.Determine a products totalperceived customer value1 2 3

Product "Car"

Consumption

Power 

Brand

Car X

Value drivers

   V  a   l  u  e

Audi 80 PS 8 L Total

Brand

   V  a   l  u  e

Audi Ford Peugeot

Power 

   V  a   l  u  e

80 PS 90 PS 100 PS 110 PS

Consumption

   V  a   l  u  e

7 L 8 L 9 L

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Pricing: Estimating price elasticity using conjoint analysis

We provide a flexible tool integrating many of the established methods to create and performconjoint analysis projects online and offline.

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Brand

     V    a     l    u    e

Audi Ford Peugeot

Power 

     V    a     l    u    e

8 0 PS 90 PS 1 00 PS 11 0 PS

Brand

     V    a     l    u    e

Audi Ford Peugeot

Power 

     V    a     l    u    e

8 0 PS 90 PS 1 00 PS 11 0 PS

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Pricing: Comparison of methodologies

For efficiency reasons we favor methods based on internal knowledge and data analysis whenever possible.

Customer view Low precision New products /

Innovations

Only singleproducts

All products inthe market

Internal viewRelatively

precise

Existing productsor 

recombinations

Product portfolios

Mainly ownproducts

High complexity /cost

Mediumcomplexity /cost

Market research /conjoint analysis

External expertworkshops

Measurement of effectsof past price changes

Internal expertworkshops

Internal benchmarkingsystems and reference

price lines