Picture yourself at a farmers market shopping for tomatoes. It’s not something you absolutely need at the moment, and you know your local grocer sells them for much less than the vendor you’re talking to, so you haggle and get a lower price. Alternatively, imagine you stop to purchase apples but you don’t know how apples are priced at your local grocer. In any case, your kids love apples, so you pick the highest-priced ones they have and purchase those because you equate price to quality.
These two scenarios illustrate the concept of price elasticity, which is the responsiveness of demand of a product in comparison to changing prices. Many things can affect price elasticity, including the customer, product, base price, economy, market competition and promotions, so it’s important to develop a pricing mechanism, or a pricing rules engine, that's driven by market insights and data analytics to compensate for these factors. These pricing rules and data-driven breakdown are called demand analytics, which is meant to optimize your product margins by taking into account all of the things above that affect price elasticity. Implementing demand analytics helps retailers and brands stay ahead of their competition and market fluctuations by optimizing pricing and segmenting products into three categories — price competitive, margin drivers and margin optimized.
Products categorized as “price competitive” are the ones that have high price elasticity and are considered luxury items, such as high-definition televisions. When price changes, so does demand, as more people can afford them as the price goes down. Retailers need to be especially vigilant in this category when comparing their prices to competitors because the consumer is much more focused on price here.
Margin drivers are the products that have low price elasticity and are considered commodities, such as gasoline or salt. Even when price changes, demand will likely stay the same because these products are necessary.
Margin-optimized products, meanwhile, are right in the middle of the margin drivers and price-competitive products because they're optimized to have the best price to entice the consumer to purchase and keep margins steady.
The goal should be to ensure that price-competitive products are priced lower than competitors, while margin drivers are priced high to optimize margins. Therefore, it’s important to come up with a way to categorize your products into these buckets and price accordingly to stay competitive. A lot of retailers get wrapped up in making sure they always have the lowest price, but that’s not always the best strategy for the long term. As the example above conveys, there are products that people need to have because they're commodities, there are products that people will buy no matter the price, and then there are products that people price compare.
Demand analytics will help you better understand how to set your business up for success with the right price on the right product. The key to this is to know how to properly categorize your products so you’re not selling apples the same way you sell tomatoes.
Mihir Kittur is chief commercial officer for Ugam, a global leader in data and analytics.
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