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Price Optimization: Why It’s Important (And How It Works)

Vendavo< Vendavo May 18, 2021

A senior executive at a company with an effective price optimization program once told us that just one person in their entire organization understood how their pricing solution worked. He then went on to explain: more accurately, there were probably two people – each of whom half understood.

This lack of understanding is common among companies. The executive’s rationale for being okay with the fact no one understood the solution was also commonplace. The company was doing well and they were realizing an improvement in profitability. Did it matter that they didn’t really know how it worked?

Laissez-faire attitudes like this are indicative of the fact that some executives not only don’t know how price optimization works, but they also fail to truly understand its importance to business success. 

Such a lack of understanding can really limit success. And of course, any knowledge gaps are likely to kill the potential for continued or added improvements over time. That’s why the importance of pricing optimization programs must be understood – and believed in – by everyone who uses them.

What is Price Optimization? 

Price optimization is the practice of deciding upon the most effective pricing for a product or service. Reliant on crystal clear data, great pricing optimization enables companies to offer their products at the price points that are most likely to be picked up on by customers. 

Optimal price points will deliver the best possible profits for the company, and may also be designed to achieve additional goals such as assisting in improving the company’s market share or enabling expansion into previously unexplored markets. 

What Does Price Optimization Involve?

Price optimization covers a wide range of different factors, and companies looking to ensure that their prices are all fully optimized will be managing a combination of these. The first thing to consider is which pricing areas the company needs to optimize.

  1. Starting prices: The starting price of a product or service is of course fundamental to its success, so pricing optimization is key here. Pricing optimization software will analyze data to reveal the best possible starting prices, taking a wide range of internal and external factors into account. 
  2. Discounts: Many companies opt to push their products out to larger audiences, or tempt back past customers, with the offer of discounts. Well-managed pricing optimization software can also be used in these instances, to ascertain the optimal price points. 

The Benefits of Price Optimization

Pricing optimization brings a multitude of benefits, which are evident throughout the sales process. Take a look at some of the main advantages of pricing optimization strategies. 

  1. See fast ROI improvements: With pricing optimization software, it’s easy to see how things are improving. ROI can be closely monitored, with all changes available to view in real-time. This data-driven approach enables teams to respond to fluctuations in demand quickly, maintaining the best possible ROI for the company. 
  2. Maximize sales and profits: The best possible price points allow companies to achieve their true potential, particularly when it comes to maximizing sales and profits. Customers are more likely to pick up on products and services when they’re priced optimally, and companies soon reap the benefits. 
  3. React faster to market changes: Pricing software makes it possible for companies to react quickly to changes in the market, outsmarting their competitors by offering goods and services at the best possible prices for any given circumstances. 
  4. Gather insights into customer behavior: The more data a company has, the better it can understand its customers. And with this understanding comes immeasurable opportunities. Data allows companies to offer products they know their customers will love – at prices they’re sure customers will respond favorably to.

Why Pricing Optimization Sometimes Fails

Many failed pricing optimization strategies are the result of poor understanding, but there are other aspects of pricing optimization which – when overlooked – can spell trouble. These are the most common pitfalls to avoid. 

  1. Guesswork: Pricing optimization relies on the clever use of carefully compiled data. If it’s based on guesswork, it’s doomed to fail. Make sure your prices are fully optimized with the help of consistent, well-managed data to avoid such problems. 
  2. Data errors and inaccuracies: Another issue we often see is the failure of pricing optimization due to errors and inaccuracies in data. We recommend that companies make use of specialist pricing optimization software, which will filter out problem data and ensure the success of optimization strategies. 
  3. Pricing isn’t value-based: Price optimization strategies should always take value into account. Value-based pricing is of course vital to the success of any sale, no matter which external factors a brand is taking into consideration. 
  4. Heavy discounting: Discounts can be a real secret weapon when it comes to drawing in customers, but heavy discounting can put a spanner in the works of even the best pricing optimization strategies. Instead of discounting products too quickly, or by too much, offer products or services at the optimal price point for your target market. 

A Look At Algorithms And Price Optimization Models

Data is incredibly valuable when it comes to pricing, however, it can fall short if not used effectively. When it comes to price optimization models, there are a couple of different approaches – each with their own set of challenges:  

  • Simple rules engine: Individually, a rule is easy to understand, but as the number of rules builds up over time, they conflict with each other which means new rules are then created to fix erroneous combinations. The result is often many layers of conflicting rules which are far too complex to visualize.
  • “Clever” math angle: Algorithms are used to try to solve the issues that the rules engine creates. While the solution may work, it’s difficult to validate at a granular level. Users are asked to simply trust the answer. High-level statistics, operational research, and dictates from a “black box” aren’t feasible for most organizations.

The simple rules engine approach is fiendishly difficult to manage, but the “clever” approach is often just too opaque and doesn’t deliver real control to the business. Neither option builds confidence among the sales team so that they can fully deliver on the promises of the software vendor.  Regardless of whatever the black box recommends, it’s only the confidence of the front-line sales and deal negotiators that can deliver actual business improvement.

This is where strategy comes into play. While the models above deal with the number crunching, the execution is where real gains can be found. Smarter price optimization solutions allow developments in algorithm-driven technology to infuse with the intuition of humans in order to deliver when it counts.

How Do You Successfully Optimize Your Pricing?

How a successful optimization strategy looks will vary from company to company, the core ingredients include a strong understanding of the customer base and access to data and real-time insights that ensure teams don’t have to rely on guesswork or hunches. All of this can of course be aided by technology.

Take a look at our team’s recommendations to successfully optimize your pricing. 

  1. Know your customers: The key to knowing price optimization rests within each potential audience. Users of pricing solutions must have some understanding combined with a relevant level of control. Likewise, teams must have a good understanding of their target customers to achieve the best pricing optimization strategies. 
  2. Organize and analyze your data: Make use of specialist pricing optimization software to organize and analyze data with ease. By keeping a careful eye on the most important metrics, teams can tweak pricing optimization strategies and provide a fully flexible and dynamic service. 
  3. Leverage real-time insights: Far too many companies make the mistake of compiling data and only looking at it from time to time. Beat the competition by leveraging insights in real-time. In doing so, you’ll put your company in a position where it can respond to any changes in demand at lightning pace – and profits will soon soar as a result. 
  4. Look to AI and Automation: Technology has so much to offer here, so keep an eye out for the latest developments in pricing optimization. AI and automation can help companies offer the best possible pricing at any given time. They can also cut down on time spent managing processes manually, freeing up teams to explore even more advanced optimization options.  

What to Look For In Your Price Optimization Solution

A price optimization solution must be able to handle massive complexity, but not be any more complex than necessary. Sophisticated price optimization algorithms are fast becoming critical to success and while the maths may not be accessible to all, optimization solutions should be structured in such a way that it is controllable and understandable. The idea of price optimization is a ‘complex’ solution, but it can be visualized simply, in ways that are meaningful to different users. 

Good Price Optimization software solutions should have the following features:

  • Competitive monitoring: Pricing optimization software can help to monitor prices for you to help ensure you are not left behind by changes in the market. With the software monitoring the markets for you, you’re left with more time to focus on other important tasks.
  •  Data-driven: With price optimization solutions, your prices are set with help from data on all of the metrics that matter. This includes data that might otherwise be difficult to interpret and use.
  • Forecasting abilities: The best solutions will have advanced algorithms that help you to forecast market changes. Forecasting will help you stay ahead and potentially take advantage of any slow reactions but the competition.
  • Infuse automation with human expertise: As powerful as computers can be, human insight and expertise is still often needed to make the right decisions. The best price optimization solutions will let you make the best of both worlds and infuse the computing power of powerful algorithms with human input.

Where are you in the journey toward reliable, optimized profitability? Use our Commercial Excellence Maturity Assessment tool to compare your company to other B2B firms, and see how you could improve.