What is Price Optimization and Why is it Important?
In the vast realm of manufacturing, many tools and frameworks exist to address nearly every challenge. From enterprise resource planning (ERP) systems to lean methodologies aimed at minimizing waste, a plethora of resources are readily available. Yet, despite these technological strides, manufacturers grapple with a persistent dilemma: determining the optimal pricing for their products.
With so many variables at play, choosing a price point that makes a product appealing while maintaining adequate margins is tough. That’s where product price optimization enters the fold. But what is price optimization exactly, and more importantly, how do you use this technique to assign the right dollar amount to your products?
In our deep dive into price optimization, we unravel all the essentials about pricing. This includes examining prevalent models, understanding the advantages of pinpointing the perfect price for your products, and guiding you in crafting and implementing an effective optimization strategy.
What is Price Optimization?
Price optimization is the strategic process of setting the right price for your products to optimize profitability. It’s not just about assigning an arbitrary number to your products — it’s a data-driven approach that considers various factors to find the sweet spot where your bottom line is flourishing and your customers are happy. Pricing optimization leaves everyone walking away, feeling as if they got a fair deal.
Setting a perfect price point is difficult due to the number of variables at play. It is particularly challenging for manufacturers, as you must account for factors like raw materials, upstream and downstream shipping costs, warehousing fees, labor expenses, etc.
Price optimization for retail can be equally complex. However, retailers enjoy more pricing flexibility, as they can track trends across individual sales, whereas manufacturers almost always sell in bulk shipments.
If a retailer notices that their margins are slightly off after a few dozen transactions, they can make adjustments with minimal impact on the company’s bottom line. On the other hand, if you underprice a shipment with 10,000 units, the effect on your margins will be severe. That’s why you need to master the art of price optimization.
Price Optimization Models
There are dozens of different price optimization models out there. While each has its share of pros and cons, they all have one thing in common. Pricing models require high-quality data to yield accurate results. The more reliable, accurate data you have, the better.
With that in mind, here is a brief overview of a few different models to consider. There are several other models within the three frameworks outlined below. You should explore them in greater detail to find the pricing optimization option that best aligns with your organization’s needs.
Black Box Solutions
Black Box AI represents a traditional approach to AI, in which systems process data and produce recommendations. The challenge with these systems is their lack of transparency; they don’t reveal the underlying logic behind their conclusions, making it difficult to validate their results.
Simple Rules Engines
Despite the name, simple rules engines can be surprisingly challenging to manage. In this model, you establish a series of overarching guidelines, and the algorithm uses these to suggest a retail price. Yet, as you introduce additional rules, which may sometimes contradict one another, the system’s reliability diminishes.
Price Optimization Solutions and Human Input
The new-school approach to price optimization involves pairing an AI-powered price optimization tool with human intuition. The tool helps narrow your focus by providing detailed pricing guidance, but your team can also incorporate difficult-to-quantify variables into your decision-making.
Many brands prefer this option, as it provides optimal pricing control while yielding real-time data-driven insights.
Benefits of Price Optimization in Manufacturing
Investing in price optimization tools will unlock a wide range of benefits for your manufacturing business.
Increase Profits
When done right, price optimization is your golden ticket to increased profits. It is about finding that equilibrium where your prices are competitive and your margins are healthy.
Price optimization isn’t merely about pricing lower than your competitors to boost sales. If your product costs more to produce or boasts superior quality, its price should reflect that. Price optimization aids in finding that sweet spot, ensuring you achieve sustainable per-unit profits while offering exceptional value to your customers.
Attract New Customers
Consumers are inundated with choices, so pricing matters above almost everything else. Optimal pricing keeps your existing customers happy and helps attract new ones.
Your products become more appealing when potential customers see they’re getting the best bang for their buck. Pricing optimization is particularly beneficial if you’re trying to break into new markets, as prospects won’t know much about your brand other than the price tag on your products.
Customer Retention
Happy customers are repeat customers. If you want to keep wholesale distributors and retailers coming back again and again after their first purchase, you need to nail your product pricing.
Customers who feel they’re getting a fair deal are more likely to stick around. On that note, you can also use pricing optimization tools to set volume-based discounts. A great platform will help you determine what thresholds should be eligible for a discount and how much you should knock off the price tag.
Save Time and Money
Time is money, and price optimization solutions save you both. You’ll no longer need to worry about guesswork or endless debates over what price tag you should assign to your products.
Even if you use a hybrid model involving human input and AI, your pricing tools will be a great starting point for your discussions. You can quickly determine whether the platform’s recommended price makes sense for your product and come to an agreement that makes sense for everyone.
Step-by-Step Guide to Price Optimization
Understanding the concept of price optimization demystifies this essential business process. However, what’s the use of this knowledge if you can’t put it into practice? Fortunately, implementing a pricing optimization strategy is far easier than you might expect. All you need to do is:
Define Your Pricing Objectives
First, ask yourself what you want to achieve with your new pricing strategy. Having a roadmap is crucial, whether your goal is to boost profits, expand market share, or enhance customer loyalty.
If you are still trying to figure out where to start, consider working backward from a problem you face. For instance, if you fell short of revenue goals last quarter, consider how pricing optimization could help you overcome this challenge. Build your objective around realizing that solution.
Gather Data
Data is the key to successful price optimization. Whether you use a simple rules-based solution or an advanced algorithm, you will need tons of high-quality data. To build your dataset, you’ll need to collect data about consumer behavior, market demand, competitor pricing, costs of goods sold (COGS), and more.
If it is a factor that impacts your costs or customers’ willingness to buy, you need to learn all you can about it. Overlooking even a single variable can throw off your entire pricing model and lead to an expensive mishap.
Segment Your Customer Base
Once you have set some objectives and gathered abundant data, it’s time to segment your customer base. Segment your audience based on factors like location, industry, interest, and behavior. While audience segmentation is a common practice in the business-to-consumer (B2C) space, it is also highly effective for manufacturers in the business-to-business (B2B) ecosystem.
Dividing your customer base into segments will also be invaluable to your marketing strategy. But for pricing optimization purposes, it helps you understand which clients you need to appeal to with your new price point.
Analyze Market Dynamics
Imagine attempting a new sport without understanding its rules. Not analyzing your market’s dynamics is akin to that very misstep.
You need to understand the market you are playing in, including what trends have emerged and how staunch the competition is. If you are operating in a saturated market, you need to showcase the value of your products while setting a competitive price. Don’t feel like you need to beat everyone else’s price, but you don’t want to be the most expensive option out there, either.
Choose the Right Price Optimization Model
Choose a pricing model that makes sense for your products based on your objectives and the data you gather. You can use a value-based or cost-plus pricing model.
If your market is volatile, you may need a dynamic, agile pricing model that is easy to adjust. While dynamic pricing requires more frequent analysis, it allows you to adapt to shifting market conditions.
Furthermore, it’s essential to remember that no single pricing model fits all scenarios. Regularly reviewing and adjusting your pricing strategy based on real-time feedback and market trends will keep your business competitive. Embrace technology and data analytics to make informed decisions, ensuring that your pricing remains both profitable and appealing to your target audience.
Implement Pricing Optimization Software
Running calculations manually just won’t cut it in the digital age. Invest in cutting-edge pricing optimization software to automate the data collection, analysis, and visualization process. Doing so will save you time and reduce the likelihood of human error.
When it comes to pricing optimization solutions, find a platform that accommodates multiple models. Just because the cost-plus model works for you today doesn’t mean it will be the best option a year from now. Choose a platform that can scale and adapt as your needs change to maintain your competitive edge.
Incorporate Price Optimization Techniques
Even with the latest tools at your disposal, price optimization is still not an exact science. This is primarily due to the ever-changing conditions facing manufacturers. To keep your pricing optimal, you must continuously adjust it using various techniques.
The best way to determine whether you choose the right price is to test it with your target audience. Use A/B testing, bundling, or discounts to fine-tune your pricing strategy. Through experimentation, you can discover what resonates with your audience and nurture feelings of loyalty toward your business.
Test and Adjust
Continuously test and adjust based on customer response, market changes, and new data. Flexibility is your greatest ally in pricing optimization.
While there is no hard and fast rule regarding how often you should adjust your pricing, you should at least reevaluate it every month. A lot can change in a week, much less a month. Routinely evaluating your pricing will help you determine when to make a change.
Monitor Competitor Pricing
Keep a close eye on what your competitors are up to. Understanding their pricing strategies will help you stay agile and maintain a competitive edge.
If one of your top competitors suddenly changes its pricing, try to figure out why. Is a material shortage looming, or did it incur a new internal cost? Determining the “why” behind the actions of the competition can help you stay one step ahead of everyone in terms of pricing.
Measure and Evaluate
Numbers don’t lie. Regularly measure and evaluate the performance of your pricing strategy against your defined objectives. Is your pricing pushing you toward those goals, or do you need to pull a few more levers to achieve what you set out to accomplish?
Measuring, evaluating, and modifying your pricing is a cyclical process. It helps you stay on track and make informed adjustments as needed.
The Power of Pricing Optimization Software for Manufacturers
Pricing optimization is critical to maintaining healthy margins and protecting your cash cycle. With so much riding on product pricing optimization, do you really want to settle for anything less than the best tools available? Of course, you don’t! That’s why you should adopt Tacton’s pricing optimization solution, CPQ Pricing.
With Tacton CPQ Pricing, you can create custom pricing models that align with the complexities of manufacturing industries. The platform reduces downstream margin degradation concerns, offers flexible tools that can adapt to dozens of models, and offers instant pricing for each of your custom configurations.
Achieve new levels of success in the rapidly changing manufacturing environment with Tacton CPQ.