Getting the Price Right

Copyright 2013 Bottom Line Analytics All rights reserved.

The Price is Right? The Six Steps to More Profitable Pricing Leveraging Analytics to Generate More Profitable Pricing Strategies & Decisions

Sep., 2013


Content

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Forward, Objectives & Destination

Destination: The 6 Step Process

1. The importance of analytics

a) Developing a Predictive Model

b) Deriving Price Elasticity Curves with Competitive Effects

c) Measuring the Volume Drivers and Variances

d) The Importance of Determining the Sales and Profit Impact by SKU

e) Price Sensitivity by Market and Channel

f) Macro-Economic impacts on the business

g) Identifying the Critical SKUs for Pricing Success

h) Price Simulation, Profit Optimization and Scenario Planning

Copyright 2013 Bottom Line Analytics All rights reserved. 3

Forward: The Imperative and Challenge of Pricing

• Pricing is considered one of the Four-P’s of marketing

and a critical part of the marketing mix

• In fact, no single part of the marketing mix has as much

impact on sales performance and profitability than

pricing

• Yet, managers tend to spend less time and research on

improving pricing decisions and, likewise, are less

knowledgeable of the specific impact that individual

pricing decisions have on their brand’s performance in

advance of a pricing action

• Consequently, sub-optimal pricing decisions are

common and managers literally leave millions of dollars

of profit and revenue on the table due to poor pricing

decisions


Objective

• In order to adequately plan, evaluate and implement

profitable pricing decision, managers must have a

precise understanding of the sales and profit impact of

given price changes. This will require development of

advanced models or analytic tools which measure:

• Brand or Own Product Price Elasticity, which is the

percent change in brand sales due to a given

percent change in brand price over time, and

• Cross or Competitive Price Elasticity, which is the

percent change in brand sales due to a given

percent change in competitors’ pricing over time.


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Destination

• This outlines a 6-step is a proven process that will lead companies and

brands to a more effective pricing strategy.

• We take our clients directly through each of these important steps:

1. Situation Assessment and Objectives: This involves a thorough

review of sales and pricing trends by market and channel for the

client brand and key competitors in order to identify where pricing

issues and problems might exist. This will then involve identifying

specifically the revenue and profit objectives that the client wants to

get from its pricing.

2. Analytics: This is all about building predictive models and deriving

specific price elasticities by brand and SKU for both the client brand

and the cross elasticities versus competitors.

3. Generating pricing scenarios: Once price elasticities are

determined, these are estimates of the revenue and profit impact of

various pricing alternatives. Once we have generated a sufficient

number of scenarios to understand a desirable course of action, we

formalize a general pricing plan


Destination

4. Evaluating Risk: This involves understanding and predicting how

competitors are likely to respond to the client brand’s pricing actions

and the impact of that. In addition, this also involves what is needed

and the cost of rectifying various in-market imbalances in the client’s

brand pricing.

5. Consolidating insights and developing pricing principles and

strategies: With sufficient scenarios and full understanding of

current conditions, we formalize pricing principles and develop a

formal multi-year pricing strategy and action plan.

6. Optimizing pricing to maximize profit yield. We develop a specific

SKU-by-SKU pricing plan by optimizing the price changes by SKU to

maximize profit yield. We then plan on implementation,


1- 3 Plan & Assess

4- 5 Prepare

6 Optimize

Assess &

Set Yield

Targets

Situation &

Objectives

Model

Price

Elasticities

Analytics Competitor Response

Evaluate

Risk

When & What to

Implement

Generate Scenarios & Plan Timing

Consolidate Insights Summarize

6 Principles

Profit

Yield Optimize

A Proven 6 Step Process


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Step 2 Analytics: Sales Model Architecture

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Brand

SKU

Price

Comptv.

Price

Macro-

Economic

Season-

ality

Weekly Retail

Sales by

Market

Determining Price Elasticities starts with a Predictive Econometric Model of Brand Sales

Weekly Retail Sales

are driven by

Brand SKU Price

Plus

Competitor’s Price

Plus

Macro-Economic Factor

Plus

Seasonality


Econometric models are used to derive price elasticities. All models need to be thoroughly vetted for their accuracy and predictive validity.

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Actual

Model

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Models show an excellent predictive fit to actual sales

R2 =97.3, Holdout R2 =89.9, MAP = +/- 1.9%


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We derive price and profit elasticity curves with and without competitor price reciprocation

1.08

1.10

1.12

1.14

1.16

1.18

1.20

10.0

12.0

14.0

16.0

18.0

20.0

22.0

-15% -10% -5% 0% 5% 10% 15%

Un

it S

ales

Mil

Net

Pro

fit

Mil.

Price Change

Profit Mil wo ReciprocationProfit Mil w ReciprocationUnit Sales Mil wo ReciprocationUnit Sales Mil w Reciprication

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When competitors match Brand price changes, it reduces the impact from that pricing change

Brand Price & Profit Elasticity


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Models also used to understand what is driving growth and decline across markets

4.5%

1.3%

-11.3%

-1.0%

-15.0% -10.0% -5.0% 0.0% 5.0% 10.0%

Market 1

Market 2

Market 3

Total

2012 Sales % Impact

Competitor Pricing

Your Brand's Pricing

Macro-Economic Impact

Base Momentum

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From the econometric model, we can determine the impact of different drivers and pricing on overall performance. The problem Market 3 is the

one area dragging down overall brand growth


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Price Elasticities and Effects must be at the SKU level, where pricing decisions are made

0.1% 0.1% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.5%

1.6% 2.5%

3.2% 5.4%

7.2% 7.3%

9.7% 25.7%

35.2%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%

SKU 1

SKU 2

SKU 3

SKU 4

SKU 5

SKU 6

SKU 7

SKU 8

SKU 9

SKU 10

SKU 11

SKU 12

SKU 13

SKU 14

SKU 15

SKU 16

SKU 17

SKU 18

Retail Unit Sales Impact % Due to Pricing

Retail Sales Impact %

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BLA models pricing elasticity at the SKU level, where pricing decisions are made. Evidence usually shows that a relatively small proportion of a

brand’s SKUs drive most of the pricing impact.


We also look at how pricing at the SKU level affects profits

-1.5% 0.0%

0.9% 1.3% 1.3% 1.5%

2.3% 2.3%

3.3% 4.4% 4.5% 4.7%

5.6% 7.3%

9.7% 13.8%

15.9% 22.8%

-5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0%

SKU 1

SKU 2

SKU 3

SKU 4

SKU 5

SKU 6

SKU 7

SKU 8

SKU 9

SKU 10

SKU 11

SKU 12

SKU 13

SKU 14

SKU 15

SKU 16

SKU 17

SKU 18

Net Margin Yield Impact % Due to Pricing

Retail Sales Impact %

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And similarly, a few SKUs tend to drive most of the profit impact due to pricing


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Different markets and channels have different price responses or elasticities under different conditions

-0.3%

-0.6%

-1.4%

-0.5%

-0.2% -0.3%

-1.0%

-0.3%

-1.6%

-1.4%

-1.2%

-1.0%

-0.8%

-0.6%

-0.4%

-0.2%

0.0%

Market 1 Market 2 Market 3 Total

Price Elasticity: Change in Retail Unit Sales Due to a 1% Increase in Retail Price

WO Reciprocation Full Reciprocation

20

Our price elasticity model looks at market/SKU level and with and without competitor reciprocation of your price change


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The model also factors in the effects of macro-economic trends

785,000

790,000

795,000

800,000

805,000

810,000

815,000

820,000

825,000

830,000

835,000

840,000

-15% -10% -5% 0% 5% 10% 15%

An

nu

al R

etai

l Sa

les

Change in Housing Starts

Housing Starts and Unit Sales

Unit Sales

22

Our Model is also able to isolate the impact of key macro-economic drivers


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Deriving a pricing strategy involves knowing which SKUs are the most critical players in the brand pricing equation

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Quadrant Plots visually show which SKUs are the most critical in terms of pricing

Bubble size represents net revenue


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Step 6: Optimize: Optimized Pricing

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A simulation tool which permits us to estimate different scenarios and optimize profitability within specified targets and constraints, is essential


Step 4 Generate Scenarios & Plan Timing: Generate Pricing Scenarios

$0.86 $1.04

$1.28 $1.14

$1.42

$1.77

$-

$0.50

$1.00

$1.50

$2.00

Yield $Mil

Incremental Revenue & Profit Yields from Optimized Price Scenarios

Revenue 3% Increase

Revenue 4% Increase

Revenue 5% Increase

Net Profit 3% Increase



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The final pricing decision is from running various optimized pricing scenarios and selecting that which achieves profit goals


Step 4 Generate Scenarios & Plan Timing: Price Elasticity Trends by Period

0.30

0.32

0.34

0.36

0.38

0.40

0.42

Total Elasticity (Absolute Value)

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BLA’s modeling approach can identify points-in-time when price sensitivities are highest and when is the strategically best time to implement pricing

increases or decreases


Contact Us

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Michael Wolfe [email protected]

David Weinberger [email protected]

770-649-0472 678-314-8446 (m)

770-485-0270 (o)

www.bottomlineanalytics.com

Masood Akhtar [email protected]

+44 7970 789 663

http://www.bottomlineanalytics.com/

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Getting the Price Right