Setting up the best price for your products may seem easy, but price optimization requires some strategy. As strange as it may seem, businesses struggle with determining how much something should cost, and our biases tend to hold us back in this area.
Unfortunately, these terrible pricing decisions can cost a business some severe money. In truth, most of them are not even aware of how much they are losing due to this terrible pricing. That is why price optimization is crucial for your overall business strategy.
Optimizing your pricing can balance value with profit which will lead to your company seeing success. Once you find the proper price, everything becomes smoother, from marketing and sales to growth and profitability.
Overlooking price optimization will eventually lead you to trouble. While trying to understand what each of your customers is willing to pay does take some effort and research on your part, it will be worth it. There are pricing optimization tools that have made it much easier and faster to optimize your pricing.
For this article, I’m going to explain what price optimization is and why you need it.
What is price optimization?
Price optimization is a technique of using collected data from customers and the market to discover the most effective price point for your product or service that shall maximize sales or profitability. The optimal pricing spot is the price where businesses can best meet their goals, whether that is to increase profit margins, customer growth, or a combination of both.
The information that is commonly used in price optimization includes:
- Demographic data
- Psychographic data
- Operating costs
- Churn data
- Customer survey data
- Inventory data
- Machine learning outputs
- Subscription lifetime value
Businesses these days are moving exceedingly quickly through many sales channels. The corresponding data that gets collected expands at an exponential rate, causing ever-increasing complexity as new market changes cause force companies to adapt. These changing factors each uniquely sway price from one selling scenario to the next.
Without the correct price at the head for each of these circumstances, a united consequence of attempting to manage pricing complexity manually with spreadsheets or homegrown tools, businesses will become exposed to severe margin leakage.
The analysis will typically use spreadsheets and other manual tools to manage and input prices. If your company only has a few customers and a small catalog, then this works well enough for you. However, if a company has tens of thousands of SKUs and thousands of customers, it is dealing with an immensely complex business environment. That is the reality for most B2B businesses these days.
Why do you need price optimization?
Customers these days are far savvier, and they know how to get the most out of their money. They are comparing prices online when shopping around, and they have apps that offer them deals. They are also incredibly loyal to brands that give them the most bang for their buck.
That makes your price optimization strategy immensely crucial to a healthy and growing bottom line. Unfortunately, plenty of businesses are still relying on old-fashion pricing practices and using outdated trends or even gut instincts to set up their prices. But it does not need to remain this way.
Price optimization has managed to improve for a more modern era, with the advent of various technological solutions such as pricing analytics platforms designed to keep business on top of everything. These platforms and the insight they offer empower businesses to make data-driven decisions and take their operations to a whole new level.
Take a quick look at the price optimization research data provided by ProfitWell below:
The customer’s reaction to pricing
Coming up with a price is all about the numbers, but the way customers react to them is intensely emotional and therefore, very complicated. Let’s go over some of the more critical aspects at play.
- History. If a product is priced around $10 and was changed to $8, that $8 will not be seen the same by people compared to a product that was previously $6. This pricing history is a crucial aspect for software solutions as for people addressing price optimization.
- Competition. If competitors’ prices are refined, the customer’s image of your prices will be affected. That should be kept in mind when making any changes to your own pricing optimization strategy.
- Content. The way a customer sees the price matters, especially when it comes to online stores vs. brick and mortar stores. The ease in which products and services can be price-compared online means customers will have a set of varied expectations and reactions to pricing.
- Reputation. Your company’s reputation will potentially come into play. Is your business known for its competitive prices? Similar to our example in the history part, this can account for customers and price sensitivity that would not otherwise make sense.
- Season. When the season changes, everyone’s purchasing pattern changes. Price optimization requires you to take account of the season as well. Seasons impact product price and the customer’s willingness to pay as demand varies.
What needs to be optimized
The idea of price optimization is to discover the perfect balance of desire, profit, and value. Since you are incapable of controlling which products and features customers want, and including valuable product features takes time and effort, most businesses begin finding the balance by setting two things. The first is the starting price of their service or product and any promotions or discounts they may offer.
1. Base price
Your base price is vital since it allows customers to know whether your product or service is worth their time and hard-earned money. The starting price has to be optimized to match the baseline demand for your product before any promotions or discounts are set in motion. Optimizing the base price works well for businesses with products and services that remain reasonably stable over time, such as SaaS products.
2. Discount prices
If you have dabbled with sales long enough, then you should know what works best to entice new customers to your business. Offering your product at a discounted price, or offering a freemium version, is an excellent way to lure in new customers. Moreover, customers gained through freemium offerings costs almost half as much to acquire as the ones who sign up for paid offerings directly.
3. Promotional offering price
Have you ever considered what promotional offers would serve your customer and you best?
Is marking down cause an increase in profit, or are you better off charging the starting price?
How high of a discount should you offer beneath your starting prices? How long will something take to sell at a particular price point? Optimizing your promotional prices can assist with increasing sales for newly introduced products and promotional bundles. For instance, a SaaS company could launch a new product or bundle multiple ones.
The 4 rules of price optimization
Trying to find the perfect price point for your product that increases the value will be challenging. That is especially true when you have to consider your profits as well.
However, you can pull this off by getting a deep understanding of your customers. It is crucial for you to understand who your best customers are, what features they enjoy, and what features they require.
You also need to gain an understanding of your market. Retailers will have their own set of considerations than B2B companies. Once you managed to understand that, you can align your pricing with what they value, track down the results of the price alterations you made, and improve over time.
1. Learn about your customers
Optimizing your pricing will require some quantitative and qualitative data. Solid data is the only way you will discover how much customers are willing to pay for your product, and it is the gateway to breaking free from having to guess.
Quantitative data such as customer reviews, churn rate, supply and demand data, MRR, transactional data, and more reveal how you are doing and what needs to be altered.
When it comes to qualitative data, you get it from talking to your customers. Surveys are ideal, but they are not a match for communicating with your customers through voice chat and talking to customers.
You can ask them all sorts of questions, such as their price sensitivity and what feature or benefits they value the most from your product.
2. Assess the value
Once you have accumulated enough data from your customers, you need to take some time to work out what value actually means to your customers, which means working out your value metric.
The value metric is practically what and how you are changing your product. Identifying and rating along your proper value metric is the variation between flourishing and surviving.
Some other value metrics for SaaS companies include the number of files hosted, bandwidth used, page views, the number of seats, and so forth. Your value metric should align with your customer’s requirements and should be seamlessly scalable.
3. Scrutinize the data
Since you have managed to collect some customer data and discovered what your customers value, it is time for you to look for patterns in the features, price points, benefits, and value metrics that run or reduce from value.
You can also find out how willing various segments and personas are willing to pay varying prices for your products and services.
Use the information you have discovered to build tiers and proper packages for your products or services. Each tier should be priced along with your value metric and should align with your various buyer personas. That ensures you are offering them the correct amount of product or service to each customer segment.
4. Fine-tune pricing and monitor
Even with having set up your prices, you are still not completely done. The value you provide versus your competitors is periodically changing, so you need to keep a steady watch over them and adjust accordingly.
Your pricing will remain an ongoing process. You need to apply your pricing optimization strategy to shave off as much doubt as possible. Constantly adjusting your prices assists you with cutting off parts that could hinder you. It allows you to concentrate on the right areas of your business as you learn about what works.
You also need to collect data frequently and analyze the value customers are gaining from your product. It will make sure what you are offering still meets the needs of your customers and pricing desires.
Make sure you keep a close watch over your pricing and see how customers react to them. If required, reevaluate and change your strategy, but do not be too quick on making changes since you could alienate your customers.
[BONUS] Additional Considerations on Price Optimization
There are some things that you need to take into consideration when it comes to pricing strategy. Here are some critical factors to contemplate:
- Demand. There is hardly a more severe concept to price than demand, so this needs to be integrated into the core of any price optimization strategy. While you want to ensure you are not leaving any money on the table, you also need to make sure that there is enough demand for the price you are charging.
- KPIs. You need to consider what matters the most for your company. Is it your customer’s loyalty? Quantity of products being sold? Average price per product sold? Your business KPIs are critical in determining optimal pricing.
- Competition. Is it more significant to your business to be the price set by your competitors? For instance, do you need to make sure your prices are always equal to or lower than your competitors?
- Operating costs. Price optimization needs to take some input costs into accounts if it is going to optimize your final sales price and increase profit margins. That means using operating costs is necessary.
Price optimization is something you need to take into heavy consideration. It’s a crucial aspect of your business that will make sure your business continues to increase its revenue and remain ahead of the competition.
Customers like it when companies offer them great prices, especially when it is an affordable price. However, if you are not careful with your pricing strategy, you could be either losing profit due to how low you set the price or because of how high it was set.