The Economist March 26th 2022 pp59 |Business|Pricing Power (1)|”Artificial prices” “How companies price their products is turning from art to science
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Summary by 2244
Price Elasticity of Demand (PED). This chart from penpoint.com shows that as price is increased from P1 to P2 the quantity demanded would fall from Q1 to Q2. Based on the equation shown on the graph, “revenue is maximized when price is set so that the elasticity is exactly one." (wikipedia.org).
Retail pricing has recently gone from old-school to new-school by exploiting large transaction datasets and AI-powered computing. With PED, as described above (See the Graph), the idea is to find the price that maximizes revenue. Revenue equals the number of units sold times the price of each unit [Revenue=units*price/unit]. Raise the price beyond ideal and units sold and revenue decline. Lower the price and units sold rises but revenue declines.
As always, for the company, the impact on profit is key. In 2010, a McKinsey study “estimated that raising prices by 1% without losing sales can boost operating profits by 8.7%, on average.
Given these new computing tools, companies are studying the effects of pricing more often. Cited as an example, Walmart now evaluates prices twice a year rather than once a year. eCommerce sellers reportedly are especially able and willing to adjust pricing based on supply and demand. Uber surge pricing comes to mind.
Retailers can now incorporate data on individual products and full product lines. As an example, a retailer could actually increase revenue by lowering prices for popular items and then offset that lower price by raising prices on other items in a product line. These revenue and profit calculations are also leveraged today to understand price and sales data across a firm’s geography.
Uber, Coca Cola, Starbucks, Johnson & Johnson, US Foods, Sysco, Raley’s Supermarket, Walmart and JC Penney are exploiting these new pricing capabilities. US Foods “has touted its pricing system’s ability to use ‘over a dozen different inputs’ to boost sales and profits.”