How to Use Data Driven Marketing Results to Price Your Product
Determining how to price your products is partly an exercise in basic accounting, but it can be helped by data driven marketing. How much does it cost to produce a product, and what is a reasonable profit margin? And this is only the beginning of the story when it comes to pricing decisions.
The science behind pricing actually gets quite involved. Sometimes discounts are necessary to address sales shortfalls. Sometimes certain products are sold at a loss in order to gain future sales. An understanding of customer behavior is central to making effective pricing decisions.
What is revenue management?
The discipline of pricing actually has a more technically flamboyant cousin known as revenue management. Revenue management is an analytic process that takes into account customer buying patterns and available inventory. This approach was initially developed in the airline industry. But its use has spread to many other industries as well.
The problem for airlines is two-fold. First, it’s incredibly expensive to fly a plane. And it’s incredibly unprofitable to fly an empty one. Second, once a flight is scheduled, the seats on that flight are perishable assets. Once the departure time arrives, empty seats mean lost revenue. There’s no way to recover it.
Everyone who travels at all knows that airline ticket prices fluctuate constantly. Also, you may get a flight that has a connecting flight for less than you would have paid for a direct flight, even though you are actually taking more flights.
These price fluctuations and counterintuitive pricing structures are the result of revenue management techniques. Ticket prices are constantly balanced against available inventory — empty seats — using revenue management techniques.
The oddness of the pricing structure is a direct consequence of the mathematics that underlies revenue management. Essentially, they’re looking to optimize their entire inventory. That is, they’re trying to maximize their overall revenue. This can’t be done by trying to maximize revenue for each individual seat.
All consumers see is a particular flight or small group of flights to a given destination. In the case of the example about a flight being cheaper if it includes a connection, the revenue that’s being optimized is the total revenue for both flights. They may get less money from customers that way, but they manage to fill up both flights with this strategy. This actually equals more revenue.
One theme that comes up with regards to revenue management folks is that they try very hard to avoid training customers to wait for a discount. If airlines consistently discount tickets the week before the flight departs, consumers will pick up on this pattern. And the airline will have for all intents and purposes lowered its fares.
So one technique they use is to offer discounts for early bookings. If there’s one trend that’s pretty recognizable in airfares, it’s that waiting to book gets you a more expensive ticket. By discounting early, they’re filling up their inventory. This in turn makes tickets for that flight a scarce commodity, and, according to the law of supply and demand, up go the prices.
Beyond the airline industry
The use of revenue management techniques has spread far beyond the airline industry. Naturally, its first expansion encompassed other sectors of the travel industry — namely, rental cars and hotels.
First, folks in the travel industry talk. Travel agents and travel planning websites are constantly bundling car and hotel offers with airline ticket purchases. The executives in those industries have a vested interest in cooperation. So it’s natural that these industries would be the first to find out about revenue management success stories.
Second, the rental car and hotel businesses have something in common with airlines: perishable inventory. An empty seat on a flight can never be recovered after the plane leaves the gate. So too with rental cars and hotel rooms. Every day a car goes unrented or night that a hotel room stays empty is lost revenue.
Revenue management techniques have since been adapted to a wide variety of industries. Industries from financial services to retail apparel sales have found ways to apply the mathematics of revenue management to their pricing and discounting strategies.
In all these cases, revenue management techniques begin with customer data. In particular, customer purchase data plays a central role. How price sensitive are customers? What effects do various discount levels have on sales volume? How far in advance do customers book travel? All the customer behavior information contained in your marketing database is potentially relevant to advanced pricing analysis.
And it’s not just behavioral data. Your profiles and segmentation analysis will also be of interest. Pricing decisions, particularly discounting decisions, can be made based on purchase channels as well as particular audiences.