Validating price positioning and performance rules.
To make sure that prices do comply with the agreed price positioning rules and also achieve, within the agreed forecast horizon, the revenues and profits targets, representing the company's financial goals, it is critical to make sure that the price positioning rules and financial targets within which prices have to be maintained are compatible with each other. Typical price positioning and financial targets rules are:
Price positioning rules:
- Min/max price bounds
- Min/max spreads between brands or between own and competitor prices
- Min/max parity price per UOM differences between large and small size products
- Min/max weighted average price index (weighted with unit sales)
- Min % margin for each product in a group
- Min average % margin for a group of product
- Min total revenue or profit to be generated by a group of product
Clearly, many of the price positioning and financial rules are dependent upon each other. For instance, the minimum total revenue or profit rule to be achieved for a group of products, depends on the price changes to be allowed by the price bounds, spreads and parity rules applicable to products’ prices of the group. How can one check that all price positioning and financial rules are compatible with each other?
A retail specific demand model
To solve this problem one first have to build and maintain overtime a retail specific causal demand forecast model, which quantifies the relationship between prices and sales, and in particular to predict how many sales units are to be sold taking into account the prices of the products, together with associated sales cross-effects and potential promotions taking place over the forecast horizon. Specifically, the demand model form needs estimate the direct and cross price/sales elasticity coefficients. Obviously, forecasting methods such as simply using the past sales data as a surrogate for a calculated sales forecasts, or exponential smoothing based methods such as Holt Winter cannot be used as they do not calibrate the sales / prices relationship.
Optimisation method to validate all the rules
The validation of the price positioning and performance rules can be ascertained by implementing an optimisation method, which uses causal demand models, determines if the price positioning and performance rules are compatible with each other, and whether prices can be calculated, which satisfy both types of constraints (rules). The additional benefit of using an optimisation engine to validate the rules, is that conflicts between incompatible rules are resolved by computing the necessary minimum rules’ bounds values adjustments for the products where the incompatibilities manifest themselves.
Contrary to most of the Rules Based Pricing solutions, which evaluate rules using some implicative logic (i.e. “if, then, else “type of rules) and arbitrarily defined relaxation thresholds and priorities, our rules management optimisation based approach allows for a complete and most effective validation of all types of rules and in particular:
- Takes into account sales related performance rules
- Considers both price positioning and performance rules
- Evaluates together rules defined for either individual prices, pairs of prices or group of products
- Minimise the amount of rules relaxation which is necessary to reconcile conflicting rules of different priorities
Point to takeaway
Ensuring that all price positioning and performance rules are compatible with each other is a compulsory prerequisite of a pricing solution for evaluating prices and managing performance.