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Essentials of Pricing Analytics
This book provides a broad introduction to the field of pricing as a tactical function in
the daily operations of the firm and a toolbox for implementing and solving a wide range
of pricing problems.
Beyond the theoretical perspectives offered by most textbooks in the field, Essentials of
Pricing Analytics supplements the concepts and models covered by demonstrating prac-
tical implementations using the highly accessible Excel software, analytical tools, real-life
examples and global case studies. The book covers topics on fundamental pricing theory,
break-even analysis, price sensitivity, empirical estimations of price–response functions,
price optimization, markdown optimization, hedonic pricing, revenue management, the
use of big data, simulation, and conjoint analysis in pricing decisions, and ethical and
legal considerations.
This is a uniquely accessible and practical text for advanced undergraduate, MBA
and postgraduate students of pricing strategy, entrepreneurship and small business
management, marketing strategy, sales and operations. It is also important reading for
practitioners looking for accessible methods to implement pricing strategy and maximize
profits.
Online resources include Excel templates and PowerPoint slides for each chapter.
“This book explains the impact of pricing on companies’ profit in a highly accessible way.
Excel examples help readers to further deepen their understanding of these topics. I highly
recommend this book to anybody who wants to learn the basics of pricing analytics in a
very short time.”
Peter Molnar, Associate Professor at University of Stavanger, Norway
“More and more businesses are embracing analytics. But not everyone can afford a price
analytics software. This book is a good way to get started, learn, and practice the pricing
fundamentals. The ‘cookbook’ approach breaks down the barriers to getting started. Now
every business professional can start answering real pricing questions by using a tool they
are familiar with.”
Stephan M. Liozu, Chief Value Officer of Thales Group
“Essentials of Pricing Analytics is a valuable and original contribution to the pricing lit-
erature. Managers and academics will appreciate up-to-date tools that enable them to esti-
mate demand curves, optimize prices and increase profits. Highly recommended.”
Andreas Hinterhuber, Associate Professor of Marketing,
Ca’ Foscari University of Venice, Italy
Essentials of Pricing Analytics
Erik Haugom
First published 2021
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
and by Routledge
52 Vanderbilt Avenue, New York, NY 10017
Routledge is an imprint of the Taylor & Francis Group, an informa business
© 2021 Erik Haugom
The right of Erik Haugom to be identified as author of this work has been asserted by him
in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988.
All rights reserved. No part of this book may be reprinted or reproduced or utilised
in any form or by any electronic, mechanical, or other means, now known or
hereafter invented, including photocopying and recording, or in any information
storage or retrieval system, without permission in writing from the publishers.
Trademark notice: Product or corporate names may be trademarks or registered trademarks,
and are used only for identification and explanation without intent to infringe.
British Library Cataloguing-in-P ublication Data
A catalogue record for this book is available from the British Library
Library of Congress Cataloging-in-P ublication Data
Names: Haugom, Erik, 1982– author.
Title: Essentials of pricing analytics: tools and implementation with excel/Erik Haugom.
Description: New York: Routledge, 2021. | Includes bibliographical references and index.
Identifiers: LCCN 2020026974 (print) | LCCN 2020026975 (ebook) |
ISBN 9780367363222 (hardback) | ISBN 9780367363239 (paperback) |
ISBN 9780429345319 (ebook)
Subjects: LCSH: Pricing. | Pricing–Computer programs. |
Microsoft Excel (Computer file)
Classification: LCC HF5416.5 .H378 2021 (print) |
LCC HF5416.5 (ebook) | DDC 658.8/160285554–dc23
LC record available at https://lccn.loc.gov/2020026974
LC ebook record available at https://lccn.loc.gov/2020026975
Figures 1.4, 9.3 and 9.5 are adapted from Pricing and Revenue Optimization by Robert L. Phillips.
Copyright © 2005 by the Board of Trustees of the Leland Stanford Jr. University. All rights reserved.
Used by permission of the publisher, Stanford University Press, sup.org
ISBN: 978-0 -3 67-3 6322-2 (hbk)
ISBN: 978-0 -3 67-3 6323-9 (pbk)
ISBN: 978-0 -4 29-3 4531-9 (ebk)
Typeset in Times New Roman
by Newgen Publishing UK
Visit the eResources: www.routledge.com/9 780367363239
To Alexander and Leon
Contents
1 Introduction 1
2 Fundamentals of price theory 12
3 Segmentation and price differentiation 36
4 Break-even analysis 49
5 Price sensitivity and willingness to pay 64
6 Empirical estimations of price–response functions 82
7 Price optimization 105
8 Case study: Optimal prices of movie theater tickets 128
9 Markdown optimization 154
10 The hedonic pricing model 169
11 Revenue management 178
12 Big Data and pricing analytics 188
13 Monte Carlo simulation for pricing decisions 218
14 Conjoint analysis for pricing decisions 245
15 Acceptance, ethics, and the law 264
Bibliography 274
Index 277
About the contributors
Author biography
Erik Haugom holds a PhD in Managerial Economics, Finance and Operations from
the Norwegian University of Science and Technology and an MSc in Business
Administration from Copenhagen Business School. His employment experi-
ence includes positions as a taxi driver in Lillehammer, child welfare, and research
planner at Omnicom Media Group. Today he is employed as a Professor in Business
Administration at Inland Norway University of Applied Sciences. He is also project
manager of the ongoing research project, Innovative Pricing Approaches in the Alpine
Skiing Industry. His special fields of interest include energy price and volatility model-
ling and forecasting, risk analysis, risk management, demand and price analyses, and
econometric modelling and forecasting in general.
Contributor biography
Andrew Musau is a senior research fellow at the Inland Norway University of Applied
Sciences and a statistical consultant for the social sciences research institute
Agderforskning. He obtained his PhD in Economics and Management from the
University of Trento. His research interests are in behavioural and experimental eco-
nomics, energy economics and macroeconomics.
Gudbrand Lien has a dr. oecon (PhD) in finance and a cand. oecon. degree in business
administration from the Norwegian School of Economics (NHH), and a cand. agric.
degree in agricultural economics from the Norwegian University of Life Sciences. He
is currently a Professor in Business Administration at Inland Norway University of
Applied Sciences. His main fields of research have been within energy finance, energy
economics, agricultural economics, quantitative innovation studies, and econometric
modelling in general.
newgenprepdf
Preface
Essentials of Pricing Analytics –Tools and Implementations with Excel is written for academics
and practitioners who want a “cookbook approach” to learning and understanding pri-
cing analytics. The book is an introductory text to pricing analytics and offers the basic
theoretical foundation needed to understand the numerical examples better.
Most of the material in this book is at the introductory level and the majority of readers
should be able to follow the examples without any prior knowledge of the field of pricing
analytics. It is an advantage to have some prior knowledge of microeconomic theory, or
at least a strong interest in quantitative analysis in general. Some of the topics covered
are at a more advanced level. An example is the chapter on conjoint analysis for pricing
decisions.
I would like to thank the many people who have contributed to improving this text.
These include Steinar Veka, Gudbrand Lien, Iveta Malasevska, Sophia Levine, Emmie
Shand, Louise Bolotin and three anonymous reviewers.
I would also like to thank students of the course, Pricing and Revenue Management, at
the Inland Norway University of Applied Sciences for their valuable feedback on earlier
versions of the manuscript.
Finally, I send very special and warm thanks to Andrew Musau, who has contributed
with writing and editing parts of the manuscript.
Lillehammer, 2020
Chapter 1
Introduction
More generally, the focus will be on introducing you to a range of basic techniques that
are useful in many practical business situations, rather than on the technical nuances of
algorithms. By following the instructions in the book, you should be able to reproduce
all the examples and/or exercises using Microsoft Excel. If you are not familiar with
Microsoft Excel, you should spend some time in the beginning to familiarize yourself
with the interface and some basic formulas for doing simple calculations in a spreadsheet.
The book is accompanied by Excel files containing both the examples and solutions to
the problems at the end of each chapter.
Z = pv − cv v − c f (1.1)
In this model Z is the total profit, p is the price, cv is the variable unit costs, v is the
volume, that is; the number of items sold, and cf is the fixed costs. The first term ( pv) in
Equation (1.1) constitutes the revenues, while the two latter terms reflect the total costs.
A local coffee shop has done a market survey of consumers’ preferences related to
regular black coffee. The survey indicates that setting a price of $1 per cup will lead to
a demand of 100 cups per day. Increasing the price to $2 reduces demand by 40 cups/
day. It turns out that the variable unit costs associated with producing one cup of coffee
are $0.50 and the fixed costs are $20 (this will not affect the solution; why?). What price
should the local coffee shop charge per cup of coffee to achieve the highest profit?
To help the manager of the coffee shop with this problem, we can calculate the total
profit using Equation (1.1) and check which of the two price levels induces the highest
profit. This problem is small enough to be solved with pencil and paper. However, as
this book makes extensive use of Microsoft® Excel, we shall do the calculations needed
to advise the manager on what price that maximizes the profit from selling coffee in an
Excel spreadsheet. Another reason for implementing the problem in Excel right away
is that we can adjust the calculations quickly once new information arrives. And soon
enough the problems we want to solve get so big that just using pencil and paper would
be a very tedious task.
The results of the Excel calculations are illustrated in Figure 1.1 and show that char-
ging a price of $2 is most profitable. By charging a price of $2 instead of $1, the total
profit ends up at $70 instead of $30 even though the sales volume is 40 cups lower per
day at the high price level. Even though this example is simple, it illustrates the major
impact price can have on demand and profit. Without doing the survey, and the subse-
quent analysis, the manager could wrongly believe that a price of $1 induces the highest
profit.
Introduction 3
A B C D
1
COMPUTING TOTAL PROFIT FROM SELLING COFFEE
2
3
4 Price Demand Profit (Z) Formula
5 $1.00 100 30 =A5*B5-0.5*B5-20
6 $2.00 60 70 =A6*B6-0.5*B6-20
Figure 1.1 Implementation of the profit function for two price/demand combinations in Excel.
However, it is important to note already at this stage that there could be several other
good reasons for setting a price of $1 to achieve a demand of 100 cups, even though
this price in isolation induce a lower profit compared to setting a price of $2. One such
reason could be that the coffee shop sells other items, such as cookies, and that this
bundling aspect justifies a lower profit on the coffee.
Another aspect worth mentioning is the potential bias occurring in a survey where we
ask about the customers’ intended behavior instead of measuring their real actions. It
turns out that there rarely is a 100% match between stated purchase preferences and real
purchase behavior.
The manager of the coffee shop is somewhat concerned about this potential bias
and decides to run a simple price experiment. For four consecutive weeks the price is
adjusted by $1 per week. The price/demand data for the four weeks are handed over to
us and are presented in Table 1.1
This time we decide to impress the manager even more with our Excel skills and
choose to first depict the relation between the various price levels and the corresponding
demand. This is presented in Figure 1.2. The dots in this figure represent the quantity
demanded (Y-axis) at each price level, which is referred to as a price–response function in
pricing analytics. As the data points are discrete, we refer to it as a discrete price–response
function. A price–response function specifies the quantity of coffee cups demanded
at various price levels for this particular coffee shop and therefore contrasts with the
market demand curve for coffee. An illustration of the price–response function will help
the manager to understand how the quantity of coffee demanded varies by price for her
own shop. The information in this graph can also indirectly be used to imagine how a
continuous price–response function may look. This will become clear in later chapters.
The objective now, though, is still to set the price that will maximize the total profit
accruing from selling coffee. Hence, we should make it easy for the manager to make the
correct decision based on the data we have at hand. To do so, we can calculate the profit
140
120
100
Demanded quan ty
80
60
40
20
0
$0.00 $1.00 $2.00 $3.00 $4.00 $5.00
Price
Figure 1.2 A discrete price–response function for coffee based on the data given in the text.
120
100
80
60
40
20
0
$1.00 $2.00 $3.00 $4.00
using the same formula as in Figure 1.1 and then create a graph that shows the results.
This is done in Figure 1.3.
The graph clearly shows that charging a price of $2 induces the highest profit. In fact,
the difference between the optimal price and the next-best price in this example is as
much as 25%. The impact from improved price management on operating profit has also
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be in the Scheldt, struggling in his gun-boat against a gale which, in
spite of all his endeavors and seamanship, drove him ashore, under
the guns of the Belgians. A crowd of Belgian volunteers leaped
aboard, ordered him to haul down his colors and surrender. Von
Speyk hurried below to the magazine, fell upon his knees in prayer,
flung a lighted cigar into an open barrel of powder, and blew his ship
to atoms, with nearly all who were on board. If he, by this sacrifice,
prevented a Dutch vessel from falling into the enemy’s power, he
also deprived Holland of many good seamen. The latter country,
however, only thought of the unselfish act of heroism, in one who
had been gratuitously educated in the orphan house at Amsterdam,
and who acquitted his debt to his country, by laying down his life
when such sacrifice was worth making. His king and countrymen
proved that they could appreciate the noble act. The statue of Von
Speyk was placed by the side of that of De Ruyter, and the
government decreed that as long as a Dutch navy existed there
should be one vessel bearing the name of Von Speyk.
To return to the knights of earlier days, I will observe that indifferent
as many of them were to meeting death, they, and indeed other men
of note, were very far from being so as to the manner in which they
should be disposed of after death. In their stone or marble coffins,
they lay in graves so shallow that the cover of the coffin formed part
of the pavement of the church. Whittingham, the Puritan Dean of
Durham, took up many of their coffins and converted them into horse
or swine troughs. This is the dean who is said to have turned the
finely-wrought holy-water vessels into salting-tubs for his own use.
Modern knights have had other cares about their graves than that
alluded to above. Sir William Browne, for instance, one of George
II.’s knights, and a medical man of some repute, who died in 1770,
ordered by his will that when his coffin was lowered into the grave,
there should be placed upon it, “in its leathern case or coffin, my
pocket Elzevir Horace, comes viæ vitæque dulcis et utilis, worn out
with and by me.” There was nothing more unreasonable in this than
in a warrior-knight being buried with all his weapons around him.
And, with respect to warrior-knights and what was done with them
after death, I know nothing more curious than what is told us by
Stavely on the authority of Streder. I will give it in the author’s own
words.
“Don John of Austria,” says Stavely, “governor of the Netherlands for
Philip II. of Spain, dying at his camp at Buge” (Bouges, a mile from
Namur), “was carried from thence to the great church at Havre,
where his funeral was solemnized and a monument to posterity
erected for him there by Alexander Farnese, the Prince of Parma.
Afterward his body was taken to pieces, and the bones, packed in
mails, were privately carried into Spain, where, being set together
with small wires, the body was rejointed again, which being filled or
stuffed with cotton, and richly habited, Don John was presented to
the King, entire, leaning upon his commander’s staff, and looking as
if he were alive and breathing. Afterward the corpse being carried to
the Church of St. Laurence, at the Escurial, was there buried near
his father, Charles V., with a fitting monument erected for him.”
Considering that there was, and is, a suspicion that Philip II. had
poisoned his kinsman, the interview must have been a startling one.
But Philip II. was not, perhaps, so afraid of dead men as the fourth
Spanish king of that name. Philip IV., by no means an unknightly
monarch, was born on a Good Friday, and as there is a Spanish
superstition that they who are born on that day see ghosts whenever
they pass the place where any one has been killed or buried, who
died a violent death, this king fell into a habit of carrying his head so
high, in order to avoid seeing those spirits, that his nose was
continually en l’air, and he appeared to see nobody.
Romance, and perhaps faithful history, are full of details of the
becoming deaths of ancient knights, upon the field. I question,
however, if even Sir Philip Sidney’s was more dignified than that of a
soldier of the 58th infantry, recorded in Nichols’s “Anecdotes of the
Eighteenth Century.” A straggling shot had struck him in the
stomach. As he was too dreadfully wounded to be removed, he
desired his comrades would pray by him, and the whole guard knelt
round him in prayer till he died. Bishop Hurd remarked, when this
was told him, that “it was true religion.” There was more of religion in
such sympathy than there was of taste in the condolence of Alnwick,
on the death of Hugh, Duke of Northumberland—a rather irascible
officer, and Knight of the Garter. “O,” cried the Alnwick poet—
But all fruitlessly were the millions so suspended, for as the minstrel
remarked in his Threnodia—