Retail_Price_Optimization

• Price optimization models are complex algorithms designed to evaluate the change in demand at various levels and match the results with data on costs and inventory levels to craft optimal prices and maximize profit.
• Retails need to ensure they factor in all the interrelations between products when changing prices.
• It is challenging to determine which products and how many of them require price changes. Besides, sometimes a price change can damage KPIs instead of fueling them.
• By changing the price of one product, the retailer triggers a chain reaction across a group of ‘neighboring’ products in the perception of the shoppers.
• To maximize the KPI of choice the retailers need optimization models that factor in both the elasticity of the product and its cross-elasticity with related products
• Elasticity of the Product
  • Elasticity measures the responsiveness of the quantity demanded or supplied of a good or service to a change in price, income, or other relevant factors. It helps assess how sensitive the demand or supply of a product is to changes in these variables.
  • Elasticity = % change of quantity supplied / % Change in Price
  • e.g. Suppose the price of coffee increases by 10%, and as a result, the quantity demanded decreases by 15%. The elasticity of coffee is calculated as Elasticity of coffee = -15%/10% = -1.5 The negative sign indicates that coffee is an elastic good. This means that consumers are relatively responsive to changes in the price of coffee, and a price increase leads to a proportionally larger decrease in the quantity demanded.
• Cross Elasticity of relative Products -
  • Cross Elasticity = % Change in quantity demanded of a good A/ % Change in Price of good B
  • e.g. the cross-elasticity between coffee and tea. Suppose the price of coffee increases by 10%, and as a result, the quantity demanded of tea increases by 5%. The cross-elasticity between coffee and tea is calculated as
  • Cross Elasticity = 5%/10% = 0.5
  • The positive sign indicates that coffee and tea are substitutes. When the price of coffee rises, consumers shift to tea, leading to an increase in the quantity demanded of tea. This suggests that these two beverages are interchangeable, and a change in the price of one affects the demand for the other.