While the effect of prices and price changes is usually measured as part of a business driver analysis, it often makes sense to put special emphasis on this topic, as price is one of the most direct profit levers.
Sales vary in reaction to price changes, but other factors also have an influence. A model is built to extract the influence of price independent of other activities.
Knowing the relationship between price and sales allows to simulate the revenue and profitability impacts of price changes and to find the optimal price configuration.
To sharpen intuition, note that for a single product with elasticity E (taken as positive), the operating margin at the profit optimum is 1/E. This allows for an easy initial assessment of activities.
If special price effects, like e.g. price thresholds, are suspected, we strongly recommend to include these in the model. As shown in the graph, in the case of price thresholds, i.e. price points (1.99€ say) above which customers buy significantly lower quantities, the profitability optimum tends to get caught in these points.
A differentiated product portfolio allows for higher prices and margins overall, as some of the volume lost when increasing the price of one product will be captured by the other products (blue lines above). Thus, a detailed modelling of these substitution effects is of the essence when optimising across the portfolio.
Boris Vaillant - Quantitative Consulting 17