Marketing & Sales Practice

Pricing and promotions:

The analytics opportunity
Many retailers underestimate the value of coordinating decisions on
pricing and promotions. A new analytics approach can help.

by Claus Heintzeler, Mathias Kullmann, Karin Lauer, and Maximilian Totzauer

© Getty Images

June 2021
 The scenario is a familiar one to e-commerce level. (For more on dynamic pricing, see “How
retailers: a supplier increases prices on an item, so retailers can drive profitable growth through
a category manager increases the item’s selling dynamic pricing,” on McKinsey.com.)
price. But this effort to make sales of the item
more profitable is promptly undermined by a While most companies consider price sensitivity
well-intentioned marketing manager, who lowers when they make pricing decisions, the scores often
the price of the item by 20 percent as part of a don’t incorporate enough factors and thus aren’t as
promotion. accurate as they could be. The best price-sensitivity
scores are calculated with advanced analytics, using
Such uncoordinated and counterproductive input factors that take customer, competitor, and
decisions happen much more often than most company considerations into account. For instance,
retailers realize, and they are expensive. Many price elasticity is based on different models for
promotions don’t turn a profit at all, or at least they each product category, because customer behavior,
don’t add nearly as much profitable revenue as including purchase frequency and reaction to price
retailers expect. Addressing this conflict can quickly changes, differs for each product. By aggregating
turn into a game of cat and mouse, in which retailers individual input factors for price sensitivity and
find themselves constantly chasing the next issue in promotion affinity, individual scores for each
a highly reactive way. Sometimes they simply avoid product category can be developed. With price
the problem by keeping prices low or making small sensitivity identified for all products, items are then
adjustments across the board, in effect creating a grouped into three buckets based on their scores:
permanent discount on their entire assortment.
— Key value items: top sensitivity. These are
With better analytics, though, e-commerce retailers everyday products, such as common grocery
can create value by intelligently linking pricing and items, whose prices most customers know,
promotions based on optimal price setting and making it easy for them to comparison shop. As
promotion design. We have observed, for example, a result, customers are especially price sensitive
several innovative e-commerce retailers increase when it comes to these products, and their
revenue and profits by three to five percentage prices must be competitive. These products
points using a highly differentiated analytics typically account for 10 to 20 percent of a
process and often achieve improved customer retailer’s sales. Investing in keeping their prices
satisfaction and loyalty as well. low pays off in significantly better customer
price perception, which leads to more frequent
Companies that effectively and profitably link visits and larger baskets.
pricing and promotions through advanced analytics
engage in the following three-step process, which — Foreground items: midlevel sensitivity. These
first determines customer price sensitivity, then are items that have attributes that are more
gauges the likely effectiveness of promotions for important to customers than price and hence do
every product, and, finally, links the two: not require as great a degree of competitiveness
in pricing as key value items. However, their
prices should be competitive enough to avoid
1. Use a wider range of factors to any negative impact on customers’ price
determine price sensitivity perception. Prices for these items can be set
A price-sensitivity score considers the extent to within a range that falls between, for example,
which customers perceive a product’s price and, the highest and lowest competitor prices, or the
as a result, react to price changes. If a product has minimum margin and recommended retail price.
a higher price-sensitivity score, it means that a
customer is less likely to accept a price increase. In — Background articles: low sensitivity. The items in
this case, the price should be kept at a competitive this bucket are either products for which price is

2 Pricing and promotions: The analytics opportunity

 not an attribute that customers focus on much the specific situation, retailers can adjust the
at all, or products for which a price comparison relative importance of five other factors: customers’
isn’t possible. Correspondingly, the products in willingness to buy the product without a promotion,
this bucket offer the strongest opportunity for the increase in the number of transactions due
retailers to finance their investment in low prices to discounts, volume purchased of the product
for the key value items. promoted, basket product variance, and any
changes in buying behavior, such as more frequent
store visits or larger baskets (Exhibit 1).
2. Build a clearer picture of where to
target promotions Finding the right path through this complexity
Similar to the way they improve the accuracy of a requires two things: an overview of each relevant
price-sensitivity score, retail leaders need to rethink key performance indicator (KPI) that needs to be
how they score promotions to better understand understood, and a way to express the cumulative
their impact on a particular product’s sales or profits. results of all relevant KPIs. This cumulative KPI—or
“total customer effect” (TCE)—shows how much
Promotion-affinity scores primarily measure the additional revenue or margin a promotion accounts
impact of earlier promotions in terms of transaction- for by looking at what additional sales (or gross
and customer-based success factors and basket profit) it generates and whether it actually brought
composition. The most important are increases more customers into the store or increased the
achieved in revenue and margin. Depending on value of their baskets.

Exhibit 1
AAvariety
variety of
of input factors
factorscan
canbebeused
usedto to
determine eacheach
determine product’s precise
product’s price
precise
sensitivity
price and promotion
sensitivity affinity.affinity.
and promotion

Price-sensitivity score Promotion-affinity score

Share of revenue and sales volume Increase in revenue

Number of product variants (upselling Increase in gross profit
potential)
First-product-in-basket share Company
Share of new vs existing customers

Number of relevant competitors

Competitive intensity

Competitors Customers/
Price elasticity market Customer value
Number of product views (traffic) Transaction elasticity
Direct-search-results share Basket elasticity
Conversion rate (number of product Order elasticity
views vs orders) Difference from list price

Source: McKinsey analysis

Pricing and promotions: The analytics opportunity 3

 3. Optimally link prices and retailers use a strategy of keeping regular
promotions prices low, at a level below the recommended
To make better pricing and promotions decisions, retail price but above what a promotional price
companies need to then combine both scores in a would be.
price-promotion matrix so that an optimal balance
can be identified for each product being sold — Low price sensitivity and high promotion
(Exhibit 2). Products are then placed into one of four affinity. These occasional purchases are given
quadrants of the matrix: a “high-low” strategy, with prices that are
close to the recommended retail or highest
— High price sensitivity and high promotion competitor prices but with discounts that
affinity. Retailers using this approach respond lower promotional prices as much as possible.
to consumer sensitivity regarding prices for Leading retailers also vary promotion type,
these products with a “low-low” approach—that mix, and frequency, and they focus on product
is, both setting the lowest prices possible categories with high promotion affinity.
and maximizing discounts. Also, they focus
promotions on products in this category that — Low price sensitivity and low promotion affinity.
specifically help to increase frequency of Leading retailers generate additional value
purchase or basket size. with these products by increasing the margin
earned on them. They price these items close
— High price sensitivity and low promotion affinity. to their highest competitors’ prices, and they
For these necessity-type products, leading reduce or stop promotions on them.

Exhibit 2
A price-promotion matrix
A price-promotion matrixidentifies
identifiesthe
theoptimal
optimalbalance
balanceofof
pricing and
pricing promotion
and
for each product
promotion being
for each sold. being sold.
product
# of product categories Everyday value pricing (EDVP):
Share of gross profit Everyday low pricing (EDLP): very limited low-low strategy
promotions Match competitors’ prices and
Low prices, few promotions; match competitors’ promotions on products with high
base price and long-term promotions price-sensitivity score
High
100 EDLP/very limited EDVP+ (low-low
Higher 90 promotions strategy)
score 80 39 18% 14 15%
indicates 70 Cutoff indicative—
.
higher 60 not fixed
Price–
customer
sensitivity 50
sensitivity
score 40
to price
levels for 30
a certain 20
124 55% 51 11%
product 10
EDVP/optimize for value High-low strategy
0
Low 0 10 20 30 40 50 60 70 80 90 100
Low High

Everyday value pricing Promotion-sensitivity score High-low strategy

(EDVP)—optimize for value Higher score indicates Targeted promotions on
Increase prices and offer few stronger customer reaction products with high promotion–
promotions: no immediate to price discounts for a affinity score; list-price level is
need to react to competitors’ certain product higher, as price-sensitivity
price adjustments score is low

4 Pricing and promotions: The analytics opportunity

One international online retailer’s efforts to closely employee involved—whether they work in
link pricing and promotion decisions indicated a pricing, sales, analytics, or product or category
potentially quick payoff as soon as the first pilot management—has access to the pricing and
phase was completed. Previously, the retailer sold promotions scores. They also put the same
about 80 percent of its assortment below the list incentive system in place for everyone, to
price. Pricing required significant manual effort avoid potential conflicts between, for example,
and was rarely transparent, which was a recipe for category managers who benefit from higher
employee frustration. A lack of coordination with sales and their marketing counterparts who
promotions not only created additional work but also want to see higher margins.
caused the company to leave revenue and profits on
the table. Also, the retailer wanted to build customer — Data and resources. As retailers scale up this
trust into its pricing and to boost perception of its approach, data availability and quality become
brand, so an important aspect of its initiative was increasingly important. Strongly differentiated
to design prices that would be consistent from the transaction histories are also essential for
customer’s perspective. activities such as price analyses at the SKU
level. At the same time, updating data is time
The team first tested the approach in five product consuming and expensive. Gathering and
categories in a single country for periods ranging consolidating data takes people and systems
from four to six weeks. After this pilot phase was with the right capabilities to glean, analyze, and
concluded successfully, the bulk of the results translate the results, and such efforts must
were carried over to other categories and countries often compete internally with other digitization
and optimized further. Motivated by this success, projects. It is therefore critical that managers
the retailer has since launched a pricing-and- make this topic a priority, invest enough in its
promotions transformation across other products implementation, and get needed employees on
and countries. As a result, the company expects board.
its sales revenue to increase by 3 to 5 percent and
profits to grow by two to four percentage points — Culture and mindset. Any retailer working
over the three years following implementation of to develop, test, and broadly launch a new
the approach. Also, its brand position has already approach to pricing and promotions will
improved and is far less dependent on discount encounter many obstacles. The available data
promotions. will never be perfect, and no model used as a
starting point will meet every one of a company’s
needs. Companies that have a clear willingness
Three prerequisites for success to test and learn will find it a big advantage.
In our experience with a number of programs for Involving the different stakeholders early on
integrating pricing and promotion management, is also essential, to be sure they understand,
three areas play an especially large role in question, adapt to, and stand behind the models
determining whether retailers’ plans succeed: as they develop. As with all change, this level
of engagement is the only way to ensure that
— Strategy and implementation. Leading retailers employees across departments accept the new
initially leave it to top marketing management methods and are equipped to use them.
to decide whether to set more consistent prices,
reduce both the number of promotions and While these success factors and the skills to apply
associated discounts, and design an overarching analytical methods and tools are vital, they don’t add
pricing and promotion strategy. Once that is up to a new pricing-and-promotion strategy on their
done, they look to boost coordination across own. In our experience, retailers find that such an
product categories and regions to anchor the overarching strategy emerges only from the mixture
new strategy throughout the organization. To of science and art that takes place when analytical
make this happen, they ensure that every

Pricing and promotions: The analytics opportunity 5

 approaches are combined with individual managers’ expand—including to areas where links between
capabilities and experience. pricing and promotions are still uncommon today,
such as brick-and-mortar retail.
As these new methods find increasing use in the
future, opportunities to apply them will continue to

Claus Heintzeler is an associate partner in McKinsey’s Berlin office; Mathias Kullmann is a senior partner in the Düsseldorf
office, where Maximilian Totzauer is a specialist; and Karin Lauer is a consultant in the Frankfurt office.

The authors wish to thank Katharina Buhtz, Marcus Keutel, Anna Kloss, Felix Lösch, Krzysztof Szyszkiewicz, and Stephanie
Vehrenkemper for their contributions to this article.

Copyright © 2021 McKinsey & Company. All rights reserved.

6 Pricing and promotions: The analytics opportunity