Optimal margin levels

Welcome to the advanced topics. These approaches are suitable for those who have already established the previous tactics and principles:

• Your portfolio is properly segmented into groups, each with a defined minimum margin.
• You can create basic pricing rules and apply changes directly to your store.
• Your product team understands dynamic pricing and actively uses fundamental rules.

In the introduction to group setup, we recommended that each group have a defined margin. The percentage level of this margin is often based on expert judgment, which is acceptable for starting out or when the sales volume within a group is low.

A more advanced tactic is to adjust and test margin levels. A standard approach is to test a fixed margin level for a set period, then adjust the margin for the entire product group and compare the results.

For a deeper dive into pricing evaluation, see the chapter Evaluating Pricing Strategies.

But what if we lack the necessary product expertise, or we don’t have the resources or sufficient data to test margin levels? There is a specialized survey method that can help determine the optimal price—the Van Westendorp Price Sensitivity Model (PSM), which is even covered by Forbes.

This model consists of four key questions about how consumers perceive the price of a specific product. It is most commonly used for newly launched products. The questions ask at what price the product would be considered:

1. Too expensive
2. Expensive but still acceptable
3. Cheap / good value
4. Too cheap to be of good quality

By plotting the distribution functions of these four price points, you can analyze their intersections to gain valuable insights into price sensitivity.

Of course, the PSM model is not a perfect solution. If used, we recommend a “sanity check” by comparing prices of similar competitive products. There are also alternative models, such as Gabor-Granger, but at the end of the day, nothing works as well as real market testing.

For completeness, here’s a semi-academic perspective: you can also determine margin levels based on your overall business strategy and positioning. Pricing typically falls between two extremes:

Penetration pricing

Used by discount retailers or aggressive market entrants when expanding into new markets. Simply put, you aim to be the cheapest option and attract price-sensitive customers by offering the lowest price.

Price skimming

Used by premium brands with strong competitive advantages, whether through brand power or product quality. This approach is commonly applied to premium private labels—starting with a high price and gradually lowering it over time.