Pricing Optimization: How to find the price

that maximizes your profit?

The main idea behind this problem is the
following question: As manager of a
company/store, how much should I charge in
order to maximize my revenue or profit?
• MS-Excel
• Excel Solver
• Free Pricing Calculator
• LINGO
• R
• A contribution margin is the amount of
money a business has to cover its fixed costs
and contribute to net profit or loss after paying
variable costs.

Contribution margin = Revenue − Variable Costs

For example, if the price of your product is $20

and the unit variable cost is $4, then the unit
contribution margin is $16.
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What Is the Demand Curve?

The demand curve is a graphical representation of the relationship between the price of a

good or service and the quantity demanded for a given period of time. In a typical
representation, the price will appear on the left vertical axis, the quantity demanded on the
horizontal axis.
 Model Formulation

• Decision variables -mathematical symbols representing

levels of activity of a firm.
• Objective function -a linear mathematical relationship
describing an objective of the firm, in terms of decision
variables -this function is to be maximized or minimized.
• Constraints –requirements or restrictions placed on the
firm by the operating environment, stated in linear
relationships of the decision variables.
• Parameters -numerical coefficients and constants used in
the objective function and constraints.
• A monopoly is a structure in which a single supplier produces and sells a
given product or service. If there is a single seller in a certain market and
there are no close substitutes for the product, then the market structure
is that of a "pure monopoly“

• An unregulated monopoly has market power and can influence prices.

Examples: Microsoft and Windows, DeBeers and diamonds, your local natural

gas company.
• Imagine a company that has been selling the
product which follows the demand curve
above for a while (one year changing prices
daily), testing some prices over time. The
following time-series is what we should expect
for the historical revenue, profit and cost of the
company:
We can recover the demand curve using the historical data (that is how it is done in the
real world).
• And now we need to apply equation 2 and
equation 3.
The final plot with the estimated prices:
As you can see, the estimated Revenue and
estimated Profit curves are quite similar to the
true ones without noise and the expected
revenue for our estimated optimal policies
looks very promising. Although the linear and
monopolist assumption looks quite restrictive,
this might not be the case
References
• Phillips, Robert Lewis. Pricing and revenue optimization. Stanford
University Press, 2005.
• Besbes, Omar, and Assaf Zeevi. “On the (surprising) sufficiency of
linear models for dynamic pricing with demand learning.”
Management Science 61.4 (2015): 723-739.
• Cooper, William L., Tito Homem-de-Mello, and Anton J. Kleywegt.
“Learning and pricing with models that do not explicitly
incorporate competition.” Operations research 63.1 (2015): 86-103.
• Talluri, Kalyan T., and Garrett J. Van Ryzin. The theory and practice
of revenue management. Vol. 68. Springer Science & Business
Media, 2006.