How do you set prices in an uncertain environment?

Research by Tony Atkinson and Michael Lionais investigates how a firm might set prices when there is uncertainty around demand and costs. The general argument is that managers mobilize their knowledge about this uncertainty and combine it with the firm’s risk attitude to determine price. The researchers argue that using a ‘Monte Carlo’ simulation can help this process.

What You Need to Know

A Monte Carlo simulation is a tool that allows decision-makers to estimate the risk associated with pricing, using their expertise and knowledge. Decision-makers need to have historical information and/or expert opinion to identify a range of likely cost behaviours and patterns of customer demand. Compared to the more traditional trial-and-error approach to pricing, Monte Carlo models help decision-makers appreciate the risk associated with their pricing decisions. This comes, in part, from the need to discuss risk and how to mitigate it within the context of a specific firm. However, Monte Carlo simulations are of most value when pricing decisions are too complex to analyze directly.

MORE DETAILS

What did the Researchers Do?

Tony Atkinson and Michael Lionais use a base scenario to walk the readers through three types of customer scenarios. Each scenario is assessed using a Monte Carlo simulation; allowing the decision-maker to see a range of possible outcomes based on the assessed level of uncertainty.

What did the Researchers Find?

Under three distinct scenarios with differing risk characteristics, for example being subject to a regulator or being a non-profit public sector organization), the authors are able to identify appropriate prices for a service. They thus are able to demonstrate the potential use of Monte Carlo simulations for pricing in uncertain environments.

HOW CAN YOU USE THIS RESEARCH?

While more traditional approaches to pricing may still be relevant, this research adds to the toolkit available to tech firms that face complex pricing decisions. However, those running Monte Carlo simulations will need to have, or be informed by good estimates of underlying uncertainty. Also, uncertainty should exist for numerous decision-making parameters.

WANT TO KNOW MORE?

Contact: Tony Atkinson
Article citation: Atkinson, A., & Lionais, M. 2015. An approach to pricing in an uncertain environment. Cost Management, 29(4): 12-18.