What is the price premium metric?
Price premium refers to the brand’s price to the consumer relative to a key competitors price or relative to the average price charged in the marketplace.
This particular marketing metric is often of interest to firms with strong brand equity that are looking to charge a price above the marketplace – and price premium is a metric that compares the brand’s price to key competitors.It would also be of interest to brands that tend to price their products at a discount to most other competitors in the marketplace.
The price premium metric is also important marketing metric when there are frequent pricing changes in the market, and price points are far more dynamic. This may occur in industries where there is seasonality, substantial use of sales promotions and discounting, or other frequent special offers.
Two approaches to price premium
The first approach is to compare the brand’s price to the average price charged in the marketplace. This is done on the price at retail level, as we are concerned with the consumer’s willingness to buy brands at various prices.
The second approach is to compare a brands price against their key competitors – this metric is also known as a relative price metric.
Price premium as an index
The output of price premium is expressed as index. For example, 1.20 indicates that the brand has a price premium of 20% (above the market), whereas the 0.75 indicates that the brand sells at 25% below the average price.
Therefore, do not be confused with the terminology of “price premium” as some brands will sell below the market price, effectively as a discount to their competitors.
Price premium calculation using market shares
The easiest way to calculate price premium is to have access to both revenue market shares and unit market shares. If this information is available, then the formula for price premium is as follows:
Price premium = revenue market share divided by unit market share
As an example, if a brand has a 25% revenue market share and a 20% unit market share, then their price premium would be 25%/20% = 1.20 – indicating that they have a 20% price premium over the marketplace.
As another example, a brand that has a 10% revenue market share in a 20% unit market share would have a price premium = 10%/20% = 0.50 – indicating that they have a price that is 50% below the average in the market.
Note: to convert the above index outcomes (that is, 1.20 and 0.50) simply subtract one from each number (1.20-1.00 = 0.20 or 20% and 0.50-1.00 = -0.50 or -50%).
Calculating price premium without market shares
In some cases market share information will not be available and will be necessary to utilize prices directly in the calculation. In this case the formula for the price premium metric would be:
The brand’s price divided by the average price in the market (weighted*) AND/OR
The brand’s price divided by a key competitors price
You can see there are two price premium formulas here – depending on whether you want to compare the brand’s price to the overall market (the first one above) or all whether you want to compare the brand to a key competitor (the second one).
* The role of weighting in the formula
The term “weighted” refers to the need to consider the volume of sales of each brand in the marketplace. Let’s consider a market that only has two competitors – the first of 80% market share and the second with the remaining 20% market share.
If the first/larger player charges $5 for their product and the second charges $10, then the average price paid in the market is actually $6 as most people buy a $5 product.
Price premium examples
Using the above example for the 80% market share at $5 and the 20% market share at $10, then the price premium calculation would be as follows:
You can see, the average price has been calculated on a weighted basis (80% X $5 +20% X $10 = $6).
In the first part of the table in blue, each retail price is divided by the average price. $5.00/$6.00 = 0.83 and $10.00/$6.00 = 1.67.
This means that the first brand sells at a 17% discount to the average sale in the marketplace, while the second brand sells at a 67% price premium.
You will note in the second part of the table that revenue market share has been included in the same price premium to be calculated, but this using the two market share figures.That is, 67%/80% = 0.83 and 33%/20% = 1.67.As you can see both calculations generate the same outcome.
However, if you do not have market share information and cannot construct the weighted average price, then you can only calculate relative prices. In this case you pick a key competitor to be the benchmark over time for the brand.
In our example above, let’s consider that the second brand with the 80% market share is the key competitor to be bench-marked. Then in this case the relative price index would be: $5.00/$10.00 = 0.50. This means that the first brand sells at a 50% discount relative to the second brand.
Obviously in this example only two brands have been used, but multiple brands can be utilized for price premium as shown in the following diagram.
Important tip when using price premium metrics
It is generally more worthwhile to generate the price premium index using related sets of competitors. For example, it would not be overly worthwhile to compare budget competitors against high-quality competitors as the price premium metric would be relatively useless.
In this case you would pick two benchmarks – the first being the average price in the budget part of market and the second being the average price in the high-quality end of the market.
Price premium calculation is automatically included in the free Excel template
Because the price premium metric is calculated using unit and revenue market shares, it has been built into the free Excel template available on this website, as shown below (in the last column to the right):