Updated May 2023
- Here you can download the free Excel template to calculate market shares – which automatically calculates the price premium index metric
What is Meant by Price Premium?
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.
We measure the degree of difference between prices – and premium pricing used by brands – by using a metric known as the price premium index.
But before discussing that marketing metric, we need to distinguish between “price premium” and a premium product – because they are related, but still different different, concepts.
So what’s the difference, let’s find out…
What is a “Price Premium”?
A price premium is the price differential (either above or below) between a brand’s price and the average selling price in the market. While we are looking at differential pricing, there is a perception that price premiums are always above the market price average.
That means that a brand may have a price premium of greater than 1.0 (where 1.0 is the average market price) or a brand may have a price premium of less than 1.0 (meaning that it sells below the average price).
Therefore, in terms of marketing metrics, a price premium index (or metric) simply indicates how the brand is priced relative to the average selling price in the market for similar products.
What is a Premium Product?
As we know, a premium product is one that is perceived to be of higher quality than its main competitors. It is also generally perceived to have a higher selling price.
That’s why there is a connection between a premium product and the price premium metric. If a product sells for a premium, then it means that it sells ABOVE the average price in the marketplace.
Therefore, ALL premium brands will usually sell for a premium price – above average price.
However, as quickly highlighted above and as will be discussed below, a lower quality brand that sells below the average market price, will still have a price premium metric calculation, except there price premium will be less than 1.0 – which indicates that it sells below the average price.
Keep Reading and the Price Premium Index or Check Out the Instructional Video
There are Two Main Ways to Calculate Price Premium
Depending upon our needs are now competitive set, we can structure the calculation of the price premium metric in one of two ways, namely:
- The first approach is to compare the brand’s price to the average price charged in the marketplace taking into account all brands offered. 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.
Although you would generally think that the first approach may be the most suitable and statistically robust, this is generally not possible to execute in many industries. For example, if you were a local coffee shop, you would generally compare yourself against local similar competitors, rather than every coffee shop in the market.
And in many industries, having access to all brand’s pricing information is simply not possible. That is, we simply do not have access to the data and we need to rely upon a suitable sample of competitive pricing.
For example, even products sold by supermarkets, where enormous amounts of data is captured, they would generally only compare themselves to other brands sold in the same supermarket – rather than every potential competitive brand sold in the market including online sales.
Therefore, the second approach is generally more utilized, primarily because it has a more relevant competitive framework, it has the the element of simplicity, as well as being the only solution when limited data is available (as per above).
Price Premium is Calculated as a Index
Let’s now quickly look at the output of price premium, which 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.
To continue this example, let’s assume that the average selling price of a product category in the market is $5.00. This would mean that the first brand with a price premium index of 1.20 would sell for $6.00 in the market (that is, 6/5 = 1.20). And the second brand would sell for $3.75 (that is, 5/0.75 = 3.75).
The Role of Price Premium in Marketing Analytics
Price premium is a helpful metric in understanding:
- The brand’s pricing strategy – pricing above/below the competition
- The extent of the brand’s volatility of pricing – by measuring its price premium trend over time (do they frequently and substantially change their prices relative to competition?)
- A proxy measure for the strength of the brand – as stronger brands tend to have a higher price premium metric
- The price sensitivity of different target markets – able to identify price points that different consumers are willing/not willing to buy at
Therefore, in addition to knowing the price point differences between different players in the market, the price premium metric can also help the marketer or analyst understand strategy, brand strength, and even aspect of consumer behavior.
The price premium metric is often of most interest to firms with strong brand equity that are looking to charge a price above the marketplace. Particularly as the price premium metric can compare the brand’s price to the prices of its key competitors only, rather than the market overall.
For example, some brands may set a price premium KPI – that is they want to be priced at a certain percentage ABOVE their competitors – as part of their brand strategy (to reflect the high quality of their product).
However, in some cases, the price premium metric would also be of interest to brands that tend to price their products at a discount to most other competitors in the marketplace. This is because they want to monitor and ensure that they always stay at a certain price point BELOW their key competitors.
And in addition, the price premium metric is also a very helpful metric 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.
In this case, tracking your price point relative to your competitors is quite helpful, because in a “flurry” of pricing changes in discounts and special offers, we may lose track of the average market price and may adopt a poor pricing strategy as a result.
How to Calculate the Price Premium Metric
There are two ways to calculate price premium, depending upon whether or not we have access to market share information. If we do have access to market share data then the calculation is much easier and more accurate.
However, if we are pricing against a select group of competitive brands only, then we need to calculate price premium without market shares, as outlined below.
The 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%).
The Price Premium Calculation WITHOUT Market Shares
In some cases market share information will not be available and will be necessary to utilize prices directly in the calculation, all we are choosing to construct a price premium comparison against key competitors only.
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 competitor’s price (or a selected set of competitors)
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. In other words, we consider the volume of sales when calculating the average price that people pay – not the average price of the products in the market. Although this may be complicated, if you have market share information as per above, this calculation is quite simple.
Price Premium Example Calculations
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.
Get the Free Excel Template
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 following free Excel template (see that Price Premium is calculated in the last column to the right):
- Here you can download the free Excel template to calculate market shares
And when you open it – it should look like this…