Pricing impacts risk

Threat or opportunity?

In our daily life we often think of risk as a threat to guard against. In our private and professional lives we plan and prepare for what may happen, take out insurance etcetera. Risks of course can never by avoided entirely. Our future is uncertain. And on reflection, it would be both unpleasant and dull to have full knowledge of what will happen.


But risk also has an upside. The uncertain future may benefit us, and insurance firms earn money through selling insurance. “One man’s gain is another man’s loss”, it used to be said. Most deals, even in private life, can turn out to be successes or failures. The upside (a good investment) can not be distinguished in advance from the downside (markets go down).

This is where the link between price (and price model) and risk becomes important. The choice between owning and renting is an obvious example. For customers it may be about flexibility, for the supplier between selling the object now or expecting greater profits from continued ownership. In price models we also include the duration of a contract, service promises and how termination is regulated.

Price models allocate risks!

Risk and uncertainty is split between the parties to a deal, depending on the contract. A wise price model may reflect that their views differ. The supplier may have past statistics showing that repair needs are infrequent or that most customers overestimate their use of a service, like the case is with gym cards. A customer may worry about high monthly fees and therefore prefer to buy full service at a fixed, high price on joining.

Especially for objects whose price on the market is highly cyclical, like housing, this may seem rather self-evident. We probably think less about it for price contracts for audit books or an e-book library, or suppliers delivery capacity. But in those cases also, there are price models that mix a fixed (monthly) component with variable charges based on usage. And usage can be measured differently, in the audit book example for instance based on how many books you started reading, how many you actually read through, how long you used them, and if you are allowed to download and keep them.

Mixing different price models for different deals can have a high impact on profitability. A gym that charges per visit, but has high fixed costs for staff and premises, takes a greater risk than another gym which sells annual membership long in advance and can adapt staff and localities after customers usage pattern.

To identify risk and how they can be handled through price models is a field where we at CASIP want to learn more through continued research. In our books and article we have not yet written that much about it, but that will come soon!