Price Level Index (PLI) 101: definition, formula, how to use in your pricing strategy

Introduction to Price Level Index

The Price Level Index (PLI) is an economic measure that compares the price levels of a basket of goods and services across different countries or regions, with respect to a base country or region. It's a crucial indicator used to understand the relative cost of living and purchasing power between economies. By expressing these price levels as a percentage of the base country's costs, PLI offers insights into the economic conditions and market dynamics of various regions, making it an invaluable tool for businesses, policymakers, and researchers alike.

Why do we calculate Price Index in Retail and E-commerce

In the competitive landscapes of retail and e-commerce, understanding and strategically adjusting pricing is key to attracting and retaining customers. PLI plays a pivotal role here by providing a benchmark for comparing prices across different markets. This enables businesses to:

• Adjust Pricing Strategies: By analysing PLI data, retailers can set competitive prices that reflect the purchasing power of their target market.
• Conduct Competitive Analysis: PLI helps businesses benchmark their prices against international competitors, ensuring they remain attractive to consumers without compromising profit margins.

PLI vs. Purchasing Power Parity (PPP) Index

While both PLI and the Purchasing Power Parity (PPP) Index offer insights into price level variations and purchasing power across countries, they serve different purposes.

PLI compares the price levels of goods and services, while PPP focuses on the exchange rate at which the currency of one country is needed to purchase the same amount of goods and services in another country. PLI is often used for comparing retail prices, whereas PPP is more geared towards macroeconomic analysis.

Formula for Calculating PLI

The formula for calculating the Price Level Index is relatively straightforward:

PLI=(Price of Basket in Base Country/Price of Basket in Target Country) x 100

‍

‍

Price Level Index Calculation Example

Let's consider a simplified example comparing the price levels of a selected basket of goods and services in two different regions of the United Kingdom: Region A (which will serve as our base region) and Region B.

Step 1: Selecting a Basket of Goods and Services

First, we select a basket of goods and services to compare across regions. For simplicity, our basket will include:

• 1 liter of milk
• 1 loaf of bread
• 1 kg of rice
• 1 hour of housecleaning services

Step 2: Gathering Price Data

Next, we gather price data for each item in our basket from both regions. Assume the following prices (in GBP).

Step 3: Calculating the Total Cost of the Basket

Calculate the total cost of the basket in each region:

• Total Cost in Region A (Base): £0.90 (milk) + £1.10 (bread) + £1.50 (rice) + £10.00 (services) = £13.50
• Total Cost in Region B: £1.00 (milk) + £1.20 (bread) + £1.40 (rice) + £12.00 (services) = £15.60

Step 4: Calculating the PLI

The PLI for Region B relative to Region A (base) is calculated using the formula:

PLI=(Price of Basket in Base Country/Price of Basket in Target Country) x 100

PLI=(£15.6/£13.5) x 100 = 115.56

This PLI value means that the cost of the same basket of goods and services in Region B is 115.56% of the cost in Region A. In other words, prices in Region B are, on average, 15.56% higher than in Region A for the selected basket.On a side note, in many cases these data doesn’t have to be obtained and calculated manually. There are regional statistical databases that collects and publishes PLI indexes dynamically. If you’re using a solution like Aimondo, you can add these databases to your optional price calculation data streams, and PLI for various regions will be calculated automatically.

How to apply calculated PLI

But what does it mean in practical terms? Does this mean that if you’re selling goods (say, socks) in both regions A and B, you can easily make my prices 15,6% higher for for region B than for region A, and it will be accepted by the shoppers as normal?

Unfortunately, no.

While PLI can guide pricing strategies across different regions, and you can easily apply it with one click if you’re using Aimondo platform, it's still one of many factors to consider. Before raising  your pricing for the region B, you have to pay attention to the following aspects:

Competition

The competitive landscape in Region B might differ from Region A. If multiple competitors in Region B offer similar goods at lower prices, arbitrarily raising your prices might make your products less competitive. It's essential to analyse the specific market dynamics, including competitor pricing and market saturation, before setting prices. You can collect data on your competition manually, or easily add this factor to the optimal price calculation if you’re using Aimondo.

Price Elasticity of Demand

This economic concept describes how the quantity demanded by consumers changes in response to price changes. If socks have a high price elasticity of demand, a small price increase could lead to a significant drop in quantity demanded. Understanding the elasticity of your product is crucial before adjusting prices based on PLI differences. Again, price elasticity calculation function is available for Aimondo customers.

Brand Positioning and Customer Segmentation

Your brand's position in the market—whether as a premium or budget option—also influences how price changes are perceived. A premium brand might successfully implement higher price points in higher PLI regions if aligned with its brand perception and consumer expectations. It’s smarter to tailor your pricing strategy to align with your market segmentation and product positioning, while also considering the unique aspects of Region B's market. Can it be done with Aimondo? Absolutely!

All-in-all, the best approach with using PLI is to Test and Learn. Consider implementing small-scale pricing tests to gauge consumer response before rolling out significant price changes across the board. Very easy to implement using Aimondo Price Management dashboard where you can A/B test different strategies on a small scale, and implement a nuanced approach, considering market-specific dynamics, competition, and product/category characteristics (like price elasticity of demand).

‍

‍