Tax and pricing strategy optimization model for tobacco industry

Political decisions significantly impact price setting for sectors that commercialize products such as alcohol, tobacco, and oil, which have special excise taxes. The project aims to assist governments and businesses in making better tax decisions by calculating the expected impact of each change on consumption and revenue. Moreover, it may help companies communicate with governments, guiding them to mutually beneficial decisions, as well as optimizing their prices when tax structures change.

This project’s scope was to improve taxation and pricing strategy decision-making for a worldwide consumer goods company. To achieve this goal, three main questions needed to be targeted:

• How does a new tax structure impact the market?
• What is the optimal tax structure for a market?
• What is the optimal pricing strategy for all the companies?

Predicting customers’ behavior

A price-demand elasticity model was designed to assess the impact on the market of a new tax regime. This model analyzes historical sales, product attributes, and markets survey data, finding patterns that can help to predict future behavior. A multivariate regression estimates future sales and consequent market KPIs by incorporating multiple market factors, such as price, distribution, switching behavior, seasonality, and short and long-term market trends.

‍Optimizing scenarios

First, by leveraging genetic algorithms on top of the customers’ model, we developed a prescriptive tool to create tax structure scenarios that maximize or minimize user-defined goals.

Then, for a specified tax structure, the tool optimizes the correspondent company pricing strategy by considering the insights of game theory. Therefore, the leading players enter a noncooperative game to define their optimal price strategy.

As a result, this tool is able to maximize different objectives such as government revenues, total market volume, or a company’s net sales while complying with a set of business restrictions.

Ultimately, the methodology exhibits substantial results, showing that it is possible to boost government revenues by 5.5% without expanding the market size.

Additionally, the tool found scenarios where a market’s net sales increased by 12.4% without compromising government revenues.

Although the initial model’s application was the tobacco industry, the methodology can be adapted as a generic tool for the various sectors affected by excise taxes. Therefore, the tool developed provides good insights regarding public health policies and taxation and a roadmap to price strategies in oligopoly markets.