Roadmap to Price

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Roadmap to Price

By Alana Okun - 04/01/2006

The time of driving returns primarily with cost reductions is quickly coming to an end. Retailers seeking to drastically increase financial performance are increasingly turning to price optimization software. Because of the competitive advantage gained by retailers using the technology, pricing solutions are one of the most closely guarded secrets of today's leading retailers. These forward thinking retailers are turning inefficient pricing processes and poor pricing analysis into real business benefits -- revenue and margin uplift.


What It Means

Price optimization is the process of optimizing price through more accurate demand forecasting to maximize profit. Price optimization relies on sophisticated forecasting and optimization algorithms incorporated in high-performance decision support systems.


The technology helps retailers establish correct initial prices and better manage markdown cycles. The applications are designed to maximize profit margins while managing information about price changes resulting from competitor price alterations, cost increases or inventory aging. Retailers who implement price optimization solutions are able to establish prices based on historic, competitive and customer demand information, as well as other analytical factors.


"Retailers are looking at technologies that maximize profit potential of each individual item on their shelves," notes Greg Buzek, president of IHL Consulting Group, in the "Price Optimization - A Retailer's Guide" report.


"Price optimization software uses historical and current sales trends to identify the best price for which to sell that item. This maximizes margin and improves financial performance," he continues.


The process has quickly emerged as a high-priority merchandising initiative, since even minor improvements in pricing effectiveness can lead to substantial bottom-line savings.


What's at Stake

Retailers who miss the boat on price optimization are forfeiting substantial bottom-line benefits. Price optimization can generate an impressive ROI, typically 5 percent to 19 percent profit improvement.


The advantage is in the shift from a traditional two-tiered pricing structure, featuring regular and discounted clearance items, to a multi-tiered program that drops prices only as a factor of sales, says Buzek.


"A number of retailers are now quietly, yet aggressively, deploying RLPM (Retail Lifecycle Price Management) technologies that can add $10 million or more to a major retailer's bottom line within a year of full implementation," says Scott Langdoc in the AMR Research report, "How To Add $10M to Store Profit Next Year". "It's creating a competitive advantage that those retailers not willing to change their traditional pricing and promotion processes will be hard pressed, if not completely unable, to catch," he says.


While many retailers are hesitant to share their results in an effort to maintain their competitive advantage, AMR Research tracked a number of RLPM-related projects and reported that a typical $5 billion Fast-Moving Consumer Goods (FCMG), retailer with 200 stores averaging $25 million in annual sales will see as much as $50,000 of incremental profit per store, says Langdoc. "Additional improvements in promotion planning, modeling and execution can create enough targeted sales lift to add an extra $1 million in revenue per store.


Assuming a fully loaded enterprise RLPM-oriented project cost of $5 million to $8 million for this size retailer, the project has payback well within a year of chain-wide implementation."


How to Succeed

Don't race blindly into the price optimization arena, experts warn. Initial price optimization rollouts have met with a number of pitfalls. Retailers considering an implementation should beware of data quality issues, challenges in the execution of optimal price changes, lack of organizational alignment, technology vendor risk and high cost of ownership as the primary deterrents to a successful implementation.


Vendors that offer sub-par price optimization packages are likely to get swallowed up by competitors, which could leave a number of retailers in the lurch.


"Forrester predicts rapid consolidation in the pricing solutions market over the next 12 months," says Noha Tohamy in Forrester Research's "Pruning the Pricing Landscape" report. "User companies must manage the risk of vendor acquisition when choosing their pricing solutions by requiring ROI estimates for each project phase, devising contingency plans for key vendor employee departures, and looking into hybrid deployment models."


To recoup the maximum benefits from price optimization, retailers must weave it into the fabric of the company's overall business structure. The biggest impediment to a retailer achieving maximum benefit is if the retailer doesn't think broadly, but only tactically toward specific application areas like initial pricing or promotional event creation, according to Langdoc.


"Even if different RLPM components are implemented over a long period of time, as long as they are part of a larger, enterprise-wide architecture toward creating a new pricing and promotion platform, the benefits will come," explains Langdoc.


Real World Example

A number of early adopters, including The Home Depot, Liz Claiborne and 7-Eleven, have realized benefits of price optimization.

"With hundreds of price zones and thousands of stores selling thousands of items, we needed a solution that would enhance our ability to make optimal pricing decisions in a way that fit the scope of our operations," says Kay Trapp, manager of pricing, 7-Eleven.


After a comprehensive evaluation process that included a forecast test and a controlled pilot project, the convenience retailer selected Khimetrics' Customer Demand suite and pricing technology.


"It was important for us to validate the science and models, and we felt

a forecast-accuracy test would be a critical first step," says Trapp. "Next on our list of concerns was to ensure the solution provided us measurable improvement from our current pricing practices."

Benefits exceeded expectations, according to Trapp. Khimetrics significantly outperformed the control stores in both sales and profit on a per-store, per-day basis as well as unit sales. The pilot results were analyzed based on measurement criteria that is determined by Khimetrics and 7-Eleven.


Using the new system, 7-Eleven improved store performance without adversely impacting store traffic. The implementation has allowed the retailer to measure price sensitivity of each category and determine the strategic role that categories such as profit builders, traffic builders and image builders should play in reaching merchandising goals. Initial short-term results should translate into long-term benefits.


"The real value won't be realized until price and promotion plans are drawn into appropriate inventory and replenishment planning models, as well as into the task management and store operations systems that help ensure that store personnel follow through on required actions to ensure successful price and promotion delivery," says Langdoc.