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Price optimization. (Spotlight).

NEW YORK -- Over the past 10 or 15 years many developments in retail technology have debuted with a tremendous amount of hype and a seemingly promising future, only to fizzle out a short time later. In the case of price-optimization technology, however, that does not appear to be the case, even though adoption rates have been somewhat slower than originally anticipated.

Retailers are beginning to spend more time evaluating and redefining pricing strategies, according to analysts at Arthur Andersen's retail practice. That is because they increasingly recognize and accept that cost reduction programs and process reengineering alone cannot optimize profitability.

"True profit potential cannot be realized until virtually every item in the store is optimally priced--that is, priced to produce the ideal balance between volume and profit," says a spokesman for the consulting firm. "On average, a 1% increase in price, without a corresponding drop in volume, can lead to operating profit improvements of 11% or greater."

The challenge for retailers is picking the right price, of course. Among the factors that must be considered are the point at which profits increase, the point at which those increases are offset by lost volume, and the impact of raised or lowered prices on customer perception of the retailer's value image.

A new generation of retail technology software designed to optimize pricing decisions and retail revenue management promises to make those decisions easier for retailers, adding significant gains to the bottom line as a result. At least a dozen software developers now offer such programs, including ProfitLogic, DemandTec, Spotlight Solutions, KhiMetrics, Retek, Manugistics, JDA Software and i2 Technologies.

In fact, price optimization is just one component of a broader retail revenue management (RRM) strategy. The good news for mass market retailers, however, is that they are unique among other players in the retail industry in that they are well positioned to benefit from price-only RRM strategies, says Greg Girard, vice president of retail application strategies at AMR Research Inc.

"Only grocery, chain drug, mass merchant and department store retailers will benefit from price-only RRM strategies, but such strategies can improve revenues, margins and traffic when the right conditions are met," Girard says. "Retailers in the highly competitive and mature mass market segments should deploy price-centric RRM now."

Girard notes that there have been several high-profile success stories with price optimization among mass market retailers, notably Longs Drug Stores Inc. and ShopKo Inc.

"Other early adopters are not telling their competitors just how effective their price optimization applications have proven to be, but their chief executives are talking about it to their non-competing peers," he adds.

The price-only RRM strategies that Girard and others espouse for mass market retailers generally include both markdown optimization and price optimization applications. The first manages sale prices of seasonal and fashion items with a finite shelf life, boosting retailers' ability to time markdowns more efficiently and clear shelves in a timely manner.

Price optimization tools help retailers set the right price at the time an item is added to the mix. They are generally used for consumer packaged goods and similar products with a long life cycle. Both applications rely on complicated mathematical algorithms and process massive amounts of retail data using proprietary analytical techniques.

Longs and ShopKo have been quite forthcoming about the success of their RRM efforts. Longs credits its use of the new technology with helping it beat analysts' estimates of its first quarter earnings in 2002, and ShopKo attributes a 30% gross profit improvement in one product category to its RRM system.

Other mass market retailers that are using or testing RRM technology or some variation of it include Wal-Mart Stores Inc., Target Corp., Circuit City Stores, H.E. Butt Grocery Co., Big Y Foods and Meijer Stores.

Shelf-price optimization strategies have worked best for retailers selling fast-moving consumer goods and other long-life cycle merchandise when a number of conditions are met, according to AMR Research. They include:

* The price optimization models used are calibrated on more than one year's worth of store-level price and sales data.

* The models earn the confidence of the chain's price analysts through training, technical support and management commitment.

* The strategy reduces prices on most known-value items and raises prices on most blind items.

* Price execution systems and processes support store-level price changes.

* Well-defined and documented rules governing price image strategy are used to constrain price optimization models.

"Markdown price optimization strategies have worked well for retailers selling fashion, seasonal, technology and other merchandise with outdates," Girard says. "The benefits are significant when the right conditions are met."

Those conditions include:

* Merchandise outdates are properly set once and kept there.

* Optimization models are calibrated on at least one-year or store-level price, unit sales and assortment-on-floor inventory data.

* The models incorporate markdown budgets, turn and margin goals and support simulation.

* Merchants had been setting initial markdown too late and too shallow and setting subsequent reductions late again and too deep.

* Merchants take markdown as a signal to take appropriate action--execute the recommendation, cancel an order, return merchandise, seek cost concessions or increase marketing.

* Merchants are trained thoroughly, management has set clear objectives for the system, and recommendation acceptance and effectiveness are monitored and reported.

Given the well-documented advantages of price optimization and retail revenue management, the obvious question is why this new technology is not being adopted more rapidly. Part of the answer is the tough climate facing retail chief information officers, who by and large are being asked to do more with smaller budgets. This technology is not cheap, with analysts pegging the cost for a multibillion-dollar retail chain at several million dollars a year. Committing to that kind of investment requires the strong support of top management, and that can be difficult to obtain during trying economic times.

However, many industry observers are convinced that it is only a matter of time before RRM becomes standard practice in mass market retailing.
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Title Annotation:retail revenue management strategy trends and applications
Author:McDermott, Michael
Publication:MMR
Geographic Code:1USA
Date:Jan 13, 2003
Words:984
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