One of the most basic -- and at the same time most complex -- decisions a retailer needs to make is what price to charge for a product. Can technology make this process easier and more effective?
Since the late 1990s, that technology, variously called retail revenue management, demand-based management, or just price optimization, has been commercially available. The small-but-growing cadre of vendors that supply it argue that their systems can help retailers navigate through the complexities of consumer demand, competitive pricing and other factors to come up with an intelligent strategy for putting the best everyday prices on products.
In some cases, that strategy suggests making prices a little higher; in other cases, a little lower. Sometimes, it just leaves them alone. It's all with the goal of driving greater sales or profits.
While price optimization pertains to everyday prices, related systems attempt to optimize promotional and markdown prices. They have all been hot topics at trade shows and in the trade press over the past few years, though only a handful of retailing pioneers has invested in them to date.
The difficult economy has played a mixed role in this: On the one hand, it may have prevented retailers from making the steep investment in what is very costly software. On the other hand, retailers looking for a way to squeeze more sales or profits out of existing resources may be able to find it in price optimization, based on results reported by initial users.
Pete Abell, a former AMR Research executive who recently launched The ePC group, Reading, Mass., said that "internal readiness" for the software may also be an impediment for some retailers. This, he noted, would include "price maintenance foundations, quality of data, a framework that makes sense to the merchand-isers/price managers, and cultural difficulties." He added that markdown optimization, which tends to target nonfood retailers, has seen more usage because it "can be used more easily than price optimization."
Still, there remains significant interest in price optimization. In SN's Ninth Annual State of the Industry Supermarket Technology Report (SN, Feb. 10, 2003), just under one in four retailers surveyed (24%) said that in 2003 price optimization is considered a high priority, compared to 7% who said that was true in 2002.
The two major price optimization vendors marketing to food retailers, DemandTec, San Carlos, Calif., and KhiMetrics, Scottsdale, Ariz., have been making some progress of late. Two of DemandTec's key customers, H.E. Butt Grocery and Longs Drug Stores of California, both signed new multi-year contracts with the vendor in February and earlier this month, respectively.
Other DemandTec customers include D'Agostino Supermarkets, D&W Foods and RadioShack. The vendor has been working with Kroger and General Mills, though details are not known at this time.
DemandTec's customers to date have used the software on a browser-based ASP (application service provider) model, though the software can be installed in-house as well, said Kevin Sterneckert, vice president and general manager, retail, for DemandTec. Annual ASP cost, which varies by installation, ranges from $1 to $5 million.
Earlier this month, KhiMetrics announced that Petsmart would begin implementing the vendor's price optimization software in more than 580 stores nationwide. Other KhiMetrics customers include ShopKo, Pamida and a top-10 supermarket chain that KhiMetrics prefers not to name. The cost of KhiMetrics' software license "generally exceeds $750,000," not including services, said Tim Manning, the company's vice president of marketing.
Linking ESLs and Software
One of KhiMetrics biggest successes to date resides across the ocean -- Safeway UK, based in Hayes, Middlesex, United Kingdom. And whereas retailers are notoriously reticent about their experiences with price optimization, Safeway UK, perhaps because of its overseas location, agreed to give a presentation on it at the Retail Systems 2003 Conference & Exposition, held in Chicago June 10 to 12. In addition, the chain's chief information officer, Ric Francis, spoke to SN about the technology at the show.
No relation to Safeway in the United States, Safeway UK is the fourth-largest food retailer in the United Kingdom, with 480 supermarkets, 170 convenience stores, and 54 joint-venture stores with British Petroleum. Though targeted this year for acquisition by other U.K. supermarket operators, notably William Morrison, Safeway UK has nonetheless been testing price optimization in two stores since last fall, and now plans to extend the system to 31 more stores this month, according to Francis.
Safeway UK's price optimization test has been especially notable for being among the first, if not the first, to incorporate electronic shelf labels. The chain has installed ESLs, from NCR, Duluth, Ga., in 50 stores over the past year, with more soon to come, said Francis.
Tim Lawrence, commercial pricing manager for Safeway UK, who gave the Retail Systems presentation, explained that Safeway's pricing evolution, which led to adopting both ESLs and price optimization, began in September 2000 when it became a high-low retailer using a local pricing strategy. The ESLs, in particular, were critical to the retailer's promotional strategy.
In testing price optimization in two stores equipped with ESLs, Safeway UK recognized the "synergy" of the two systems, Lawrence said. The ESLs, he noted, obviously enable price changes recommended by the software to be executed much faster and with greater flexibility than in manual methods. In addition, the shelf labels, which effectively add no labor cost to price changes, enhanced the profitability, and even the sales volume, driven by the price optimization software.
But Francis said that price optimization and ESLs do not need to work in tandem. In the future, Safeway UK could apply price optimization in stores that lack ESLs, he said.
Lawrence characterized the price optimization approach as being "customer-centric" rather than "competition-centric." Competition and cost, along with store format, size, location and demographics, are layers added onto the key factor driving pricing calculations, which is consumer demand.
Francis said that Safeway uses two years of consumer demand, looking at about half of store sales, excluding perimeter departments like the deli as well as such products as greeting cards and CDs. "Out of that, it says this is where the prices could be," Francis said. "It looks at the price elasticity." He said prices are changed "no more than once every four weeks."
The data is provided to KhiMetrics, which does the analysis and returns the pricing suggestions. Lawrence noted that the KhiMetrics process is iterative, with estimates of elasticity becoming "more confident over time." He said that in Safeway UK's pilot, "we saw key lines that went down in price and background lines that went up. So there was a benefit to customers and to us."
In the initial test this year, the goal was to drive margins rather than volume, which the chain succeeded in doing, Lawrence said. Safeway UK preferred not to release specific results. Francis said that based on the results so far, Safeway UK concludes that "there is an ROI model that will work" for the chain's investment in the software.
Francis noted that the software does not optimize prices in isolation, but on a category basis, to compensate for the cannibalization and product affinity effects price changes have on other products. "It's a logical extension of category management," he said. Ultimately, the system attempts to optimize commodity groups and, ultimately, the store as a whole, he said.
In addition, observers said, price optimization software is designed to ensure that a retailer's overall price image is not affected by the price changes.
While promotional factors figure into historical sales, the software is not aimed at this point at optimizing promotional pricing, noted Francis. Lawrence said the chain eventually plans to apply KhiMetrics to promotional and clearance pricing.
Lawrence warned that price technology "challenges traditional thinking and approaches." He advised that buyers interact with the tools since "their expertise is key to understanding sudden changes." In addition, he suggested getting buy-in from store operators.
"Retail revenue management is a complete shift in pricing," said Lawrence. "If you don't shift, you're not getting the most out of it."
