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04/21/2009

Optimizing Pricing in a Turbulent Economy

You don't have to go far to see the impact the economy is having on retailers. The evening news is plagued with store closings and going out of business signs seem to pop up around every corner. So how can retailers keep merchandise moving and revenue coming in? One key strategy is optimizing product pricing. Gone are the days of zone or corporate pricing strategies that operated in a vacuum.

In order to survive today's economic environment, retailers must tailor assortments specifically to consumer demand, as well as price and promote items according to local preferences to see maximum value. They also must tie pricing changes all the way back into demand plans to ensure that inventory is readily available. By utilizing advanced price optimization solutions, retailers can gain visibility into the impact of a pricing decision on the entire supply chain and address three key areas - initial pricing, promotional pricing and markdowns.

Once these areas have been addressed, they form a solid foundation for effective lifecycle pricing - a proven strategy that links promotional planning, price determination and advertising execution processes. Lifecycle pricing plays an essential role in creating a valuable customer-centric retail environment.

Initial Pricing Strategies
Setting the 'right' initial product price is one of the most important steps companies can take to ensure solid profit margins and top line revenue. However, determining the right everyday price for a product is no simple task. In fact, the idea of corporate or chain level pricing has become antiquated as a product's price needs to vary across locations. Furthermore, simply maximizing unit sales, margin or revenue are not the only considerations. Cross-product relationships, competitive factors, brand statements, and multiple selling channels are just some of the factors contributing to an individual product's price.

Consumers vary greatly from market to market, so determining preferences based on local demographics, as well as geographic location and economic conditions is critical when setting initial product pricing. Beyond basic product assortment indicators - such as differentiation in client preference based on geographic store location - it's also critical for retailers to have an understanding of nuanced customer preferences. Advanced technologies can detect these nuances, such as demand for ski attire in Phoenix due to large population of consumers that travel to nearby Colorado for ski season, enabling retailers to accurately tailor assortments and determine the most appropriate initial price.

Market conditions are not the only important factor to consider. Cross-product pricing must be taken into account to ensure that no product is priced in isolation. For example, a grocer selling a cola product in a two-liter bottle, a six pack, a 12-pack and a 24-pack assortment needs to ensure there is some distance in the prices between the items. Without a shared view of products, companies run the risk of under-pricing themselves.

The cola example above demonstrates a cannibalistic relationship in which each size is potentially a substitute for the others. There are also complimentary relationships that must be considered when pricing an item. A classic complimentary product example is hot dogs and hot dog buns. The demand for hot dog buns may be impacted as much by the demand for hot dogs as it is by the price of the hot dog buns themselves. Thus, pricing the hot dogs correctly is critical to both hot dog and hot dog bun sales.

Every retailer, whether apparel, grocer or consumer goods, has key items that drive traffic into their store. Knowing what those items are and pricing them at or below market value is critical to getting customers into the store. Once in the store, there is a variety of convenience or complimentary products that customers will buy simply to avoid the hassle of going to another store. Those products can often carry a slightly higher price point because of the convenience of offering them at one location. For example, a home improvement store might price power tools at a competitive price but may sell batteries at a slightly higher profit margin to capitalize on the convenience of getting both items in one location. Revenue lost in one area can be recouped in others by capitalizing on opportunities.

Promotional Pricing
Promotions, when used effectively, are powerful tools for increasing sales and revenue. Pricing promoted items presents many of the same challenges associated with setting every day price in terms of cross-product impacts, competitive activity and brand statements. To effectively set promotional prices, retailers need to have a thorough understanding of the uplift of demand. Non-promoted accessories such as bracelets, earrings or belts could also see an uptick in sales if paired and displayed with a promoted dress. Understanding cross-product relationships and knowing what related item sales will be driven by a promotion can help retailers capture better visibility into consumer demand. Additionally, sales of complimentary items can help recoup margins lost by a promotional discount.

Not all promotions are made equal. Situations often arise where manufacturers offer a discount to retailers on promoted items. While at first glance this may seem like an ideal way for retailers to drive sales at a discounted cost, these promotions don't always lead to increased sales. For example, promoting soft drinks over the fourth of July, when consumers would buy soft drinks regardless, is not ideal unless the sale of these soft drinks can drive sales of related items such as hot dogs, chips and salsa. Without these ancillary sales, the promotion would actually reduce profit margins, despite the retailer having gotten a lower cost from the manufacturer.

Understanding price sensitivity, specifically as it relates to brand loyalty, is also an important factor when establishing a promotional strategy. Some products, such as toothpaste, tend to have very high brand loyalty. So running a sale on a particular brand of toothpaste will only attract the particular segment of people who already buy that toothpaste and not drive increased traffic but rather may result in pantry loading at a lower margin to the retailer.

Price changes and the marketing associated with them can have enormous impacts on demand. Companies using advanced pricing systems have the ability to proactively plan for this lift, ensuring inventory is readily available during the promotional period and sales and customers are not lost.

Markdown Optimization
With the economy in turmoil and consumer spending down, retailers are also looking to shift the consumer mindset in terms of markdowns. Consumers have been trained to only shop when items are marked down or on clearance. This means a continuous cycle of lost margin on sales. The last thing any retailer wants to have to do is slash prices to get goods off the shelves. Markdown clearance is the ultimate balancing act. Inventory needs to go in order to make room for new inventory, but retailers need to assess the true margin impact. Tailoring markdown plans by store/location, factoring in the price sensitivity of the customer base, and understanding opportunity costs are essential. Knowing how a 40 percent markdown today will prevent a 70 percent markdown in two weeks is critical to the decision making process, and this is possible with a comprehensive view of demand.

The benefits of investing in price optimization solutions that can set initial, promotional and markdown plans that factor in demand, consumer demographics, cross-product relationships and convenience sales include:

- Optimized pricing to drive sales, volume, and profit while maintaining your price image

- Improved efficiency by automating cumbersome, time-consuming pricing tasks

- New insights into how your customers shop

- Intelligence and discipline to better understand customers, better predict demand, and establish base prices that influence demand in effort to achieve business objectives

- Insight into how consumers respond to everyday pricing and improved financial predictability, accuracy and responsiveness

- Ability to maximize margin and revenue

Lifecycle Pricing: Tying it all Together
Most retailers agree that customer-centricity is a top priority to achieving success and competitive differentiation in today's crowded marketplace. One key component of a customer-centric experience is to successfully implement lifecycle pricing. Along with well-defined pricing strategies, these lifecycle pricing initiatives provide retailers the opportunity to streamline workflows, customize promotional strategies and deliver a consistent price message to their customers1.

Once retailers have the solutions in place to effectively set and manage initial, promotional and markdown prices, the next step is to integrate these strategies with promotional planning and advertising execution strategies to create streamlined workflow within the retail organization.

The benefits of end-to-end lifecycle pricing include:

-Improved store clustering that better aligns points with customers

-Better pricing rules that drive consistent policies

-Demand-modeled decisions that provide input into downstream processes such as replenishment and labor scheduling

-Expanded market baskets through improved understanding of product affinities and halo effects

-Decreased lag time between promotional event creation and execution, which improves promotional effectiveness through the ability to create store-specific advertising messaging2

In conclusion, those retailers that create a united planning and execution platform - from accurate price management to advertising and promotional planning - will succeed in creating a model that can easily adjust to shifting customer demand and challenging economic conditions. Thus enabling improved customer satisfaction and, ultimately, improved revenue generation.