What Retailers Don't Know About Price Optimization is Killing Them

When it comes to price optimization, many retailers are working with tools that are one step above pencil and paper in terms of scientific rigor. Whether it's dumping numbers into Excel or going down the impossible road of building a solidly crafted in-house solution that yields precise, science-driven outputs, big money is being left on the table due to the lack of scientifically sound methods.
Profit Is Bleeding from Three Key Areas:
  1. Neglecting Customer-Segmented Response
    Treating the most loyal customers well is crucial. You may be selling more of an item, but if a significant amount of the uplift isn't coming from loyal customers, you have a problem – not a triumph. Using precisely segmented demand models, retailers can make pricing decisions based on driving value from loyal customers.

    Another major error that results from using an overly simplistic approach is that, when customer segmentation is omitted, forecast accuracy goes out the window. Calculating demand parameters (e.g., elasticities) for your aggregate shopper population will never provide precise results. Retailers should be using different models for different customer segments, and then aggregating their forecasts to make decisions.
  2. Ignorance of Category Cross-Effects
    Many retailers lack visibility into what promotions, display and other events will do within their product categories. It's crucial to understand the interaction of items within the same category, so that individual pricing and promotion decisions are not made in isolation. For example, those seemingly attractive vendor subsidies can really cannibalize margins. Do you know what that promotion on the big name soft drink will do to sales of your private label soda? With a scientific solution, retailers can see what the best combination of price changes for the next pricing cycle will be – and whether or not that subsidy will hurt more than it helps.
  3. Long-Term Strategic Objectives and Real-Time Optimization are MIA
    Retailers know their long-term strategic objectives, but the tools they use often do not. Many rely on spreadsheets or simple rules-based tools. Business rules are important, but if you can't relax your constraints or challenge them effectively in the context of true optimization, you could be leaving money on the table. Real-time price and promotion optimization, vital to making the smartest decisions without long latency times, must be at retailers' fingertips, too. From price image to competitive realities, the ability to calculate and recalculate impacts in a matter of seconds, as opposed to hours or days, provides a huge advantage in efficiency and agility.

With best-of-breed price optimization software, 20% uplift in profit is typical during the first two or three years of implementation. Those are results an Excel spreadsheet is never going to yield, no matter how much of a whiz you are with formulae.
Meticulous, scientifically rigorous price optimization can help deliver more value to the right customers, increase profits, and reduce uncertainty as data-driven retail trends change the way you do business. If you're settling for anything less, so is your bottom line.

Dr. Paul Helman is chief science officer of KSS Retail, a dunnhumby company.