Key factors to consider in price optimization
A customer, while looking at a product in your store, may decide to search for it online – while in your store. Finding a better deal, he leaves your store – to go and get it elsewhere at a better price. Price – it has become a key consideration in the purchase decisions of today’s budget-conscious shoppers, as they grapple with a recessionary economy.
Intense competition for the shoppers’ wallet leaves you with a very narrow margin for errors in your pricing strategy. For every SKU in your store, you have to hit on that ‘magic’ price which best drives its sales and profitability – while fitting in with your overall price image.
Not surprisingly, price optimization is an essential part the retail game today. It helps you have better control over your pricing decisions across every category and product type – from fast sellers to perishables. With price optimization, the process of determining the right price of a product has clearly moved away from rudimentary tools and ‘gut-feelings’ to an actual data-backed science. It involves relying on techniques such as demand modelling and ‘what-if’ scenarios to understand the impact of an item’s price on its sales and margin performance – and fixing a price that works for your retail business goals.
Basic microeconomic theory only factors in the customer’s assessment of the utilitarian value of a product. It doesn’t account for psychological factors like reference pricing, which play an equally important role in the customer’s purchase decision.
An effective price optimization strategy, on the other hand, will prompt you to factor in the product lifecycle, category goals and competitor price strategies. You also need to keep in mind the product’s price elasticity, the psychological influence of reference pricing, the price image of your brand and the seasonality of products.
What does this tell us? Price optimization is not an out-of-the-box solution — there are several factors that affect your price decisions and its impact on the customer.
Here are some factors you should keep in mind while implementing price optimization decisions for your products.
Factor in price elasticity of products
Price elasticity is the response of an item’s sales to changes to its price. Different product categories display varying degrees of price elasticity. Grocery store items, for example, are often very price sensitive with +/- 1 per cent price changes resulting in as much as an 8 – 10 per cent change in sales. In contrast, high-end gourmet food categories are often inelastic as consumers who purchase these premium-priced categories are not as value-conscious as shoppers in a regular grocery store environment.
An effective strategy is to fix lower prices for the more price-elastic items to get your customers into the store as a first step. You can then offset this through higher prices on some of the higher-margin or price inelastic items. Effective optimization programs look at all products, especially those in the mid-price range and recommend price tweaks, sometimes as little as a nickel an item, which translate into huge operating profits.
A surprising find in grocery retail is that customers almost always react strongly to price increases. But lowered prices very often go unnoticed – at least for a while. A leading grocery chain found that lowering the price of flavoured yogurt by 10 cents was likely to boost sales as much as 35%. The price optimization was implemented across its urban stores with not much of an uptick in sales, following this. The retailer followed the price change with “new low price” advertisements and prominent ‘special price’ signage near the yogurt shelves. Sales increased by nearly 45%, exceeding initial projections.
While playing with price, keep lifecycle and seasonality in mind
In short life-cycle retail segments such as apparel, books, toys, video games and music, pricing decisions vary vastly depending on the product’s lifecycle stage. From initial launch and rapid growth to maturity and the end of its lifecycle, price has to be used as a strategic tool – to extract as much revenue as possible at every stage. So, ‘special launch offer’ pricing can be used to encourage large numbers of people to try a new product until it gains traction in the market. Similarly, you can fix premium pricing for a new, limited edition dress or assign the right per cent of discount at the end of a product’s life cycle – when its sales are slowing down.
Tying price to seasonality is another smart strategy to get the best results out of your price optimization efforts. For example, toys and electronics tend to exhibit very sharp increase in demand during the period from Thanksgiving all the way up to Christmas. Your price strategy should take advantage of this this run-up and peaking of seasonal demand.
In the past, Walmart has announced a flat $10 price on hundreds toys in its stores, right through Christmas – a strategy that saw footfalls and sales volumes sky rocket during the period. In a run up to the holiday season, leading retailer Target announced price cuts on some of its popular toy brands, including Barbie and Fisher Price, by as much as 50 per cent. The price cuts, which came into effect from the beginning of October, applied to online and in-store purchases – and resulted in higher profits and sales.
Watch out when jumping on to the pricing trends bandwagon
Customers today are more empowered because of the availability of information at the click of a button. High rates of smartphone adoption combined with easy access to retailer information through mobile devices, and access to applications like the Amazon Price Check App, give customers immediate, real time insights into the pricing landscape.
To counter this, many retailers have begun “Every Day Low Prices” (EDLP) model in an effort to attract customers with the promise of low prices – without the need to wait for sale price events. This has worked well for retailers like Sam’s Club, Costco and Walmart, which is the largest EDLP retailer in the world today. However, JC Penney’s recent shift to an EDLP pricing strategy by rounding prices off to the nearest dollar did not work well with loyal customers. Before the switch, JCP was the most aggressive coupon retailer next to Bed Bath & Beyond. Frequent JC Penney customers subscribed to the culture of discounting (in 2011 alone there were 590 sales). Its shift to the EDLP strategy was out of sync with customer expectations. So it’s important for you to evaluate how well a new pricing strategy will affect your customers and your brand before deciding to adopt it.
Optimum prices that work for you – and your customer
Keeping track of hundreds of products and altering prices manually is a near impossible task for any retailer. And as if this was not complicated enough, your pricing decisions should also keep in mind shopper preferences, market trends and the latest purchase patterns i.e., information available to you in your POS systems, loyalty card schemes and online transactions.
An efficient price optimization system, with a strong analytics back-end, will process the impact of customer and sales data, to fine-tune your pricing strategy. It will help you automate your pricing processes and manage prices effectively at every level of your retail value chain – from stores to categories and SKUs. These analytics driven pricing mechanisms will use the vast array historical price, sales, cost, customer and competitive price data to help you fix prices that dramatically increase profits while keeping your customers coming in.
Are your price optimization decisions driven by a strong analytics system?