Price optimization software is one of those tantalizing applications that have garnered much attention in recent years without many retailers pulling the trigger on an implementation. That may be changing.
The cost of sophisticated analytical systems like price optimization, which has ranged from $750,000 to $5 million, can be daunting for even the largest retailer. Still, what these applications offer -- the ability to price items through an understanding of consumer demand, competitive prices, and other factors -- is increasingly appealing these days. For one thing, it's a way to squeeze out additional revenue at a time of intense competition with low-cost operators like Wal-Mart. Beyond helping to determine base prices, price optimization can be used to forecast demand and launch better promotions. The interest in price optimization was reflected in SN's 10th annual State of the Industry Report on Supermarket Technology, published in February. Of the retailers surveyed, 30% said price optimization would be a high-priority IT area in 2004, compared with 11% who said it commanded high priority in 2003. Moreover, 23% of respondents said they would test or launch a price optimization program in 2004.
Price optimization got one of its biggest endorsements last November when Albertsons, Boise, Idaho, announced it would be using price optimization software from KhiMetrics, Scottsdale, Ariz.
"There was a lot of waiting on the sidelines, besides smaller retailers who were testing the technology, to see if there would be adoption by one of the larger tier-one grocery chains," said Scott Langdoc, vice president of research for retail at AMR Research, Boston. "When Albertsons announced the selection of KhiMetrics to do price and promotion, it became a very visible milestone in adopting optimization technology."
The other major optimization vendor, DemandTec, San Carlos, Calif., also enjoyed a big win last year when H.E. Butt Grocery and Longs Drug Stores signed multi-year contracts in February and June, respectively. Other technology players in the field include Lawson Software, St. Paul, Minn., and SoftSolutions, San Francisco.
In the competitive supermarket industry, the fact that Albertsons, H-E-B and other chains are more open about using pricing software suggests they realize "everyone will be using it," said Cathy Hotka, senior technology consultant, Retail Industry Leaders Association (formerly IMRA), Arlington, Va.
Though Albertsons was the first to go public with its project, all of the larger chains have done a "deep evaluation" of price optimization, analysts said. Since the Albertsons announcement, there has been an uptick in inquiries about price optimization and in-pilot projects by the larger chains in the United States and Europe, Langdoc said.
Meanwhile, DemandTec said it will add three to four grocery and drug customers this year, while KhiMetrics plans to add two grocery chains in the United States. "The technology became even more appealing when we announced the integrated forecasting ability," said Sandy Hanover, vice president of global services, KhiMetrics. "You can't look at pricing in a vacuum."
European grocers, including Metro Group and Carrefour, have successfully employed price optimization technology for a few years. They were the first to adopt it because they have been "forced to be more competitive" in a limited space, according to Tom Rauh, managing director, SoftSolutions.
"It led to a level of sophistication in Europe before we saw that in North America, but North American companies are coming up quickly," Rauh said.
In fact, SoftSolutions is involved in a pilot project with Smart & Final, Commerce, Calif., which operates more than 200 food warehouse stores. "Their pricing group didn't have the tools to analyze their competitive situation and make decisions on a practical level," Rauh said. Smart & Final declined to comment.
Since last September, Smart & Final has been testing SoftSolutions' price optimization system with one store that is also piloting electronic shelf tags from NCR. "They are running new prices [electronically] from our system to the shelf," Rauh said. "They believe the frequency of price change is an important driver of value."
According to Rauh, Smart & Final will implement the optimization software later this year, but has not decided whether to go chainwide with electronic shelf tags. The chain wants to confirm that it can "make many small changes [in prices]," he said, adding it has confirmed the integration of pricing software and the tags.
More Than Base Price
Although vendors are now offering price markdown and promotion capabilities with their price optimization packages, many supermarkets are taking an incremental approach, said observers. Retailers are first testing or implementing the technology for basic pricing functions, then demand forecasting and promotions, with a few progressing to markdown and other capabilities.
"Most retailers want to get their base prices optimized. Then a lot will progress to promotion optimization," said Joel Weingarten, senior vice president of products, DemandTec.
Hotka sees untapped potential in the promotions application. "Look at the number of times the consumer has gotten excited about an item on sale, and retailers don't have it. As the retailer gets better at merchandising, the product will be in the store," she said.
H-E-B has been using DemandTec's technology more for demand forecasting than basic pricing and promotion functions. "DemandTec is a rules-based pricing system, and our predominant use is understanding the consumer behavior around demand," said Mark Beaty, merchandising process owner for H-E-B, who spoke at a DemandTec conference held in conjunction with this year's Food Marketing Institute Marketechnics conference in March.
Forecasting applications can impact the entire supply chain, Beaty said, including improving in-stock conditions. "If we get a view of what the predictive lift is going to be, then suddenly we've got the ability to go out and deliver inventory in a more timely and cost-efficient manner," he said.
Markdown technology has been used more by the electronics industry for marking down seasonal items, or products that might become obsolete. "The percent of revenue impacted by markdowns in the grocery industry is not as significant as in the specialty industry," Weingarten noted.
Langdoc agreed. "Markdown optimization has been more of a general merchandise, specialty apparel capability. In grocery, price and promotion optimization are the primary requirements."
Beaty, however, made the case for applying price optimization technologies to other business processes, including promotion and event management, and even markdown capability. "We all want to know when to get out, and what it's going to cost us," he said.
Rauh said retailers interested in price optimization want to handle it internally, vs. using an ASP (application service provider) model. In the past, most retailers wanted to outsource the systems. Now about 75% prefer an internal system, he said. "Advanced pricing and price optimization is something they want to have internally, in the same context as procurement and other systems."
Getting the Data Right
Many grocers are taking a slow approach to price optimization because they don't have clean and reliable data in place. Many don't keep historical pricing data for more than three months, said technology vendors, who recommend having at least two years of good price history built up.
"The data they're working with is iffy, including retailers who re-use SKUs or use [Microsoft Excel] spreadsheets for really critical functions," Hotka said.
As a result, some vendors use price software to gather the data or, in some cases, reconstruct the price history.
When a retailer's price data is not clean, DemandTec puts the data through 97 cleansing routines, and fills in the gaps in information.
"It takes time to accumulate and cleanse your data, and load the data," Beaty said. "It takes time to build and understand the demand models and the elasticity associated with your strategies."
In some cases, retail executives are also "risk-averse" -- unwilling to change the pricing methods they've used historically (which is still manual pricing at many chains), according to Rauh. "We're talking about decisions that can have a huge impact on finances."
Price optimization technology can be flexible, depending on the retailer's pricing needs, Beaty added. "It's really your business strategy, your business rules, and your processes that will drive the output of the underlying science," he said. "That varies from industry to industry and retailer to retailer."
Manufacturers Getting Into the Act
Although food retailers are taking a cautious approach to implementation of price optimization technology, most analysts agree that it will be used by many major U.S. grocery chains in the near future. The retailers won't be alone.
Technology vendors said a three-way collaboration between grocers, consumer packaged goods manufacturers and vendors will be the next step in the progression. "Consumer goods manufacturers want to use it for more accurate demand forecasting," said Joel Weingarten, senior vice president of products for DemandTec, San Carlos, Calif., a major optimization software provider.
Already, DemandTec has been involved in pilot projects in which a CPG manufacturer sold a particular trade promotion to a retailer, then used pricing technology to predict demand. "We take into account the best use of trade promotion funds from the vendor," Weingarten said.