As category captains, manufacturers have expanded their relationships with retailers by taking on the role of trusted advisers in all these areas.
Until now, pricing has been conspicuously absent from that list. Supermarket pricing, sometimes referred to as a "black art," has traditionally involved a combination of standard markups, pricing to the competition and intuition. Retailers do a heroic job, but with thousands of items to price in multiple price zones, it has been impossible to set the most effective prices for profitability and image.
The fact is that today's supermarket pricing leaves a lot on the table. Pricing systems help retailers manage thousands of items, but use approximate "rules" at best. Recent advances in pricing analysis are starting to prove that prices are often far from optimum.
Think about it like this: On average supermarket retailers make a 1% net profit margin, and within that average some items are losing 8%, and some are making 12%. We are finding, for example, that some of those high-net margin items could be priced lower and generate more sales and more margin dollars.
Another common example we are finding is low-margin items priced to move and pump up sales that are draining profits by cannibalizing sales of similar, higher-margin products. Further, these analyses are starting to show that even greater bottom-line profit can be squeezed out by pricing to optimize the net margin (gross margin, less items' costs like transportation, labor and inventory carrying) rather than the gross margin.
The fact is that, with the traditional supermarket pricing system, it is impossible for a merchant to consistently figure out how raising or lowering the price of a particular item affects the total sales and profits of that item -- never mind the additional effect on the sales and profits from competing items in the same category, complementary categories and competing categories.
Fortunately for retailers, help has finally arrived. Several companies have developed pricing applications that "optimize" item prices across the store using factors such as chain price image, item purpose (for example, loss leader or profit maker?), competitive pricing, price demand elasticity (how much sales change with changes in price) and handling/carrying costs if pricing to optimize net margin. These new pricing systems can accurately predict how sales of an item will change as the price changes and some can predict how that will affect the sales of related items. Merchandisers can use these predictions to figure out the "best answer" for each item -- the price that maximizes profit and protects price image.
Because of the sophisticated nature of "optimized" pricing analysis, pricing applications are moving towards commercial packages and outsourced services. Three of the leading providers are DemandTec in San Francisco, KSS in Manchester, U.K., and Khi-Metrics in Phoenix. Every retailer has unique requirements and they should select the price optimization solution with the right capabilities for their priorities and environment.
This requires answering questions such as: Do we want to manage gross profit or the more bottom-line-oriented net profit after handling/holding costs? Do we want to optimize items separately or do we want to be more sophisticated and optimize the total category or store simultaneously? Do we want to measure price demand elasticity at the category-average level or do we want to much more accurately measure it at the individual item-store level.
What does all this mean for manufacturers? As supermarkets learn to use pricing more precisely to manage sales and profits the category captain role will necessarily also incorporate this capability. Manufacturers will need to understand and measure the price demand elasticity of items for both everyday shelf pricing and promotion pricing. The net margin measure will necessitate manufacturers having a command of supermarket Activity Based Costing to accurately estimate handling/holding costs. Manufacturers will have to have the capability for sophisticated pricing analysis that parallels tomorrow's sophisticated retailer analysis.
Many manufacturers may find that the greatest value in a better understanding of how price affects consumer demand will be the ability to design more effective promotions. Manufacturers will be able to allocate funds to the areas where they'll get the best results. But that's a subject for another article.