How common is price irrationality? That's a question that really doesn't have an answer, of course, but there's no question that it happens all too frequently.
Another difficult question is this: What exactly is price irrationality? It's difficult to define, especially since it takes different forms, but it's easy enough to recognize when it happens.
- Suppose a shopper arrives at a store intending to spend within a certain price range for a product. The product is selected and the shopper makes a tacit decision to pay the perceived price. Unbeknownst to the shopper, though, the product is on sale. That could happen because of, say, failure to install a shelf talker. So the shopper will pay less than was anticipated. Worse yet, that fact may be entirely lost on the shopper in the swirl of checkout activity. This costs margin.
- Conversely, an item might be put on sale with that fact well communicated to shoppers. But maybe it's the wrong product, say a low-velocity product that relatively few shoppers will select regardless of price. So in the end, only opportunistic shoppers come to the store, and they leave with the sale item and little else. Cherry picking costs margin.
- Finally, loyal shoppers may come to the store with the idea of paying a certain price for a product, basing that expectation on experience. If that price expectation isn't met, the shopper may not be quite so loyal in the future. This costs sustainable margin.
In sum, price irrationality occurs when the wrong price -- whether too high or too low -- is put in front of certain shoppers, or if the price of product doesn't match market conditions well, resulting in the loss of valued customers. Many instances of price irrationality occur because of a lack of sophistication about what pricing levels will yield the best margin productivity. After all, many retailers establish price based on examining competitors' ad circulars, by making notes about prices in competitors' stores or by intuition and experience. Price irrationality can become akin to circular reasoning.
Further, pricing can be based on promotional allowances, which brings the consideration close to category management. It would be best for a retailer to know the true cost of accepting an allowance that's premised on promoting a certain branded product. Suppose the promotion pulls sales from higher-margin product that otherwise would have sold well. Is the allowance really productive? It's not likely the answer will ever be known, but it should be.
This brings us to the news feature on Page 42, which takes a look at price optimization, a computer-based application that examines product movement over time to develop right-pricing models based on variables such as margin, inventory depth, turn rates, the value of rewarding certain patronage styles and so on.
Although the need for price optimization is evident on its face, there are only about 20 supermarket companies well along in implementing the process. Part of the reason adaptation is taking a little time is that it's a complex and costly process.