Planning for Pricing: Retailers Embrace Optimization

Given that food retailers make just pennies on the dollar, it’s probably not surprising that a software tool like price optimization would catch on as it has.

Price optimization, at its most basic, gives retailers a way to squeeze out a little more margin, or drive a little more volume, by appropriately tweaking their price points up or down. Not only that, but it predicts what the outcome is likely to be before the price change is even made. Overall, the tool helps retailers navigate the treacherous waters of a still-recovering economy, rampant price competition and wild swings in commodity pricing.

As a result, numerous retailers, large and small — from K-VA-T and Bashas’ to Rouses and Fairway — have been signing on with price optimization vendors in recent months, in some cases for software-as-a-service rather than in-house systems. The two most active vendors have been Revionics and KSS Retail, but others have also staked a claim in food retailing, notably DemandTec and SAS.

“In the beginning price optimization was so expensive that only the largest retailers used it, but now regional players are, too,” said Nikki Baird, managing partner, Retail Systems Research, Miami, noting that less expensive, cloud-based applications are now available. “And retailers are not worried about whether the science is real. They are past that.”

One retailer that is in the midst of a multi-year journey to improve its command of pricing, assortment and category management through the use of technology is Winn-Dixie Stores, Jacksonville, Fla. At the National Retail Federation’s 100th annual convention in January 2011, the chain announced an agreement with SAS, Cary, N.C., to implement a variety of corporate merchandising applications over a five-year period, including price (revenue) optimization, merchandise financial planning, merchandise assortment planning and space management. Winn-Dixie will also use several of SAS’s marketing applications, such as campaign management, marketing automation, marketing optimization and customer insights.

Another retailer that is leveraging price and promotion optimization along with assortment optimization is Target, Minneapolis, which is using tools from DemandTec, San Mateo, Calif. (recently acquired by IBM).

“Pricing should just be a component of an entire business planning process and not a silo unto itself,” said Chris Vukich, Winn-Dixie’s vice president of business optimization and pricing, during a session last month at the NRF’s 101st annual convention in New York, where he detailed the chain’s approach to pricing. 

Over the course of the past year, Winn-Dixie has been laying the groundwork for price optimization. Last month, the chain finally launched a pilot in about 80 stores covering three categories — cereal, frozen dinners and packaged salads — with plans to add another 14 categories over the next few months. Vukich declined to provide any results from the pilot.

What may complicate the rollout plan is Winn-Dixie’s planned merger with 207-store Bi-Lo, Mauldin, S.C., which was announced in December. “As a result of [the merger], we are evaluating the rollout timeline of the price optimization system,” said Vukich. Integration of the two companies will be the priority IT assignment leading up to the merger, expected in March or April, as well as post-merger, he said.

Rules-Based Pricing

Under Vukich’s direction, Winn-Dixie has been working on upgrading its pricing system and strategy since he joined the company in October 2007. For example, Winn-Dixie has implemented a rules-based pricing system, the HQ application from Retalix, for about 300 categories in Center Store and general merchandise. “We’ve seen huge results just with rules-based pricing, let alone optimized pricing,” said Vukich.

On the other hand, he expects the price optimization system to offer much more latitude on pricing than a rules-based system. “The beauty of optimized pricing is that it allows you to establish guard rails, and optimize within those guard rails, rather than the single, specific point you have with rules-based pricing,” Vukich said. For example, instead of setting a mark-up at 25%, it can be set between 23% and 28%, and it may turn out that 24% produces a better final margin than 25%.

Whatever technology is employed, a retailer needs to have a pricing strategy beyond simple cost-plus pricing or match the competition, he said. Winn-Dixie, for example, matches competitors’ pricing for “important items” and creates pricing zones. In addition, the chain assigns roles to categories, such as margin-drivers or traffic-drivers.

Because pricing is such a sensitive area that cuts to the heart of any retail operation, one of the biggest challenges associated with price and promotion optimization is overcoming internal cultural resistance to it, particularly from the merchandising side of the operation. It is therefore imperative to have the support of senior executives, up to and including the chief executive officer, said Vukich, who meets with senior executives every four to six weeks. “Without [the CEO’s] support, you inevitably run into resistance from merchandising and your pricing strategy doesn’t go anywhere,” he said.

Trying to change cultural attitudes, Vukich rebranded the pricing analyst as a manager-level position equal to the category manager. Pricing managers could then “come to the table with value-added analysis that helped improve the category manager’s business” and not be ignored, he said. “That was a huge mindset change for us, particularly in merchandising.”

In preparing for price optimization, Winn-Dixie has also made a big effort to “clean” its product data, vetting the accuracy of item attributes like size, whether natural/organic, etc. The chain also made sure it could accurately track the costs of products for vendors that have different “cost zones.”

Forecasting Demand

Perhaps the biggest advantage of price optimization is its ability to forecast the consumer demand in response to a price change or promotion, thereby pinpointing an item’s “price elasticity.”  In making these forecasts, which are typically more than 90% accurate, the pricing system is able to take into account factors that are not necessarily related to price, such as holidays, seasonality, cannibalization and halo effects. “It allows you to accurately forecast [the impact of] these changes before they happen,” he said.

Moreover, the price optimization tool is able to predict the effect of a price change not only on an item but on the category in which it resides. This represents “one of the big sea changes in mindset” for both pricing and category managers, Vukich said.

For example, he said, in the past the reflexive reaction of category managers to a cost increase would be to boost the retail price. But the price optimization system may advise against doing that because it could result in a loss of dollars at the category level.

The forecasting capacity also allows Winn-Dixie to play “what-if” games, such as postulating three scenarios — maximum unit volume, maximum profit or matching the competition — coming up with the best solution.

One of the retailers already wielding the forecasting ability of its in-house price optimization system (from KSS Retail, Cincinnati) is Lund Food Holdings, Edina, Minn., which operates 21 stores across two banners. In one example, Lund uses the system in promotional negotiations with suppliers, said Brian Weigel, Lund’s corporate pricing manager. The retailer will run a proposed price through the system to see its impact not only on unit sales but on the category as a whole. “We need to make sure we’re still going to be profitable,” he said, adding that the forecasts have been “dead accurate.”

Lund vets promotions in this way for about 20% of its categories, but plans to apply the forecasting in upcoming six-month planning sessions with all of its vendors, said Weigel. “If someone offers us 50-cents off, maybe we can push it to $1 provided we come up with [projected sales] numbers.” Price optimization is also applied to all categories for everyday pricing.

The pricing tool has been having an impact, said Weigel, who pointed to recent traffic increases of 3% to 5% and unit movement gains.

Another retailer using price optimization in decision-making is Longo’s, a 24-store EDLP operator based in Vaughan, Ontario.  “It’s provided us with an opportunity to look at the entire enterprise in a customer-focused manner vs. working in silos,” said Tom Sfetkopoulos, manager, merchandising and pricing for Longo’s, which has been using a price optimization system from Revionics, Roseville, Calif., for everyday pricing over the past 1.5 years. “You can look at a category and how it impacts a department and the entire enterprise.”

For example, Sfetkopoulos said, the system allows Longo’s to stay competitive on certain items and “look at other options to make up the profit you may be giving up.” And the system enables the chain to pass through a major commodity cost increase and “look to offset it in other parts of the enterprise.” 

Longo’s employs price optimization on a software-as-a-service basis, providing Revionics with historical and current sales data and costs. The system covers all Center Store products and is starting to be applied to fresh departments. The chain has experienced some “very significant successes” in both sales and margins with the system, and achieved an ROI “in a shorter time than anticipated,” said Sfetkopoulos, declining to provide specifics. Longo’s plans to start promotional forecasts in the next few months.

A more recent trend in price optimization is for retailers to aim pricing strategy at discrete segments of consumers. “There is an interest in putting in customer-type data, whether you’re looking at customer segments or demographics, or tying to store clusters,” said Baird of Retail Systems Research.

Retailers such as Food Lion have broken their merchandising and pricing down to the store cluster level, each cluster defined by shopper characteristics like affluent, budget, etc. Winn-Dixie’s SAS system has the flexibility to model pricing at different levels — store, zone or market, Vukich said.

Taking this even further, vendors like SAS and DemandTec say are moving in the direction of merging pricing systems with targeted marketing systems that deliver specific deals to individual shoppers.

For all of Winn-Dixie’s emphasis on automation, Vukich cautioned against relying too much on a price optimization engine, and too little on the art of pricing. “Pricing is really a combination of science and art,” he said. “The natural tendency for companies is to think pricing is a science and just let the machine take over. But that’s the worst thing you can do.”

For example if the system automatically set prices, it might not take into account a change in market conditions, such as deflation. “You need an experienced pricing manager along with merchandising to understand that conditions have changed,” he said. Another example is pricing in multiples – two for $3, say. “Imagine going down a grocery aisle and every price is a multiple,” he said. “There needs to be a balance between multiple and single price points and that’s where the art comes in.”

Fighting RedLaser

Sure, price optimization systems can help retailers keep their prices up-to-date. But in an age where consumers can track competing prices via their cell phones, are retailers still behind the eight ball?

Perhaps not as much as consumer electronics retailers like Best Buy that sell high-ticket flat-screen TVs. Still, consumers could use price comparison apps like RedLaser to check prices of key items like milk and bread and “develop a perception of a [food retailer’s] overall pricing,” said Nikki Baird, managing partner, Retail Systems Research, Miami.

“If people check the prices of the most important things in their basket on a semi-regular basis, that could be hard for retailers,” she said.

The solution, ironically, could lie in other mobile apps, such as list-making apps that arrange the list by a store’s layout and save the shopper time, she said. “The retailer then makes shopping so convenient, it’s not worth RedLasering prices.”