The right price bulls-eye

When a $99.99 winter jacket wasn’t selling as rapidly last holiday season as Northern Group Retail Ltd. merchandise managers planned, they contemplated a 30% markdown. But first they ran their plans through a new web-based pricing optimization system that the Canadian-based retailer had installed just a month earlier. The word from the system: hold steady. “We took the recommendation and sold the balance of the jackets at full price,” says CFO Michael Stanek.

The success in holding onto the full price was especially helpful because of a directive from Stanek to boost margins. “We’ve targeted to improve our gross margins by 2% a year over three years,” he says. He expects the web-based price optimization system—which sits on a web server on the corporate intranet—will account for half of that margin improvement.

Northern Group and a handful of other retailers are at the head of the curve on new web-based price optimization software, which in the past year has begun to replace traditional—and more cumbersome—methods of figuring out the best way to price merchandise in order to sell it within a planned schedule.

Guts and spreadsheets

Merchandisers strive toward improvements in pricing strategies by wrestling to gain better control of their markdown activity—a laborious and time-consuming chore that has been largely made up of veteran merchandisers’ gut instinct after poring over inches-thick spreadsheets of POS and inventory data for thousands of SKUs. A new crop of web-based price optimization software is letting retailers trade in their paper spreadsheets for software that applies mathematical algorithms to back-end data on pricing, merchandise sales and inventory levels, and recommends prices for particular SKUs. “Merchandisers and buyers have a certain level of intuition, but when you try to look at all the different combinations of pricing options, it gets beyond the ability of the human mind,” says Chris Boone, analyst with researchers IDC.

Retailers lose more than $200 billion every year to markdowns, according to the National Retail Federation and the U.S. Census Bureau and an analysis by vendor ProfitLogic. STS Market Research reports that 78% of all apparel sold by national retail chains is marked down. Because retailers usually operate with a budget on how much they can afford to lose on markdowns, the software helps them choose which recommended prices to accept by enabling them to conduct what-if analyses.

Providing retailers with all that information and analysis easily runs into millions of dollars a year in software fees. Yet Northern Group and other retailers express confidence that these systems will produce quick returns on investment. “We think we’re headed for an ROI within a year,” Stanek says.

If it weren’t for web technology, this combination of software performance and user ROI would be virtually impossible to implement without more costly and disruptive changes to a company’s computer network infrastructure, software providers say. “The web makes this all easier to implement, and deployment is far simpler and faster than it would be without it,” says Richard von Hirschberg, vice president of product management for ProfitLogic, which provides the web-based pricing optimization software used by Northern Group and several other retailers. “Without the web, we would have to set up a separate network infrastructure for each customer, making it too costly for them to realize a return on investment.”

He notes that retailers have the option of deploying ProfitLogic either as a web application hosted by the vendor or on their own web servers, as Northern Group has done. Either way, the web-based technology provides for a relatively fast implementation within about 12 weeks.

In addition to speed of access and ease of implementation, the web provides another benefit in allowing retailers to adopt price optimization software without disrupting their existing systems, Boone says. Thus vendors get a strong sales pitch to retailers that they can deploy a price optimization tool and begin improving margins in a short time without changing their infrastructure. “The merchandise managers don’t have to take a back seat to IT plans already in the works,” he says.

Northern Group never attempted to manage its markdowns before deploying the ProfitLogic system last year because it would have been too time-consuming and labor-intensive to be worthwhile, Stanek says. “We didn’t even go through this process of forecasting pricing or going back to look at historical sell-through rates,” he says. “All the data has always been in our system, but to use it we would need to employ 30 pricing analysts.”

Northern Group, which operates 280 apparel stores across Canada as well as a retail e-commerce site for the U.S., began deploying its price optimization system last fall and had it operating in time for the holiday shopping season. In addition to the software, which costs about $1 million to implement, Northern Group invested in a web server and dedicated two employees as pricing analysts to work directly with the ProfitLogic system. Employee training, which takes about two days, is included in the cost of the implementation. Although Stanek declines to give the cost of the web server, he admits it’s a big expense. Nonetheless, he sees a quick ROI from the price optimization system. “It had a big impact on the gross margin dollars we generated for the holiday season,” Stanek says.

Beyond hype

The tech-hype of the late 1990s made many executives skeptical about technology claims. But the fact that a growing number of retailers is moving toward pricing optimization technology is overcoming skeptics’ defenses. At a time when business at large has been slow to invest in new technology, more companies—and particularly retailers—are looking at web-based price optimization software and finding room for it in their spending plans. “It can be purchased as a software module without rebuilding network infrastructure, it’s not hard to implement, it’s browser based and it offers a quick ROI,” Boone says. “That’s what retailers are looking for today. Although it’s still a small, emerging market, pricing optimization software is definitely an area of high interest. Once IT budgets start to grow again, this will become attractive as an IT investment on a broad scale.”

And then there’s the case of J.C. Penney Co. Inc., which improved its margins by 290 basis points during last year’s holiday selling season, largely from smarter pricing. J.C. Penney worked with ProfitLogic last year to develop the web-based software. “J.C. Penney was one of the few retailers hitting and exceeding sales targets, especially among general merchandise retailers,” Boone says. “A lot of that performance was due to pricing optimization.”

Penney declines to directly comment, but it said in a statement on its fourth-quarter results that gross margins increased due to improved inventory management and better merchandise assortments. “2003 is definitely a breakthrough year,” says Garrett Sinclair, vice president of strategic initiatives for Spotlight Solutions, vendor of web-based pricing optimization software used by retailers such as Saks Inc. and Shopko Stores Inc. “We’re seeing many more retailers taking it seriously.”

Penney, Northern Group and others are realizing that they can tie their pricing and markdown decisions more directly to consumer demand. “Pricing optimization gets retailers closer to real-time demand parameters,” says Kent Allen, analyst with Aberdeen Group. “The suggested retail price doesn’t mean anything anymore. It’s being replaced by value pricing, because retailers are getting better insight into real-time demand parameters.”

Precision responses

With the flexibility that a web-based system provides, retailers can respond more precisely to demand, retailers say. For instance, pricing managers may analyze such information as which products are selling unusually well in which regional markets, before deciding whether to accept an optimization system’s recommended prices. “Prior to this system, we took markdowns across our whole chain,” says Steve Schwartz, senior vice president of planning and allocation for Casual Male Retail Group Inc., which implemented a ProfitLogic web-based price optimization system last June. “For example, on July 4, we would mark down swimwear across the whole country. Now we can do it by groups of stores. We may mark down swimwear on July 4 in the northern part of the country, but in the central areas not until Aug. 1 and in the south not until after Labor Day.”

Automated systems also force retailers to be more realistic about their pricing. “Retailers are a pretty optimistic group and tend to mark down too late,” Schwartz says. “In the past, we would mark down products really late in the selling season, or after the season when customer traffic is less, and take a deeper hit with margins. Now we take a far smaller hit.” The system, which was up within two months, will pay for itself within the first year, Schwartz says.

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Unlike Northern Group, which licenses ProfitLogic’s software to run on its own web server, Casual Male went with a hosted web application to free up its corporate infrastructure, Schwartz says. For hosted applications, ProfitLogic charges $500,000 to $1 million, depending on the retailer’s volume. For licensed software to run on a customer’s web server, ProfitLogic charges about $1 million for every $1 billion in annual revenue and a one-time implementation fee that’s about half the licensing fee.

Until recently, before web-based pricing optimization software from vendors like ProfitLogic, Spotlight Solutions Inc., KhiMetrics Inc., DemandTec Inc. and Marketswitch Corp., in-depth insight into pricing strategies was practically impossible, especially for larger retailers, because it requires review of too many data points among what may be thousands of SKUs and hundreds or thousands of stores. The data include historical prices for each SKU, the length of time it took products to sell at particular prices, the impact on the timing of sell-throughs on other inventory and related inventory and supply chain costs, and the re-compilation of data for each store.

Using data recorded in spreadsheets, retailers have attempted to come up with pricing strategies based on their hunches of which price would move a particular product within a planned timeframe. “Few retailers have any formal process around this,” von Hirschberg says. “Some literally work with paper reports one or two inches thick on sales performance of each style of product, and the average rate of sales for the past few weeks. They sit there with a highlighter and a pen, make some arbitrary decisions on how much and when to mark down, then give those figures to a clerk to enter into their price management system. But the analysis is really all manual, and the decision process is not informed by mathematical analysis.”

Multi-source pulls

Price optimization software changes all that by pulling data from multiple sources, such as POS systems and inventory records. Those multiple points of input also mean that price optimization systems work best in a web environment, because it allows faster access to the various information managers need to make decisions about which prices to post. “If you’re web-enabled, you see patterns faster, react faster and plan better,” says Deborah Vollmer Dahlke, a board member of the Professional Pricing Society trade association and president of pricing consultants DVD Associates.

After gathering the data, the software applies algorithms to come up with price recommendations and makes them easily accessible through a web browser. The browser-based user interface lets managers customize the way they view price optimization reports, such as by setting parameters on how quickly a retailer wants to sell out of particular SKUs to get the corresponding pricing recommendations.

A retail manager who accepts a recommended price inputs it directly into the price management system, instantly updating pricing throughout the chain. As price optimization systems become commonly integrated with back-end software systems, as analysts expect, approved price recommendations will flow automatically into enterprise software systems.

For price optimization systems to work, they must be filled with a retailer’s data on sales, pricing and inventory, including the length of time it took different SKUs to sell out. The largest part of this data transfer comes during implementation, when a retailer must retrieve three years of data on pricing, sales and inventory and send it as an electronic file to the software company. The transfer of three years of historical data typically requires an employee to transfer files once a week for about six weeks, retailers say.

Each with a niche

In a new market without deeply entrenched suppliers, pricing optimization software vendors are carving out niches. ProfitLogic and Spotlight Solutions cater mostly to apparel retailers, though ProfitLogic is developing optimization software for professional merchandise buyers and for merchandise allotment. Spotlight Solutions, while sticking to pricing optimization, says it’s focusing more on providing users with analytical views of the thousands of SKU pricing options they might want to consider at any one time. “It’s all about creating pricing scenarios, but how do you manage 5,000 SKUs without having to go through all 5,000 items? We make it easy to look at groups in any fashion, such as if you want to create two or three pricing alternatives to what the software recommended,” Sinclair says.

KhiMetrics and DemandTec focus on grocery and goods with short lifespans, though DemandTec has been expanding its customer base. RadioShack Corp. recently agreed to deploy the DemandTec 3a software to set prices and promotions in more than 7,200 stores. DemandTec’s other clients include H.E. Butt Grocery Co., Longs Drugs Stores Inc. and D&W Food Centers Inc.

KhiMetrics also concentrates on pricing optimization for promotions. Its software lets retailers analyze how well promoted and non-promoted products sell and how they sell in relation to each other. For example, it offers a basket analysis that records information for each item scanned in a shopper’s basket, then reports which products were purchased along with promoted items.

Marketswitch focuses on marketing, using data on customer relationships to come up with prices geared toward particular customer segments in different selling channels, the company says.

As retailers develop their use of optimization technology, they’ll move more toward systems that utilize both merchandising and pricing optimization tools, improving the movement of goods throughout their merchandising lifecycle. “The Holy Grail is to match merchandising and pricing optimization, so that you bring in the right stuff and price it right from the beginning,” says Boone of IDC.

Long, great winter

GSI Commerce Inc. is already doing that with an in-house developed web-based inventory management and merchandising optimization system designed to maintain strong margins on seasonal apparel. “We just came off a great winter, even though it was long, because we knew where our business was trending,” says Matthew Hoffman, divisional merchandise manager for GSI Commerce.

GSI operates online stores for The Sports Authority and other sporting goods retailers as well as for the Denver Broncos and other sports organizations. Using historical data on product sales and inventory movement, it was able to better control inventory levels for different products throughout the winter. And by combining those data with recommendations from its pricing optimization system, GSI maintained strong margins throughout the season. “As a result, our sell-through was much better,” Hoffman says. “We knew which product types, styles and brands to sell and were able to keep prices higher to get better margins.”

He adds that the system continues to get better at recommending prices and inventory levels as it works with a more extensive history of customer buying behavior. GSI integrates its optimization software with the inventory management system within its retail management software suite from JDA Software Group Inc., which provides it with automated updates of inventory levels.

Once price optimization becomes integrated into retail networks, the technology could have far-reaching effects on store operations, analysts say. For instance, electronic store shelves could become endpoints for receiving and sending data. The UK’s Safeway Stores plc is already testing electronic shelf label technology from KhiMetrics in 50 stores. Not only will the labeling systems make sure that product shelves and POS systems are using the same prices, but, using radio frequency identification technology, they’ll also send an alert to an inventory system every time a product is removed from a shelf—an information flow that will further enhance price optimization systems with information on how quickly products fly off shelves at which price. “That’s not that far away,” predicts Tim Manning, vice president of marketing for KhiMetrics.

paul@verticalwebmedia.com