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Price Optimization Software Big in Retail Business
prostoalex writes "Even if you spent only a single day in an economics class, you're probably familiar with a concept of supply and demand. The Associated Press is running an article on retailers employing mathematical models for price optimization, where some products are priced higher to generate higher margins, and some are discounted to generate larger volumes even at the expense of per-product margins. DemandTec, Oracle and SAP are some of the companies producing those mathematical models for retailers around the country, with AP listing some of the pricing optimizations employed currently."
Seriously - this is NOT new. Not even in the software field.
Yes, this is true, but you don't need complicated mathematical schemes for this. They've been doing it for years.
It's called coupons!
The product is priced on the shelf at the price most consumers are willing to pay (say, about 60%). The coupon discounts the product to a price the other 40% are willing to pay. Now you get to charge two prices for the same product! Woohoo!
One technique for this is the extended warranty racket. For the perception of improved service, and to make up for frequent shoddy workmanship, the product is available with several different layers of warranty available. The person who can marginally afford the product gets just the product but no added service or peace of mind, the person who will pay more for the product, gets the service he should expect with a quality piece of merchandise. All with just one line of product.
I used to have a cool sig, back when I cared
how many pairs of boxer shorts should you own?
2) Never look at the products at eye level, they are the most expensive and worst value.
That is really not a valid statement, for a couple reasons. The first error is the last two words 'worst value'. Only the customer can determine what the value is. If I'm looking at a condiment section and at eye level is a name brand catsup, and below it is a private label equivalent, the price per unit will probably be lower on the private label. That doesn't necessarily make it a better value. If I think the private label tastes rotten and wont eat it, the more expensive catsup is a much better value.
The second issue is that quite often what you see at eye level is determined by who payed for the placement. It may not be the highest margin item for the retailer on its own. But it is their because the vendor payed a royalty to have it where they want it.
3) Move as fast as you can to the back of the store. Start at the back of the store and work your way forwards.
That doesn't make a whole lot of sense. If you are talking grocery, very few stores are laid out the same way. There's no way this can be a 'rule' that will help you when what is at the front or back will vary from location to location. I think a better way of looking at this might be - don't buy what is on end-caps and floor displays until you have looked at the prices for comparable items. This means, not running to the back, but going to the aisle where the item is normally located.
In larger stores this really doesn't make sense. If I go to Fry's Electronics and run to the back, how does that help me? If I go to Best Buy and hustle right back to home appliances, I'm not sure what I've done to help myself out.
The psychology of all this is over rated. A little common sense - like many of the other suggestions in the list, will go a long way. That's not manipulating the 'system' it's just using your mind and operating above a visceral level.
It's hard to believe that's how Micronians are made. Why don't we see it right now by having you both kiss one another?
The amusing fact is that this is nothing more than a capitalist version of taking from the rich (those are willing and able to pay more) and giving to the poor (those aren't willing or able to pay more).
Some people might think you are kidding there, but there really are cases where everybody wins from differential pricing, and businesses really do take from the rich so they can afford to sell to the poor. Let me add an example to make it clearer:
Imagine you want to build some sort of clever new software. You see that 10,000 people would pay $100 for it (as a fun toy, say), and 5 companies would pay $1m for it, because they can each make $3m from using it commercially.
If the software costs $1m to develop and you sell all the copies for $100, your profit will be $500. Nobody's going to go to all that trouble for $500, so you wouldn't make the software. And if you did, you'd be steamed that these companies made millions while you got pocket lint.
However, if you sell the first 5 copies for $1m each (with, say, some fancy documentation and a support contract), you can then go on to release a consumer version to get everybody else. You get $5m in the bank, so you're happy. The companies netted $10m, so they're happy. And everybody else got a fun toy at a reasonable price.
Note that although your average price per copy there is $600, you couldn't get the same effect by charging $600; none of the consumers would pay that much for a toy.
Yes, you are right that they are separate but related. (Your post is not rude and I hope my response is not rude, either). The lead example concerned pricing of drills. The three models (perhaps from three different makers) define different market segments as far as the retailer is concerned. Optimizing the price on the three models gives the retailer a chance to maximize both revenues and profits even if the retailer doesn't do anything to market the products differently. Similarly, markdown optimization is both a price optimization and a segmentation issue -- segmenting the "I'll pay anything to be the first person to own this" customers from the "I'll buy it later when its discounted" customers.
The classic example, that I was thinking of, is the revenue management strategies of airlines that attempt to optimize prices across presumed underlying segments of price-sensitive leisure travelers versus price-insensitive business travelers. Technically, it's the identical seat that's being sold for radically different prices (up to 10X different) depending on issues such as how the customer buys the ticket, when they buy the ticket, whether they book a saturday-night stay, etc. The result is that the business customers pay for the plane and the vacation travelers only pay for the fuel and variable costs. The ability to differentiate does benefit the business customers because the added volume of travelers means a more frequent schedule of flights, larger planes, and more destinations.
You are right, though, that true market segmentation involves much more than just price optimization.
Two wrongs don't make a right, but three lefts do.