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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."
Customers vary in their willingness and ability to pay. If a company charges one simple price for each item, it creates a situation in which some people get a great deal (they pay less than they might be willing to) and some people don't buy the product at all (because the price is more than they want to pay). But if a company can find a way to separate the customers that really value the product from the customers that value it less, then more people will be able to buy the product and the company will earn more profit. (You mathematically prove that this increases what is called consumer surplus which is the equivalent to the consumers "profit" on the purchase and the seller's profit). Both side benefit, as does society.
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).
Two wrongs don't make a right, but three lefts do.
They can optimize their little hearts out, but it won't change the fact that I counter this with my own optimization strategy- I always look for the best deal, period.
As other posters will doubtless already have said, price point optimisation by software is neither new nor interesting. What is interesting IMHO is the scale of the whole system. Big box superstores employ an army of psychologists, ergonomics experts and statisticians to try and control your behaviour and squeeze as much cash as possible from your pocket.
:)
There was a quite fascinating article published the other day in a Digg linked blog that I am sure many here read (I don't have the link unfortunately). What is really interesting is that by knowing the system and subverting it you can make HUGE savings in your shopping. The layout of the store is carefully crafted to expose you to the products they want to push. Color schemes and shelf placememt are designed to confuse or lead you to select certain products. Prices and product sizes are carefully designed to make comparative math very difficult to ordinary folks. Bargains are placed outside the normal lines of sight.
In other words, the very existence of a cold and calculated system is what enables you to game it.
Some bits of strategy I remember:
1) Make a list and stick to it. Impulse purchases account for a huge amount of profit and the stores rely on you buying things you do not need.
2) Never look at the products at eye level, they are the most expensive and worst value.
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.
4) Do not stop unncecessarily. Deliberate impedences are put in isles to slow you down.
5) Don't take a cart or basket unless you really can't carry what is written on your list.
6) Use the bathroom before you go shopping. They place the restrooms to make you walk as far as possible past tempting impulse products.
A couple of my own...
7) Eat before you shop, never go to a grocery supermarket when hungry.
8) Take cash, just as much as you need and no more, and use the cash only fast checkout.
Perhaps someone who knows the systems they use in detail should write a piece of open source software in their spare time to calculate the optimal path through a store
This means that you're more likely to get a sale at a price you like than without price optimization. Take for example you and your MBA gadget hungry associate. Say both of you want a LCD screen and the company's cost is $500. If they have a single mark up it might be $700, which Mr. MBA would purchase one and you none, but if they can sell to him for $800 and you for $600, both of you buy a TV and the store makes more (even though they made less in your sale it was better than no sale at the single price).
Degaussing scares the bad magnetism out of the monitor and fills it with good karma.
As someone that quit IT to go into retail I will say that price optimization will benefit retailers looking for your business more than other types of consumers.
A specialty shop with unique products can just slap a large margin on a product as long as the price is fairly well justified and do fine, but when catering to a clientèle working with higher volumes, low margins and aggressively price conscious consumers then wringing every last possible penny out of them works.
Everyone knows that by and large in the U.S. that Wal-Mart is the price discount king. And even if you are really watching prices and comparing a consumer will still believe that they are getting the best deal at Wal-Mart. But I know that a significant number of their products are name brands packaged into their own unique size. Of course at Sam's Club things have to be bought in bulk for a discount but comparing product X at Wal-Mart in a 13oz size verses the same product X at a local competitor in a 20oz size can appear to be the exact same product for significantly less than a competitor although the price per ounce is a better deal at the competitor.
I sell pet food and I'll say that Ol' Roy is one of the cheapest priced pet foods per bag. Sure there are some others cheaper per bag at feed stores which may or may not be a better deal. I know some feed stores that use loss leaders to beat Ol' Roy. But, when comparing Ol' Roy to premium pet food the price per feeding will beat Ol' Roy most every time. So, buying a $15 bag of feed per week is more expensive than buying a $26 bag of feed per month.
"A government is a body of people, usually notably ungoverned." - Shepard Book Quoting Malcolm Reynolds
If I happen to be shopping at one of the other places, it is then easy to see if their current sale price beats Wal-Mart's everyday price. If so, and I need the item, or can reasonably store it, I will buy at the other store. If I notice an advertised sale on something at one of the other stores, I might go there for it.
I have a better way to game the system: don't participate in "the system". Shop at your friendly local, independent retailers. In our store, we put things where people can find them, and price them competitively.
I don't respond to AC's.
Actually that is a price optimization software I keep expecting to be put in use secretly by Walmart's competition. Walmart has "the guaranteed lowest prices every day", but only if you challenge them on it with an advertisement for lower price then they have listed. Most of the time when you do this they will match the lower price on same brand and often will on a store brand switch in for grocery store private labels advertised prices. Walmart's however does not impose purchase limits like grocery stores often will with their "loss leaders". Now imagine a software that picks out a loss leader for its greatest effect on Walmart's profit line? Generally speaking Walmart's make up for the loss on other sales just as the competition does, however there is no limit or minimum purchase applied at Walmarts so that leaves them potentially open to attack in this area.
My mother is a big fan of Walmart for the above reason, she collects all the sales advertisements she can and mostly just shops at Walmart while hitting them up for the lower prices advertised elsewhere and buying in multiples on the loss leaders she can store for later use. Saves her a bunch of money on groceries and she don't have to deal with the store cards often required to get the advertised prices at the advertiser's store or the "purchase limit"s. If a clerk won't follow this properly ask for a manager and if the manager don't meet expectations call 1.800.WALMART. As much as I am not a fan of Walmart, I hate the "Loyalty Card" dispensers and their ( dons tinfoil hat ) record keeping practices even more, so I will take an ad to Walmart myself before shopping for the advertised item at the card required companies to get the advertised prices places.
Sometimes things on a heavy loss leader sale elsewhere will disappear for a few days from Walmart shelves, now whether this is a deliberate pull of the item by the manager or whether its because the item had no limit at Walmart at the other store's loss leader pricing and simply stays sold out for the period around the sale is up to debate. Likely its the latter cause many people go in and get cases of the "no limit" purchases of other store's "loss leaders" from Walmart. This would probably even be a good incentive for the "I hate Walmart" crowd to do some shopping there, only buying the loss leader stuff heavily. If several different members of their competition colluded to each take a big loss on a different item, but limited their sale to one item per customer, it might put a huge hurt on Walmart especially if they chose items that Walmart had heavily stocked and each had such an item up on sale every week.
This may seem a bit offtopic but I wanted to make the point that there are other aspects to price optimization then software can legally figure in. Certain points if added to software in any fashion might lead to potential lawsuits or illegal business practice lawsuits. While it maybe a good tool its no replacement for a talented mind and/or a talented gut. Wish I had one of each.:)
I was the purchasing agent for a chain of auto parts stores, and we used a method called GROI: Gross Return on Inventory.
The original pricing theory in traditional auto parts stores was based on four "turns" per year: after opening a parts store and filling it up with stuff to sell, you needed to sell each stock number four times, at 35% gross profit, to make an adequate gross profit to cover your expenses -- and pay off your inventory in twelve months.
This resulted in some items being priced much higher than at mass retailers, and caused stores to lose sales on popular items: people would go elsewhere for oil, antifreeze, and the most common spark plugs, brake pads and filters, because they were much less expensive at places like Pep Boys.
The GROI method constantly recalculated sales and adjusted the prices downward on popular items, thus increasing sales and lowering the prices still further. For example, the best-selling oil filters would sell at under 10% gross profit, but we would sell out our inventory of those items twelve to fifteen times per year... thus making a larger profit on the initial purchases we had made to stock a new store. By setting a minimum gross profit percentage, runaway sales on an item would result in higher profits instead of ever-lower margins.
This was all calculated by an incredibly expensive 200 MHz Pentium Pro box, running proprietary software atop SCO Unix.
(I was the only one who could work the thing... which led to me running a newly purchased Netware 4.1 network in the chain's offices... which led me out of that filthy auto parts business altogether, thank Jeebus).
Hah. The parent basically quoted the main points of an article that hit the front page of digg the other day: 15 ways stores trick you into spending.
Advice for Wal*Mart shoppers:
Never buy produce or fresh bakery goods at a Wal*Mart. The premium at the true grocery stores often corresponds to the produce & bakery goods actually being better quality.
Also, since you actually have a choice, try to memorize the routine sale prices at your other local stores. Sales tend to be cyclical. Wal*Mart has lower prices on the most popular items; for more obscure stuff they can go higher because those items are harder to find elsewhere, or fewer people are looking for them. I learned this when trying to buy a rare iron syrup (which could've had a proof number).
Wal*Mart is a good place to shop for low prices, but other places have different selection, and it's a good idea to give at least token support to its competition.
There is a fine line between recklessness and courage... -- Paul McCartney
First, a disclaimer. I was employee #4 at KhiMetrics, the company founded by Ken and Tim Ouimet (employees #1 and #2). They're mentioned in TFA. SAP bought KhiMetrics in January of 2006. Ken had been my office-mate in grad school. That said, I haven't seen Ken and Tim in years, and I have no financial stake in KhiMetrics or SAP anymore (SAP bought out the KhiMetrics stockholders with money, not shares of SAP stock).
Yes, it's true that humans doing pricing try to do the same things. But the thing is that software can do things a human mind cannot. Yes, the opposite is also true, but here software has a lot of advantages. In the case of the KhiMetrics (now SAP) software, it works on the category level, optimizing profit for the category as a whole, which can include taking losses on individual items. The software never makes the common mistakes human beings make. For example, different "flavors" of the same size package of the same product should come out at the same price, and the unit price of a given item should go down as the amount bought increases. I can tell you that I have seen examples where humans have screwed this up this week. When there are two sizes of a given product, let's say a certain laundry detergent, then the price per weight of the larger package better be less than the price per weight of the smaller package, or there's never any incentive for the customer to buy the larger package. Still, I see examples where the pricers have gotten this wrong. I've even asked people at the stores if they were trying to move the smaller packages because of having too much of that size in stock or something, and they told me that no, they had no such problem.
The other thing is that the KhiMetrics software uses actual sales data to determine how sensitive the customers are to the price of a given product. This can be done down to the SKU (individual item) level in the product dimension and down to the level of customers of a specific store in the geographic dimension. In other words, the KhiMetrics software is capable of determining the sensitivity of the customers of each individual store to the price of a specific product. No human being could do that at all, much less in the time the KhiMetrics software can do it. Even with a pricing team for each category in each store, which would end up costing a fortune in human resource costs, the result would not be as good as what KhiMetrics can deliver. Additionally, since the Ouimets "grew up in retail," the KhiMetrics software, since the beginning, has been compatible with things like Category Management and Efficient Replenishment, and able to take into account things like having different goals for different products in a category (loss leader, profit generator, traffic generator, etc.). The software takes into account complex factors like seasonality, promotion, and product visibility. Since I have a reasonably good idea of the internal workings of the software, I can tell you with some confidence that I, a Ph.D. in theoretical physics, would not even want to try to tackle the problem of optimizing the prices for a subcategory of 20 products in a single store, much less the dozens of categories and tens of thousands of SKUs in the dozens of stores in a retail chain. KhiMetrics can do all that, basing itself on years of actual sales data, before breakfast.
There are experienced people in retail who are good at such things, but the software was created with people that have the same level of understanding of retail pricing, plus it has all the advantages of being able to do high-speed computerized analysis of huge amounts of price and sales data. I don't work for KhiMetrics anymore, nor for SAP, but I can say that if I were working in a retail company, I would definitely want us to be using software like this for pricing. And experienced retail people agree with me. One thing we saw back when I was with K
"It is nice to know that the computer understands the problem. But I would like to understand it too." --Eugene Wigner
Although, WalMart is NOT a good example of profit optimization; there strategy is more likely to take cost decreases and pass them on. Which may not optimize the short term. And certainly only works if you are the more efficient retailer, which scale tends to help. But it is very pre-consumer and relatively dificult to compete against based upon price.
A MUCH better example would be airlines; where what is practically the same product - a coach seat on the same flight might go for 5 to 8 price-points of $100 to $1000 each way. Grocery and department stores might sell comparable products for 10 to 50% more than WalMart but rarely can get the 1000%
"NOTHING about the individual case; we're just plain hard to predict..."
Don't care. While the individual case can't be modeled the group case can be. Plus a WM can price a DVD at one price in LA and another in SF, seen the trend, reverse it next week, see what happens then and adjust the price in all of the stores accordingly. Do variations of the above for 1,900 stores nationwide. See what happens when you advertise price A vs. price B and seel how many are sold. Do variations of the above for 1,900 stores nationwide. Compare against the entire history of every DVD you've ever sold. Correlate against box-office receipts. Find out that I'll sell more copies at $14.95 and make 5% more than if I sell each copy at $14.99.
Do the same thing for 140,000 other products. Rinse. Repeat.
"people do indeed communicate and discuss the prices / merits of their purchases"
Indeed. When was the last time you and your friends discussed the fact that baked beans are $1.23 at store A and $1.25 at store B, while the dial soap was $1.45 vs $1.42?
"Stores that do this well find that they can reduce the number of SKUs they stock and make even more by only stocking the items with the highest markup / fastest turnover."
They're smarter than that. By your logic my grocery store would only sell sugar water. They don't. And they understand long-tail economics and price elasticity and loss-leaders much, much better than you do.
"Nobody likes to be manipulated."
True. However, if you're selling your house or car (and all other things equal) you probably want the most money you can get for it. If you're on the other side, you want that house or car for the fewest number of your hard earned dollars as possible. Your employer would probably like to get the same work done for less, you, OTOH, would like to do the same work for more money, benefits, vacation days, whatever.
Some people will pay more for convenience, others will drive ten miles out of their way for bargins. Some people think Apples are more than worth the price, while others think that anyone who buys anything other than the cheapest beige box on the shelf is nuts. Horrses for courses.
As long as all of these variables are in play prices will be adjusted and raised and lowered and fought over... and in some cases, manipulated.
Any sect, cult, or religion will legislate its creed into law if it acquires the political power to do so.