Magazine Article | February 1, 2003

Top 10 Demand-Based Management Essentials For Price Optimization

Source: Innovative Retail Technologies

If 2002 goes down in the books as the year price optimization made its momentous debut, the new year will certainly be its coming of age.

Integrated Solutions For Retailers, February 2003

It is important for retailers to learn the essentials of demand-based management (DBM) so they can recognize a strong DBM solution among the many conceptual offerings being rushed to market. The following "Top Ten Essentials" can help you separate fact from fiction:

1. Look For A Successful Track Record
Leading retailers have already implemented DBM solutions and are optimizing prices and profits on a daily basis. At minimum, a solution provider should have a lengthy list of successful pilot and enterprise-wide implementations. This will help you avoid investing in a concept that sounds good on paper, but doesn't deliver.

2. Avoid Rules-Based Pricing
If you hear terms such as "pooling" or "probing," chances are it's an old-rules-based pricing system that's been dusted off and made to look new. True DBM analyzes years of POS data and defines consumer behavior for every item in each store. This deep understanding of consumer behavior at every price point is the only way to optimize merchandising decisions.

3. Know Your Cross-Elasticities
DBM should also calculate the cross-elasticities of complementary, substitutive, and competitive items, and account for cannibalization, halo, and pantry loading effects. If a retailer lowers the price of an item, DBM should show exactly how this will drive sales of directly and indirectly related items. For example, it should help you understand how changing the price on Tide might impact sales of Cheer, private-label detergents, dryer sheets, and fabric softener.

4. Forecast Newly Introduced Items
More than 25% of a retailer's stock may be new items or items without an extensive price history. DBM can accurately forecast demand for these items if it is able to drill down to the item-attribute level - defining an item by its size, shape, texture, and composition - and analyzing the price history of items with similar attributes.

5. Focus On Net Profits
Don't settle for gross margin measures. Good DBM providers will factor in a burdened cost of each item to calculate a relative net profit to meet your financial objectives. If a system can only handle gross profits, it may be a rules-based pricing scheme in disguise.

6. Put Your Goals First
The beauty of DBM is that it starts with a retailer's promise to Wall Street and then delivers merchandising strategies that meet those promises. Make sure the solution you evaluate prioritizes the retailer's financial objectives and long-term goals for sales, profit, and price image before it optimizes prices.

7. Trust Your Instincts
A DBM solution must be flexible enough to prioritize internal time-trusted rules and optimize prices around them. Often a DBM-optimized pricing scenario will be counter-intuitive, or suggest that you change a conventional pricing paradigm. In any event, DBM should allow you to run any number of what-if scenarios so you can decide what's most important to the bottom line.

8. Protect Your Customers
Don't let a system provider experiment directly on retail customers. Some vendors resort to probing, which is little more than a statistical sampling of price changes. Rather than risk alienating customers with arbitrary price fluctuations, DBM lets you run multiple "sandbox" experiments in a virtual rendition of real-world behaviors.

9. Keep It Simple
Price optimization shouldn't radically change the way a retailer does business. DBM doesn't automate the entire process, and it certainly doesn't replace the expertise of category managers. It's all about making subtle price adjustments - which add up to significant value across thousands of SKUs (stock keeping units) and multiple stores.

10. Count On Experience
A good price optimization solution will build years of retail experience into the software. If an item has a sudden spike in sales, does the system simply toss out the anomaly? A solution provider should ask the category manager for an explanation so they can plan for when it happens again. That's why it's important to know the company behind the product. Nothing can substitute for experience.