The Retailer’s Guide to Price Optimization Solutions to Increase Profits
Updated: Feb 5
Pricing is actually very simple. Customers will not pay literally a penny more than the true value of the product.
~ Ron Johnson, former CEO of J. C. Penney
The ideal price is an ever-moving target. Pinpointing the true value of a product depends on several internal and external factors. Cost, brand value, promotional activity, product life cycle, competition, target consumers, government policies and economic conditions – all of this affect pricing. So, developing a price optimization strategy that is convincing to your potential customers requires a lot of experimentation.
Best pricing strategies are built with the customer in the mind. Consumers of today are very shrewd. They check and compare prices online before committing to a buying decision. Moreover, they expect personalized offers based on their purchase history. To appease the smart customers of today, a lazy pricing strategy like adding a mark-up percentage to the product cost simply will not do.
Retailers are finally realizing that successful sales come through pricing your products in a way that justifies its value. As a result, marketing trends are shifting away from the usual practice of simply giving discounts. Today, it is leaning more towards authentic product pricing.
According to John D Idol, CEO of Michael Kors Holding Ltd, consumers don’t care about the pricing as much as they care about the product. If one has the right product, pricing it at its real and authentic value is all it will take for it to be a success. This has proven to be true as some of their best-selling products like Mercer handbags and smartwatches are always sold at full price to loyal, brand-sensitive customers.
Why should you go for price optimization?
Price optimization is the sweet spot between making a profit and attracting a willing customer. It allows a company to fully utilize a consumer’s spending potential, when they spend and how they spend. These consumer buying habits, allows a company to maximize profits in new ways when analysed and used properly. Which is so much better than simply judging the success of a product based on its past performance.
Zara has a dedicated team of designers and product managers to ensure an efficient system to replenish existing items in as little as two weeks, enabling the company to produce exactly what the customers want.
Switching to a price optimization model has several benefits like:
1. Higher profits
Zara, the Spanish apparel retailer, stands to be a long-term success example of the same. Turns out, Zara has a dedicated team of designers and product managers to ensure an efficient system to replenish existing items in as little as two weeks, enabling the company to produce exactly what the customers want. For Zara, to price their product is paramount, because this not only leads to profits but also helps them manage inventory, reduce market downs, and achieve higher gross margins.
2. Undercutting the competition
To stay competitive and to optimize product prices, companies like Amazon utilizes a dynamic pricing model. Most retail businesses adjust the price of their products a dozen times a day based on market conditions. The dynamic pricing strategy keeps score of the competitor’s prices. It automatically offers the best price to capture the target market share.
A case study on Amazon reported by Boomerang showed that Amazon price-tested a popular Samsung TV worth $350 for six months before discounting it to $250 on Black Friday. That price point undercut competitors and Amazon was able to snatch a lot of businesses from under their noses.
You might wonder what is so great about stealing competitor’s business by quoting a lower price. To make up the discount offered for the TV, Amazon jacked up the price of an HDMI cable that people usually buy alongside the TV. They rightly predicted that the less popular item wouldn’t affect price perception as the TV would. So, they went ahead with the price increase which brought in much higher profit.
Adopting a price optimization model for your business is a necessity. In fact, businesses that fail to keep up with their competitors are likely to drown soon. Service-based industries like Travel, eCommerce and Hospitality are some of the most avid users of price optimization. Such businesses thrive on dynamic pricing.
For example, Airlines pay attention to the date of departure, the date of purchase, time left until the flight, buying location, affluence level and any other info they can get their hands on. Depending on all these factors, the price of flight tickets can fluctuate dramatically maybe even from customer to customer.
Why should you never settle for a generic pricing model?
It’s impossible to build a price optimization model overnight for your business. It takes a lot of experimentation to find the right strategy that maximizes your business goal. Which is why a one-size-fits-all generic pricing software will not help in finding the right price.
Exploring a new pricing model means experimenting with a lot of things like demand for each product at a certain discount percentage or how much you can gradually increment the price of a product until the market stops supporting you.
Also, building your own pricing model will help you create dashboards that are relevant to your business. It is very beneficial as it will show the analytics that you care about. On the other hand, proprietary software has dashboard items that are common to most businesses. Proprietary software provides limited opportunity for customization.
Every business has a unique customer base and has its own set of industry-specific, season-specific, market-specific needs. The proprietary price optimization software is not equipped to meet these unique demands.
How is price optimization done?
Finding the right price shouldn’t feel like throwing darts blindfolded. So, you need to discover a price optimization model that perfectly complements your business.
1. Set Your Goals
Every business has its own objectives and the pricing decisions that drive a strategy must reflect those. Building a pricing model will help you to evaluate your current capabilities and find the areas that need improvement.
The objectives in the pricing of a product can be one or more of the following:
Earning a proper return on investment
Reaping maximum profit through maximum sales
Securing price stability
Bringing stability in the profit margin
Beating the competition
Maintaining or increasing the market share
Establishing goals clearly will help your business to ask questions like, “If I increase the price of a particular product by 5 per cent will it increase the profit margin by X?” or “Can I still achieve the anticipated ROI if I lower the price by 1 per cent?”
2. Identify Groups and Categories
Once you have the right pricing objective, you can now choose the category you want to test the pricing on. Preferably, it should be a high-volume category, where sales happen in large numbers. For example, if you are selling apparels, denim jackets can be used as the experiment group, where the prices are altered. Likewise, leather coats can be used as the control group, where the price stays constant.
The category you choose should be similar, to gather meaningful and valuable information about customer reaction to pricing changes.
3. Collect Data
The backbone of a price optimization model is a data-driven framework. This model predicts and measures the reactions of potential buyers to different prices of a product or service. To build a price optimization model, you need information like:
Customer survey data
Historic sales data
Incidentally, most of this information is available with your business. Competitor data can be obtained through web scraping. Leveraging competitive pricing data is crucial in understanding how your price changes impact their behaviour. Additionally, it also helps your business in finding benchmarks for your pricing strategy.
Once you have the data, you can set optimized prices for selected products in the experiment group based on competitors’ pricing, your current objectives.
4. Start Testing
Price testing offers opportunities for your business to accelerate its growth. Ideally, experimentation should not only offer actionable insights but also alternatives. Furthermore, the pricing process doesn’t have to be very complex. Simple business experiments like adjusting the price or running a certain ad when the competitor’s items are sold out etc. will work well.
A test-and-learn method is the best course of action for businesses who are newly exploring a pricing model. Which means, you take one action with the experiment group, take a different action (or no action) with the control group, and then compare the results. This approach keeps the process simple. Consequently, the outcomes become easily apparent.
5. Analyze, Learn and Optimize
Finally, you should analyze how the pricing change has affected your bottom line. The difference in the daily averages of key metrics like profit and revenue before and after the experiment is a good indicator of the success or failure of the pricing test.
The ability to automate pricing has enabled companies to optimize pricing for more products than most organizations find possible.
Wish to know more about how product price optimization can benefit your retail business? Contact us at Datahut, your big data experts.