Price Optimization Rises to the Forefront for Grocers

Discussion
Feb 25, 2008

By Tom Ryan

With razor-thin margins and constant promotional efforts, supermarkets are increasingly looking to price optimization technologies as a core merchandising tool. According to RSS News, a growing number of supermarkets are working with vendors such as Revionics, DemandTec (a RetailWire sponsor), and KSS Retail to help category management teams and pricing analysts make timely pricing decisions.

Using complex algorithms, optimal prices are computed based on factors such as historical price variations; cost and competitive data; purchase behavior; temporary price reductions; multiple geographical, pricing and demographic market zones.

Overall, the use of PO technologies appears to be on the rise among grocers. According to RSS News, grocers now working with Revionics include Hollister Supermarkets, C&K Markets, Supervalu, C&S Grocers, Grand Union Family Markets, Scolari’s, Fresh Encounter and Boyer’s Food Markets. DemandTec’s PO clients include The Brookshire Grocery Co. and BI-LO. KSS Retail works with Ball’s Price Chopper, Raley’s Supermarkets, ABC Fine Wine and Spirits, and Gigante Supermarkets in the area.

Hollister Supermarkets, an independent supermarket chain in California’s Central Valley region, implemented Revionics’ pricing system last year. Revionics system taps into competitive pricing, price changes from vendors and item movement.

The latter, said Chang So, Hollister’s general manager, is “the most important part of the equation.” It also outputs suggested retails and integrates special pricing for categories that are highly price sensitive.

“We can now charge more for certain items while maintaining velocity,” said Mr. So. “We can reduce pricing on others while increasing velocity by 50 percent or more. We’re experiencing higher margins throughout our stores and increased sales, due in large part to this system. Pricing optimization technology helps when competing with large grocery chains as well as mom and pops.”

Ball’s Price Chopper grocery stores went live with KSS in May 2007. Mike Beal, CFO for Ball’s, said the solution helps the chain “ensure we are offering the best value.” The application offers insight into how consumers perceive Ball’s pricing and promotions, providing the ability to improve its competitive positioning.

Pat Walsh, VP of industry and trade development for the Food Marketing Institute (FMI), told RSS News that pricing remains critical for the supermarket trade class, where earnings before interest and taxes are roughly 4 percent.

“Unlike in the apparel segment, where more profit is built into products, grocery items that typically generate just four cents on the dollar bring pricing thresholds directly into play,” said Mr. Walsh. “If I take the price too high or too low, what have I lost? There’s a small window where supermarkets can find pricing comfort while maintaining their marketing strategies and pricing image in terms of acquiring and retaining customers.”

Discussion Question: What impact is price optimization technology having on the supermarket business? What do you see as the opportunities and challenges of implementing PO technologies?

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11 Comments on "Price Optimization Rises to the Forefront for Grocers"


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James Tenser
Guest
14 years 2 months ago
Use of demand-based pricing models should be a core practice for retailers of all stripes–but they are not quite a “no-brainer,” I think. In fact they require quite a lot of brain power to be used effectively. The issue Ryan raises above is a case in point – intemperate use of a price application to pad margins may increase profits in the short run at the expense of a store’s price image, resulting in long term erosion of shopper trust and brand equity. Too-frequent price adjustments stimulated by the model can also lead to price distrust among shoppers. Too-frequent, too-deep TPRs may erode the perception of every-day value. To make matters even less simple, imposing certain constraints on the model–such as “we’re always going to match our competitor on these 50 known value items”–ultimately distorts the model to those KVI constraints, and may obviate other benefits. On other hand, intelligent management of everyday prices on KVIs; of the depth and frequency of promotional discounts; of the depth and timing of markdowns and closeouts; of the… Read more »
Eliott Olson
Guest
Eliott Olson
14 years 2 months ago

There is no way anyone can do as well as a properly calibrated pricing model. A good model can handle specific rules that a store might want such as “we will meet Cheapmart’s price and the top x number of prices.” Beyond that, allowing a company to maximize volume or profits through the measurement of fixed and variable costs, price elasticity and competitive activity while adjusting the variables offers a way for many stores to remain profitable.

There are many retailers who over estimate their customers’ price sensitivity and don’t capture the true worth of their store and products.

Bill Bittner
Guest
Bill Bittner
14 years 2 months ago
Price Optimization is such a “no brainer” that it absolutely confounds me why there is still any debate. Unlike so many other automated tools for the supermarket industry that require large investments in personnel training and ongoing costs associated with monitoring execution, PO is implemented with a relatively small group of people and its results are leveraged across many locations. Having said all that, the latest turmoil in the credit markets is a testimony that you can’t rely completely on quantitative analysis. I always remember walking the aisles with a very successful VP of Merchandising during a series of store visits. As we walked past the private label substitute for Woolite, he stopped. The PL version was priced at about 1/3 the retail of the Woolite. His comment was, “Who is going to put their $50 Sweater (this was few years ago) that is a gift into a product that is so inexpensive it could possibly destroy it?” The local merchandiser thought they were offering a great deal. The VP of Merchandising understood how the… Read more »
Dr. Stephen Needel
Guest
14 years 2 months ago

There’s nothing like a good pricing model. There’s also nothing like a good test of that pricing model. Just like assortment models, price optimization models have been known to fail miserably when the results are employed. They are also susceptible to user constraints–as Ryan says, it’s a price impression that’s important to the consumer. Our point of view–try these out, but test the recommendations first before doing a full-scale implementation.

Raymond D. Jones
Guest
Raymond D. Jones
14 years 2 months ago

Price analysis and pricing models can be very useful tools for optimizing prices to achieve the best combination of volume and profit. However, they must be employed within the context of an overall pricing strategy. Would Wal-Mart still be able to claim “Low Prices, Everyday” if they allowed a model to optimize their prices? I’m sure a model would tell Starbucks they could sell more coffee if they priced it at $ .99.

A retailer must first consider their position in the marketplace that may dictate their overall pricing policy. Then, determine the role of each major category and how it should be managed. Once they have established that context, they can proceed to use models to optimize pricing on key items.

Mark Lilien
Guest
14 years 2 months ago

Price optimization takes at least 3 forms: (1) everyday price, chain wide (2) everyday zone pricing and (3) promotional pricing.

Some chains use 1 or 2 forms of PO, but not all 3. Promotional pricing can be especially difficult when combined with zone pricing. For example, some independent supermarket owners in New York City throw away their wholesaler-supplied weekly sale flyers because they’re tired of losing money on the loss leaders that help the suburban stores drive traffic.

Ryan Mathews
Guest
14 years 2 months ago

It will help, but it isn’t a magic wand. It isn’t individual prices that win over the hearts, minds and pocketbooks of consumers–it’s overall price impression. If the price optimization software helps you shave pennies off enough of the items an individual consumer buys regularly then it will have an impact–on that consumer. Also, how long is it going to take someone to counter all this with a “We guarantee we’ll best their best deal,” campaign?

Lee Peterson
Guest
14 years 2 months ago

In today’s marketplace, PO is a must for grocers and the very complex job of determining a middle ground.

However, two things to keep in mind as an adjacency:
— If you develop your own brands, you’re not as vulnerable on all fronts (see also: Safeway), so, that should be a priority as well;
— Just because you’ve got the best analysis possible on price, that should not deter you from daily/weekly old-fashioned competitive shopping trips. It’s imperative to stick your head out of the sand as much as possible. For this, there is no substitute.

Dennis Serbu
Guest
Dennis Serbu
14 years 2 months ago

The models I have seen do not contemplate unit decline with a price increase, or if they do they ignore them when trying to balance gross. I don’t think they fully anticipate pantry load and pantry replenishment cycles. Some items have deep household penetration, but long pantry replenishment cycles. Taking prices up on these items may encourage trading down or trading out to a competitor.

I have witnessed market share shifts on specific brands as a result of these actions. Price management is Art and Science. You do not want a $12.00 per hour staffer in charge of the process.

Camille P. Schuster, Ph.D.
Guest
14 years 2 months ago

What is the goal of the program? Generating better margins for the retailer? How does this benefit the consumer–does it make them more loyal to your store? Does it matter to consumers? How is that extra margin being used to create better value for consumers? Will consumers feel ripped off and stop patronizing your store?

Assuming those questions are answered, have you determined whether the product is a destination product? Do consumers compare prices on that item? Do consumers choose your store for price?

There are a lot of pieces of information that need to be part of the decision when implementing a price model.

Brian Cederborg
Guest
Brian Cederborg
14 years 2 months ago

I agree with Bill that the price optimization toolset has reached such a point of maturity that it should truly be a “no brainer” for grocers today. Our view is that PO software will soon become a cost of business for most grocers to be competitive.

Others are equally correct in that PO tools must be viewed as part of a larger merchandising practice that includes quantitative analysis, merchant expertise and leading practice processes.

What intrigues me and is often overlooked by retailers evaluating PO tools are the additional data elements that come as part of the optimization models. Recommendations for price zones and category/item roles as well as item cannibalistic/affinity relationships are all information elements that benefit a category manager in crafting the best approach to maximizing value from their category. Even better, this analysis is performed at the store–SKU level from the leading PO vendors.

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