Leveraging Retail Margins: Getting Price Right
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Leveraging Retail Margins: Getting Price Right Pricing remains a retailer’s biggest margin lever. Yet the potential for getting price wrong has grown exponentially. Price has moved from an art to a science — compelling retailers to find new ways to set and manage prices to attract and retain more customers. Executive Summary No factor dominates shoppers’ decision-making processes like price. Other influences — products’ intended use, shoppers’ levels of wealth and the degree to which they desire a product — play sup- porting roles, but price is paramount. So how do retailers win the pricing game? First, they need to get prices right from the start; getting close is not enough. Today’s shoppers show a high propensity for walking out of stores when prices don’t meet their expectations. Relying on price-matching can be a “too little too late” strategy, and can result in retailers unneces- sarily giving away margin dollars. High-perform- ing retailers base their pricing decisions on their customers’ changing needs, not on the pricing moves made by their lowest-cost competitors. Second, retailers need to recognize that we are not in a “one price fits all” world, even in today’s environment of ever-increasing price transpar- ency. When it comes to price, most shoppers understand and accept a range of reasonableness determined by product type and use, the timing of a purchase and the level of customer service, and recognize that the cost to serve can vary. These factors provide the “cover” for such tactics as zone pricing, channel choices and personalized offers. Finally, retailers can win at pricing by letting tech- nology be their ally. Managing price with outdated methods — intuition, rules of thumb and spread- sheet analyses — no longer works in today’s fast- paced retail environment, which relies on volumi- nous amounts of rapidly changing data. What’s more, the potential penalty for getting price wrong has grown exponentially in terms of lost sales and foregone margins. Price is Paramount In 2013, Cognizant and RIS News conducted a survey of 2500 shoppers in the United States and Canada 1 (see Figure 1, next page). The results showed that price and promotions are the top influencers of in-store purchase decisions. What’s more, price has consistently reigned in the annual survey over the past four years. Product selection is a close second, but with multiple sources available for almost every type of product, selection carries less influence — especially for everyday consumable products. • Cognizant 20-20 Insights cognizant 20-20 insights | january 2014
Transcript of Leveraging Retail Margins: Getting Price Right
Leveraging Retail Margins: Getting Price RightPricing remains a retailer’s biggest margin lever. Yet the potential for getting price wrong has grown exponentially. Price has moved from an art to a science — compelling retailers to find new ways to set and manage prices to attract and retain more customers.
Executive Summary No factor dominates shoppers’ decision-making processes like price. Other influences — products’ intended use, shoppers’ levels of wealth and the degree to which they desire a product — play sup-porting roles, but price is paramount.
So how do retailers win the pricing game?
First, they need to get prices right from the start; getting close is not enough. Today’s shoppers show a high propensity for walking out of stores when prices don’t meet their expectations. Relying on price-matching can be a “too little too late” strategy, and can result in retailers unneces-sarily giving away margin dollars. High-perform-ing retailers base their pricing decisions on their customers’ changing needs, not on the pricing moves made by their lowest-cost competitors.
Second, retailers need to recognize that we are not in a “one price fits all” world, even in today’s environment of ever-increasing price transpar-ency. When it comes to price, most shoppers understand and accept a range of reasonableness determined by product type and use, the timing of a purchase and the level of customer service, and
recognize that the cost to serve can vary. These factors provide the “cover” for such tactics as zone pricing, channel choices and personalized offers.
Finally, retailers can win at pricing by letting tech-nology be their ally. Managing price with outdated methods — intuition, rules of thumb and spread-sheet analyses — no longer works in today’s fast-paced retail environment, which relies on volumi-nous amounts of rapidly changing data. What’s more, the potential penalty for getting price wrong has grown exponentially in terms of lost sales and foregone margins.
Price is Paramount In 2013, Cognizant and RIS News conducted a survey of 2500 shoppers in the United States and Canada1 (see Figure 1, next page). The results showed that price and promotions are the top influencers of in-store purchase decisions. What’s more, price has consistently reigned in the annual survey over the past four years. Product selection is a close second, but with multiple sources available for almost every type of product, selection carries less influence — especially for everyday consumable products.
• Cognizant 20-20 Insights
cognizant 20-20 insights | january 2014
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The same study revealed that price also dominates in the online world. Plus, shoppers cited price as their top reason for “showrooming,” the much talked-about practice in which consumers first browse in physical stores for merchandise they later purchase online — usually at prices they consider more favorable.
Needless to say, getting price wrong poses a major threat to retailers — leading to lost sales for both brick-and-mortar stores and e-tailers. Shoppers have several options when they are dissatisfied with a price. The most popular, according to our survey, is simply leaving the store and purchasing
the product from another retailer — in a physical store or online (see Figure 2).
How can retailers retool their pricing to avoid lost sales? Many are turning to price matching — beefing up in-store technology so store asso-ciates can more easily grant price matches, then heavily promoting the retailer’s new price-matching policies. Anecdotal comments from store personnel and retail executives, however, suggest few shoppers request price matches. Our research echoes those comments, revealing that shoppers send mixed signals on price matching. They identify it as an option they want retailers
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Source: Cognizant and RIS News Fourth Annual Shopper Experience Study Figure 1
Importance of Influencers of In-Store Purchase Decisions
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Source: Cognizant and RIS News Fourth Annual Shopper Experience Study Figure 2
Shopper Responses When Dissatisfied With Price
Purchase the item at the listed price.
Purchase an alternative, cheaperitem available in that store.
Ask an associate to price-match.
Leave the store and look for the sameproduct at a lower price in another store.
Leave the store and look for the sameproduct at a lower price online.
Use your mobile phone to check prices at otherstores and/or e-commerce sites.
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to offer, yet almost 75% had not requested a price match in the preceding three months. For retailers, investing in price-matching policies and the advanced verification and compliance systems to support them is of little use if shoppers won’t take advantage of them.
We believe a better investment is to get the price right from the start. This means setting prices that are consistent with customer expec-tations and that factor in competitors’ prices. Getting price right also requires consistency with retailers’ overall value propositions.
Price transparency has altered retail forever. “In the old world,” said Amazon CEO Jeff Bezos, “you could make a living by hoping that your customer didn’t know whether your price was actually com-petitive. That’s a very tenuous strategy in the new world. [Now] you can’t convince people you have the low price; you actually have to have the low price.2”
But the low-price mantra is just one of many pricing strategies available to retailers. We believe the predictions of a low-price-only environment are premature. Today’s technologies and tools enable retailers to take a more strategic, nuanced approach to managing multiple prices. With zone pricing and smarter selection of key value items, retailers can protect their margins and drive revenues.
The Resurgence of Zone Pricing Zone pricing helps retailers home in on the right price. Yet not long ago, retail analysts were pre-dicting its demise, pointing to the proliferation of easy price comparisons driven by Web apps, shopping services and the like, and forecasting an era ruled by low price. The theory was that retailers would soon have no need to get the price right because there would be only one price everywhere.
Research suggests the opposite is happening: Tech-savvy retailers are becoming more adept at executing on zone pricing and protecting their margins. In the past year, many have increased their investments in zone-pricing capabilities and refined the granularity of their pricing zones. From 2012 to 2013, the number of retailers reporting effective policies for managing cross-channel prices and promotions roughly doubled, from 20-38%, according to a report by Retail Systems Research, a Miami-based research and advisory firm.3
In an environment of increasing price transparen-cy, what’s behind retailers’ growing confidence in their ability to manage multiple prices? We have identified four factors:
1. Consumers understand that the cost to serve differs across markets. It’s more expensive to do business in New York City than in Peoria, and store prices reflect those factors. Consumers may not like that reality, but they accept it. Similarly, the airline industry’s tiered pricing structure has driven consumers’ acceptance of multiple prices. Moreover, most consumers value shopping-experience variables — such as service, selection and return policies — that affect price. They realize that not everything is a commodity.
2. The math is compelling. Pricing is retailers’ biggest margin lever. The margin gains from varying pricing, and from charging higher prices when possible, can often outweigh any lost unit volume.
3. Shoppers are not driving the market to a single price. From an economist’s standpoint, today’s market is closer than ever to being efficient. Yet factors such as need, budget and intended use continue to drive shoppers’ perception of value. What’s more, those factors vary by market, customer base, time and brand. That variability, combined with shoppers’ reluctance to request price matches, produces a complex environment in which shoppers are not forcing the market to set a single price.
4. While shoppers have more information than ever before, so do retailers. Price setting is one of those rare instances in which improvements in retail science and technology have kept up with changes in customer behaviors. Access to price recommendation tools is making it simpler to get the price right, and increasing retailers’ capacity to do more price reviews (both the number and frequency of products). Price-intelligence services provide more localized, competitive prices, and the advent of advanced price optimization and management software makes pricing calculation and admin-istration more efficient and accurate.
Matching Competitors’ Prices: How Close Is Good Enough?Many retailers adopt price matching when com-petition heats up. But price matching is often a race to the bottom that only the largest retailers
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Cumulative Influence on Customer Price Perception
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Source: Revionics retail data analysis Figure 3
can win. Retailers who price-match too often or with too high a percentage of their products can forego margin dollars for no good reason.
A report from Retail Systems Research found that the most successful retailers remain competitive by avoiding battles based solely on price;4 they focus on a broad set of issues, such as protecting the brand image, while less successful organiza-tions focus on competitor pricing.
One of the buzzwords in today’s retail world is personalization. If there are truly “persons” under personalization, then it stands to reason that when it comes to prices, shoppers will accept a reason-able range. Demand-based optimization technolo-gy, which models shopper behavior based on past purchases, can help retailers zero in on that range. This enables retailers to understand shopper price sensitivity and account for behavioral variations across stores, channels and products. By using this technology to exploit price elasticity, retailers can optimize the tradeoffs between margin and revenue, and gain the maximum “credit” for price image, or consumers’ impression of a retailer’s overall price level.
A highly elastic product shows significant swings in demand when its price is changed; the price must be tightly aligned to competitive levels (often meet or beat) in order to generate price-image credit in the shopper’s mind. Low-elasticity products show little change in shopper demand when the price is increased, and have greater price and margin flexibility.
Successful retailers often use optimization tech-nology to better understand consumers’ price perceptions and incorporate those insights into price recommendations. Figure 3 reveals that demand-based methodologies typically find that 15-20% of items drive 80% of shopper price perception. While competitive pricing needs to be sharper for items that drive significant price perception in order to get credit, shoppers allow more flexible pricing for the remaining 80-85% of items. By using a scientific approach to make fact-based decisions, retailers can improve their price image and maximize margin and revenue.
Creating a Price Impression: Is Less Really More?While price matching provides the opportunity to retain customers once they are in the store, price image is often what draws them in. Most retailers rely on key value items (KVIs) to maintain the image of fair pricing across their product lines. KVIs are subsets of retailers’ item assortments that disproportionately influence consumer price perceptions and therefore should be priced more sharply against major competitors. KVIs typically include items that shoppers purchase frequently, such as milk, eggs and bread, in the grocery envi-ronment.
Retailers often sacrifice margin on KVIs with the expectation that they will make it up on other items. The challenge has always been to identify the best KVIs. Regardless of retailers’ size, selection of KVIs has typically been based on an unscientific mix of intuition, anecdotal informa-tion and basic spreadsheet analysis.
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But KVI selection can take on a more data-driven approach as a result of two important changes: shoppers’ increasingly sophisticated, always-connected state and retailers’ ability to track shopper behavior. New technologies make it easier for retailers to choose KVIs based explicitly on shopper behavior and facilitate an expanded and more dynamic selection process — changing seasonally, and by channel and location.
How can retailers measure the effect of KVI selection on customer price perception? Science suggests that the most accurate measurement combines revenue and elasticity — elasticity-weighted dollars. By ranking items based on total dollar volume times item elasticity, a retailer can identify the items about which customers are most price sensitive. The items that top the list are typically the ones that most influence customers’ price perceptions and are therefore the best candidates to be KVIs. Our client work reveals a consistent pattern, and underscores why accurate KVI selection is so important: From 15-20% of items are responsible for 80% of shoppers’ overall price impression.
Traditional KVI selection often results in lists that are both too large — representing 20-30% of revenue — and uniform across stores that serve diverse markets and have different competitors and assortments. In most cases, KVIs are also poorly distributed across categories. Demand-based science suggests KVIs should represent
12-15% of product revenue across all categories. Categories that include more items that influence price perception will have more KVIs than others. Trimming KVI lists can have powerful results: One client, a specialty retailer, reduced its KVIs from 400 to 89 and improved overall gross margins by over 3%.
Retailers also need to manage KVIs by market and channel. Online shoppers can make quick and easy price comparisons, and are often helped by the many apps that can alert them when prices change or when the price of an item has come down to their target. With online shopping, there is no “investment” or “stickiness” that results from physically going to a brick and mortar store, which can lead a shopper to accept a higher price than desired. These behaviors manifest themselves in different price elasticity between channels. A comparison of price elasticity for brick and mortar-only retailers versus e-tailers demonstrates the impact of price transparency; elasticity values are substantially higher in the online channel, and are more densely distributed (see Figure 4).
When selecting KVIs, online retailers should consider market data and online behavioral data such as click streams, crowd-sourced reviews and conversion rates. In general, we find KVI lists for online channels need to be larger than brick and mortar, and updated more than once a year.
Comparing In-Store and Online Price Elasticity
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Source: Revionics retail data analysis Figure 4
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Looking AheadThe retail business grows more complex every day; competitors and customers are adapting faster than ever. Here are four key takeaways about pricing that retailers need to embrace as they plan for the future:
1. If you have a pricing optimization solution (and you really should), trust the science. You need to monitor it and have controls in place to guard against errant results. But don’t second-guess the pricing solution or perform blanket overrides of its results. When recommendations are summarily overridden, overlapping rules and inter-connectedness of items, categories and channels can lead to unintended conse-quences, such as lost revenue and damaged customer perceptions.
2. When it comes to creating a price image, less is more. Maintaining too many KVIs makes it difficult to manage them effectively, and many retailers give away margin where they don’t have to. More important, they risk confusing customers and blurring the image they are trying to maintain.
3. Don’t set and forget KVIs. KVIs must change with shoppers’ behavior. Revisit KVIs once a year, more often if major assortment change impacts revenue or a well-established and low-priced competitor enters the market.
4. Pricing has moved from art to science. Retailers need resources dedicated to pricing, either shoulder to shoulder with buyers/category managers or, as we see at more retailers, in a dedicated price management group.
Footnotes1 Fourth Annual Shopper Experience Study: Rise of the Individual Shopper.
http://www.cognizant.com/InsightsWhitepapers/rise-of-individual-shopper.pdf.
2 http://www.fastcompany.com/3014817/amazon-jeff-bezos.
3 “Tough Love: An In-Depth Look at Retail Pricing Practices,” 2013. http://www.rsrresearch.com/2013/04/08/tough-love-an-in-depth-look-at-retail-pricing-practices/.
4 Ibid.
About the AuthorsGreg Kameika is a Senior Manager with Cognizant Business Consulting’s Retail Practice. He has over 25 years of experience of consulting to retail clients in the areas of pricing, merchandising and inventory management. Greg received his BA from Northwestern University and his MBA from the Kellogg School of Management at Northwestern. He can be reached at [email protected].
Colleen Coleman is an Associate Vice President within Cognizant’s Retail Practice. She has 27 years of experience in retail information technology and a bachelor’s of science in Industrial Engineering from Iowa State University. Colleen can be reached at [email protected].
Karen Dutch is the Senior Vice President of Marketing at Revionics. She has over 25 years of experience in marketing and information technology solutions across a variety of industries including retail, finance/banking, insurance and healthcare. Karen has a bachelor’s of science degree in Computer Science and Mathematics from Duke University. Karen can be reached at [email protected].
About CognizantCognizant (NASDAQ: CTSH) is a leading provider of information technology, consulting, and business process out-sourcing services, dedicated to helping the world’s leading companies build stronger businesses. Headquartered in Teaneck, New Jersey (U.S.), Cognizant combines a passion for client satisfaction, technology innovation, deep industry and business process expertise, and a global, collaborative workforce that embodies the future of work. With over 50 delivery centers worldwide and approximately 166,400 employees as of September 30, 2013, Cognizant is a member of the NASDAQ-100, the S&P 500, the Forbes Global 2000, and the Fortune 500 and is ranked among the top performing and fastest growing companies in the world. Visit us online at www.cognizant.com or follow us on Twitter: Cognizant.
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Acknowledgments This white paper was written with the thoughtful assistance of our business partner, Revionics. Revionics’ end-to-end Merchandise Optimization Solution is the industry’s most powerful — enabling retailers to execute a fact-based omni-channel strategy, optimize financial performance and improve customer satisfaction. Revionics’ solutions leverage advanced predictive analytics and demand-based science to ensure retailers have the right product, price, promotion, placement and space allocation for optimal results across all touch points in the omni-channel shopping episode – online, in-store, social and mobile. Offered on a scalable, high-performance cloud-based SaaS platform, these solutions future-proof retailers from Big Data/Fast Data challenges, while providing speed-to-ROI. Over 37,000 retail locations and US$150+B in annual revenue across grocery, drug, building materials, convenience, general merchandise, discount, sporting goods stores and eCommerce sites optimize with Revionics’ solutions. Revionics has been recognized as a 2012 Deloitte Technology Fast 500™, Red Herring Top 100 Global, Red Herring Top 100 Americas and JMP Securities’ Hot 100 Software Company. For more infor-mation, please visit www.revionics.com.
