20 Nov What is Price Optimization and Management?
What is Price Optimization
Price optimization and price management are terms that often are used interchangeably, but they are not the same thing.
When used properly, both price management and price optimization can substantially affect a retailer’s profitability.
So, what exactly is price optimization and why is it so impactful to retailers?
This article will give you a distinct understanding of pricing optimization, the challenges and constraints involved in optimizing retail prices, and the price optimization strategies that leading retailers are employing today to stay ahead.
What is price optimization for retailers?
Before we go any further it is important to make a clear distinction between price management and price optimization:
Price optimization is the process of identifying the optimal price point for any given product at any given location that will yield the highest profit.
Price management is the process of setting prices, communicating changes through the organization, and updating pricing as things change in the business.
You can manage prices without optimizing them, but you run the risk of poor margins, higher costs, and downstream inventory challenges (markdowns, out-of-stocks, etc.).
You cannot optimize prices without managing them, however. Identifying the optimal price for each product is not enough — because you also need the process and infrastructure to apply those changes across your organization (change prices on your eCommerce, apply new stickers and price tags throughout your stores, etc.).
Price optimization is a very powerful and impactful lever in retail
A small change in price can have a very powerful impact on your business. According to McKinsey Research:
“Pricing right is the fastest and most effective way for managers to increase profits. Consider the average income statement of an S&P 1500 company: a price rise of 1 percent, if volumes remained stable, would generate an 8 percent increase in operating profits”
Retailers need to understand that on top of the influence pricing has over profitability, the price will also affect consumer demand, inventory levels, margins, costs, and even brand image.
Challenges and constraints involved with retail price optimization
To understand the challenges and constraints faced when implementing retail price optimization let us look at a simplified example:
Option 1: The graph below shows that if you offer a product at the low price of $10 (Perhaps at a discount store), you might sell 100 units and make a revenue of $1000.
Option 2: On the other side of the pricing spectrum (perhaps at an exclusive luxury brand), you can set the high price of $100, which will lower demand to only 10 sales, but will still get you $1,000 in revenue.
Option 3: If you want to find the “optimal price” that makes the most amount of revenue, you will choose the price at the peak of the curve below. In our example, this would be $50, increasing demand to 62 sales which would yield $3,100 in revenue.
In this simplified example, the retailer would more than triple revenue by identifying the optimal price for this specific product.
However, finding the optimal price is not that simple.
There are many constraints that will limit your ability to set a certain price. Each product will have several attributes and factors that need to be accounted for when setting prices that are specific to that product. Moreover, there are several dynamic variables that change over time that also affect the pricing decisions.
Here are a few example considerations for optimizing your prices
Price Elasticity of Demand
This is how consumer demand will react to a change in price. Some products will have a much more dramatic change in demand as the price changes.
In today’s digital age, shoppers can easily compare the price of the same or similar product that your competition offers, both in other stores and online. This is how you measure up against the competition for a comparable product. (You may want to be below, the same, or above the competition)
What time of the year you are selling the product will also matter. For example, a teddy bear with the words “Be my valentine” will be in much greater demand around Valentine’s Day as opposed to any other day and can therefore be sold for a higher price.
Product Demand Cannibalization
By lowering the price of one product, you will be driving demand away from other similar products on your shelf. Changing prices without accounting for related merchandise and family products is counterproductive.
But there are many more pricing optimization factors, including:
- Price zones & store types
- Vendor Cost Changes or Manufacturer Suggested Pricing
- Promotional and Markdown Pricing
- Different Sizes, multi-packs, and white label products
- Inventory availability
- Demand forecast
- Fulfillment methods
- Unique business-specific constraints and preferences.
Manually accounting for all these dynamic constraints for thousands of products at hundreds of locations is physically impossible to do while maintaining high accuracy. This is why most retailers choose to generalize these decisions at a high level (that is to say, for an entire category or subcategory). These one-size-fits-all approaches lead to poor pricing decisions.
Today’s most successful retailers leverage advanced analytics and retail AI for price optimization to get ahead of the competition.
Advanced analytics and strategies for price optimization
Advanced price optimization software can make a world of a difference. Advanced software such as Retalon’s PPMO software is specifically designed for unified commerce retailers operating in the modern retail landscape. This system accurately optimizes pricing as the product travels through the entire product life cycle:
From setting initial pricing when the product is introduced to accounting for all the factors mentioned above (and more) during the regular season to yield optimal revenue, and finally to optimizing promotions and markdowns at the end of the season for the highest possible GMROI.
This approach not only offers more profitability but also automates a lot of the price optimization and price management process for you which means lower resource costs and lots of time savings.
The good news is that it is much easier to get started than it would appear. As complex as advanced analytics may sound, this all happens in the background while users work with very intuitive and in-sight rich dashboards.
Experience Retalon’s Price Optimization software for yourself.
Book a personalized demo with our team.