As we continue collaborating on our Point of View (POV) focusing on executive leadership involvement and sponsorship in strategic retail solution implementations, we have identified some nuances relative to specific solution areas. With blurring lines between channels and geographies, Price Optimization solutions are an area of increasing interest to the retail community, and which can bring immense value if properly assimilated and leveraged in a company’s business environment. In this week’s blog, we talk about one area where executive involvement is critical to achieve the best outcomes from a Price Optimization solution implementation: the trade off between margin rates and margin dollars.
You may have experienced the phenomenon of senior leaders, board members and the investment community being too focused on margin rate – sometimes to the exclusion of margin dollars. This seems to make little sense, since shareholder returns are based on margin dollars, not rate. Playing devil’s advocate, however, it is somewhat understandable, since a trend of erosion in margin rates can be a symptom of a sick business that is attempting to buy sales with discounts.
Yet price optimization derives value from the trade-off between margin rate and dollars. Executives that do not internalize this, frequently fail to move forward with price decreases due to concerns about margin erosion and end up only accepting price increases. This practice leaves profit dollars on the table, since price optimization tools analyze the relationship between margin and price and suggest changes that maximize overall margin. In some cases the retailer must lower the retail price and reduce the margin rate to capture more potential margin dollars.
Furthermore, many budgeting processes exacerbate this, as margin rate increases tend to be allocated to merchants and categories relatively evenly, without taking into account the different margin and elasticity characteristics of different categories.
As an example, if the company target is a 3% increase in margin rate, not every category should be challenged with a 3% increase. Some should be higher and some should be lower, based on the elasticity characteristics of the category.
Instead of this type of “peanut butter” budgeting (evenly spreading across all categories and items), margin increases should be allocated more thoughtfully, based on knowledge of ability to manage product costs and price elasticity characteristics.
Budgeting and metrics also tie to the incentive system. Personal performance goals may need to be adjusted to de-emphasize margin rate and incentivize collaboration to ensure that behavior is aligned with desired outcomes.
Failure to understand these dynamics and thus the power of pricing solutions at the leadership level, can lead to uncompetitive pricing and can harm brand price perception.