There are two tides emerging in the field of retail pricing – both driven by advances in technology. These opposing forces are pushing retailers in different directions and contributing to confusion related to pricing policies.
The first tide is driven by advances in the retailer’s ability to target pricing, with price optimization software applying advanced algorithms to develop retail prices based on the purchasing behavior of segmented groups of customers and even individuals. Targeted price differentiation capitalizes on localized differences in price elasticity to make seemingly minor changes to prices. Collectively, these changes are capable of having a real impact on the bottom line, with benefit claims ranging from 1.5% to 5% increases in profit.
Over the past 15 to 20 years, advances in computing power together with the application of optimization methods created price optimization software. This type of application was born out of the “yield management” family of programs, originally developed to help airlines maximize profitability by balancing ticket prices and the proportion of seats filled. These programs are responsible for the wide swings in the amount a consumer pays for an airline seat or a rental car, depending on the day of week, time of year, how far in advance they reserve, and other factors. These differences in prices are the subject of widespread complaints among frequent travelers; however, airlines and rental car agencies can get away with the practice for a variety of reasons. Airlines have local monopolies on specific routes or departure times, and rental car companies can differentiate based on service or convenience. Also, business travelers, the backbone of travel industry profitability, are less price sensitive than private travelers. They are more motivated by convenience and will pay more to accommodate their exact scheduling needs. Even without these insulating factors, the practice has become so widespread in the travel industry that customers accept the frustration as a cost of doing business.
Price optimization is now being applied to the retail environment at an accelerating rate. The initial beachhead came in the form of markdown optimization. This functionality is used to help retailers sell excess inventory of unpopular or out-of-season merchandise more efficiently. All retailers carry some amount of obsolete or soon-to-be obsolete goods, but traditionally there was little motivation to pay attention to them. No retail Buyer wants to dwell on his or her mistakes, nor do they like paying attention to the last vestiges of successful programs. Nevertheless, retail executives recognized that better handling of clearance activity could yield increased margins. Markdown optimization was an easy sell to retail executives due to the comparative ease of providing convincing business cases.
Since consumers do not expect clearance prices to be consistent across selling locations or over time, the advent of markdown optimization did not present much of a challenge to customer satisfaction. Markdown optimization routines were free to suggest different prices by location, fluctuating based on local seasonality, customer buying behavior, and inventory levels.
But the original concept of customizing regular retail prices did not originate with the advent of price optimization software. Catalogers tried earlier experiments in targeted pricing with mixed success. Famously, Victoria’s Secret garnered both criticism and customer backlash when it was discovered that catalog prices varied based on the zip code to which the book was mailed. The response was so negative that the company abandoned the practice soon after it became widely known.
This brings us to the second tide in retail pricing…
The second tide is driven by the explosion in customer touch points, thanks to the technology-driven trend toward increased price transparency. Increasingly, shoppers are immersed in retail brands through persistent communication, much of it pertaining to price. The addition of the internet and social media to the traditional stable of messaging vehicles, growing importance of a consistent omnichannel presence, and increasing popularity of in-store pickup programs simply increase the importance of consistency. Creating consistency in messaging related to product offering, brand image and especially pricing, is becoming paramount in driving customer satisfaction. Feedback from consumers through on-line surveys and focus groups increasingly punishes retailers for garbled or inconsistent communication. The worst offense cited by consumers? Pricing inconsistencies.
Given this landscape, how might a retailer tackle the decision about whether to target prices? Here are a couple of factors to keep in mind:
• Retail Business Model – Customers don’t expect product and price consistency from some retail business models. In general, the higher the “treasure hunt” nature of the product offering, the lower the expectation that price will be consistent. Customers are less likely to be upset if they spot the same item at a different price at TJX/Marshall’s or Tuesday Morning than they would be at Best Buy.
• Product Offering – The more commoditized the product offering, the more susceptible it is to price-based competition. Books and other media, for example, are identical from sales outlet to sales outlet, with very little opportunity to differentiate. This leaves retailers with little opportunity to charge more than the lowest prices, unless they can find a way to compete based on other factors, such as convenience or selection.
• Differences In “Cost To Serve” – Customers are willing to pay more in markets in which it is understood that the cost basis for retailers is higher. Customers in Alaska and Hawaii are accustomed to paying more than those in the lower 48 due to higher freight charges. Customers in Manhattan are used to paying more than their neighbors in New Jersey due to higher rents and delivery costs.
• “Low involvement” Purchases – There are certain buying decisions to which customers devote little time and energy. Products bought in this fashion (typically impulse purchases) lend themselves to differential pricing. As an example, consumers are less likely to comparison shop for batteries than for a new refrigerator.
• Ability To Isolate Price Messages To Distinct Customers – No customer wants to feel like a sucker for paying more than the next person. In order to make use of differential pricing, customers should be presented with the same price information wherever and however they look for it. This is more and more difficult in the increasingly transparent omnichannel shopping world. Unfortunately, the mechanisms for isolating customer price messages, such as forcing them to input a zip code before presenting the retail, are still cumbersome and easily foiled by persistent bargain hunters or on-line shopping tools.
So, in a nutshell, a retailer’s decision about whether to pursue targeted pricing must consider and balance these factors: the incremental margin derived from differential prices, the ongoing cost to deploy differentiated pricing, and last but not least, the impact on customer perception should customers become aware of price differentiation.