Leveraging Retail Margins: Getting Price Right

• Cognizant 20-20 Insights
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 supporting 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 unnecessarily giving away margin dollars. High-performing 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 transparency. 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
cognizant 20-20 insights | january 2014
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 technology be their ally. Managing price with outdated
methods — intuition, rules of thumb and spreadsheet analyses — no longer works in today’s fastpaced retail environment, which relies on voluminous 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.
Importance of Influencers of In-Store Purchase Decisions
Competitive prices and promotions
4.5
4.3
Right product selection
Fast, easy check-out
3.9
Quality of customer service
3.9
Ease of returning products
3.8
Visibility and accessibility of product
3.6
Compelling loyalty program
3.5
Other customers’ online ratings and reviews
3.0
2.3
Comments about the product on social media sites
1
2
3
4
5
Source: Cognizant and RIS News Fourth Annual Shopper Experience Study
Figure 1
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 associates can more easily grant price matches,
then heavily promoting the retailer’s new pricematching 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
Shopper Responses When Dissatisfied With Price
Leave the store and look for the same
product at a lower price in another store.
–
38%
–
21%
Ask an associate to price-match.
Leave the store and look for the same
product at a lower price online.
Use your mobile phone to check prices at other
stores and/or e-commerce sites.
Purchase an alternative, cheaper
item available in that store.
–
19%
–
10%
–
8%
–
5%
Purchase the item at the listed price.
–
0%
10%
Source: Cognizant and RIS News Fourth Annual Shopper Experience Study
Figure 2
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20%
30%
40%
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 expectations 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 competitive. 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 predicting 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 crosschannel prices and promotions roughly doubled,
from 20-38%, according to a report by Retail
Systems Research, a Miami-based research and
advisory firm.3
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In an environment of increasing price transparency, 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 administration more efficient and accurate.
Matching Competitors’ Prices:
How Close Is Good Enough?
Many retailers adopt price matching when competition heats up. But price matching is often a
race to the bottom that only the largest retailers
3
Cumulative Influence on Customer Price Perception
Cumulative Price Perception
100
D
80
C
60
Price sensitivity decreases C->D
enabling more flexible pricing.
B
40
A
20
Price sensitivity increases
B->A requiring sharper
competitive pricings.
0
0
10
20
30
40
50
Percent of items
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 organizations 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 reasonable range. Demand-based optimization technology, 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 priceimage 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.
cognizant 20-20 insights
Successful retailers often use optimization technology 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 environment.
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 information and basic spreadsheet analysis.
4
But KVI selection can take on a more data-driven
approach as a result of two important changes:
shoppers’ increasingly sophisticated, alwaysconnected 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 — elasticityweighted 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. Demandbased 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
Percent of Occurrences
20%
15%
10%
5%
0%
0.6
0.8
1
1.2
1.4
1.6
1.8
Price Elasticity Value
Brick and Mortar
Online
Source: Revionics retail data analysis
Figure 4
cognizant 20-20 insights
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2.0
2.2
2.4
2.6
Looking Ahead
The 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 secondguess 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 consequences, 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.
Footnotes
1
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 Authors
Greg 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].
cognizant 20-20 insights
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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 information, please visit www.revionics.com.
About Cognizant
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and fastest growing companies in the world. Visit us online at www.cognizant.com or follow us on Twitter: Cognizant.
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