optimizing everything

Fifteen years ago, a young physicist named KenOuimet saw a strong correlation between the behaviorsof consumers and atoms. The analogy led him to developsoftware based on mathematics developed in theoretical physics that forecasts human buying behavior and incorporatesnew evidence in real time to update the forecast. Thus was priceoptimization software (POS) born.

Today, Ouimet’s software is used by 7-Eleven for pricing products in its stores, a venue he said is well suited to POS becauseconvenience stores provide the kind of high-volume environmentin which it performs best.

Though many people equate optimizing prices with findingthe highest price the customer will pay, Ouimet said the processactually works by lowering margins on some products and raisingthem on others. Many of his clients, 7-Eleven included, reinvestincreased profits in lower prices and use the software to figure out which products, when priced lower, can drive more volume andmore market share.

Results sound dazzling. “When our clients run a pilot programwith the software and measure the results against a control group,the result is a 1% to 2% of sales increase in profit,” Ouimet said.”That’s huge. If you look at a $10 billion retailer, 1% of sales is $100million a year.”

Not everyone advocates POS software for the conveniencechannel. RTG Management Consultant Mark Lilien sees a problem with using it to optimize prices on in-store products becausec-stores typically carry small assortments of merchandise thatremain stable year-round. POS, Lilien observes, was developed tooptimize margins of the far wider array of merchandise carried bydepartment stores faced with cutting prices on merchandise whenit goes out of season.

Customers choose a convenience store because it’s convenient, Lilien is quick to point out, and as long as the prices are in linewith other c-stores in the area few customers will switch stores. “Ifyou price items significantly less than other stores within line ofsight, your competitors will adjust their prices downward and noone will make money,” Lilien said. “If you price upward, peoplewill simply start shopping at the c-store a block away.”

And while he believes c-stores can earn stronger marginsand higher profits from using POS to determine the right pricefor every item, Jon Hauptman, vice president of Willard Bishop,counsels that convenience stores should not view POS software tobe a strategy. “Retailers get the full benefits of price optimizationonly when the system they use supports and enables their owncomprehensive pricing strategy,” Hauptman said. “C-store retailers must develop a pricing strategy that provides the guidelinesthat fuel the optimization engine.”

Loyal following
However, even those who reject the idea of using POS for instore items acknowledge that price optimization has value whenit comes to determining gasoline prices because of gasoline’s highmarket volatility—and convenience store owners using POS toprice gasoline appear to love it unconditionally.

Jeff Miller, president of Miller Oil Co., said that the KSS POSsoftware he’s been using for the past three years has reduced theamount of time spent pricing gasoline by 50%.

“Pricing is something you have to do every day,” said Miller,who operates 40-plus stores in Norfolk, Va. “This software givesyou the ability to manage prices by site and by grade on a dailybasis much more efficiently than you could ever do by hand.”

Dennis Williamson, general manager for Ricker’s Oil, whichwas one of five companies in a pilot program that began testingthe KSS for BP in December of 2005, said that before using POS,his company kept prices the same at the 14 stores near its headquarters in Anderson, Ind. “We were afraid to price differentlyfrom one side of town to the other,” he said. “With KSS, on any given day, I now often have five prices and different price spreadsas well.”

Williamson, who oversees all 30 of Ricker’s convenience stores,said that the software’s algorithm is complicated, but not difficultto manage. “I’m no geek, and I mange 90% of our KSS models,” hesaid. “I used to spend an hour and a half to two hours analyzingpricing information—now it takes me about 15 minutes.”

However, Williamson acknowledges that setting parameters for the program can be quite time-consuming. “The softwarerequires setting up a target profit and a target volume that can subsequently be tweaked more toward margin or volume,” he said.”You watch how it reflects to your competitors—you can actuallylearn that somebody you thought was a competitor isn’t nearly asstrong as you believed.”

Williamson’s managers enter competitors’ prices into the Webbased application. If the software finds a price change is advisable,within two minutes it sends an email or text message notifyingwhere the price needs to be—and if the system perceives an actionit considers necessary that’s outside the set parameters, it notifiesWilliamson that a site needs to be reviewed.

Scott Hartman, president of Rutter’s Farm Stores, consideredusing POS to set gasoline prices and rejected the idea becausehe felt that getting clean data was too difficult without investingmore time than he could justify to determine precisely when competitors’ changed their gas prices.

“You’ve got a price change notification, but timing can be reallycritical to optimizing,” Hartman said. “Did the change happen atmidnight or 6 a.m.? You’d have to know if you want to accuratelyanalyze your prices versus a competitor’s.”

Keeping close tabs on when prices change comes with theterritory today. “C-store owners already collect data on their competitors,” said KSS Vice President of Marketing Lyle Walker. “Ifthe competition begins changing five times per day, it’s the natureof your business—not the nature of the software—that demandsyou check competitors’ prices five times a day.”

Balancing movement and margin

Rather than relying on the “one price fits all buyers” process that price optimization software uses, Jack Finney, vice president of marketing for Retalix, advocates segmenting customers using loyalty software his company will roll out to the c-store market later this year. Finney said that his company’s new software will link customers’ spendingin real time and allow managers to create product promotions that optimize profit margins and avoid the danger of leaving money on the table unnecessarily.

“Our view is that not all shoppers are the same,” Finney said. “About 30% of customers make up 70% of margin and 30% of customers make up 3% of overall revenues.”

Loyalty software shifts the focus from making a price change for a particular item to tailoring prices based on specific knowledge about consumers. “You don’t want to give away margin when you don’t have to,” Finney said. “But giving away some margin in the right way to the right group increases their loyalty and the amounts of money they spend.”

Offering the same product at different prices is already being done with gas cards. Now it’s possible to define and analyze what various customer segments want most to buy by tracking customers’ purchasing DNA in an electronic journal that can drill down the data fast enough to convert purchasing information into pricing intelligence.

Though the technology for loyalty software has been around for years, Finney said that only recently has it become cost-effective for merchants to use, thanks to Web-based programs that can drill data down to degrees that disc-based capacity could never do.

“The average company needs to be able to identify and retain their most profitable customers, to get customers who were spending $15 per week to spend $17,” Finney said. Segmenting customers, following their DNA in the journal and being flexible enou
gh to offer different types of promotion for different types of buying behavior lets you optimize margins instead of prices.

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