Dynamic Pricing in Retail
Aparna Gole Ashish Banka
February 2013 1
Contents I. Definition and Evolution...................................................................................................................... 3 Migration to Dynamic Pricing .......................................................................................................... 3 Early Consumer Reaction ................................................................................................................. 4 II. Development and Strategy ................................................................................................................ 6 Key Determinants ............................................................................................................................ 7 Role of Technology .......................................................................................................................... 8 Expert-speak on Implementation .................................................................................................... 9 III. Mitigating Attempts by Brick-and-Mortar Retailers ....................................................................... 10 Adoption of ‘Favorable Technology’.............................................................................................. 11 Discounted Procurement Cost for Generating the ‘look & feel’ ................................................... 11 Exclusive Sale of Product Only Through Brick-and-Mortar Outlet ................................................ 12 Harmonization of Taxes of Online and Brick-and-Mortar Retailers .............................................. 12 Price Matching ............................................................................................................................... 12 IV. Conclusion ....................................................................................................................................... 13
Table of Figures Infographic 1: Comparison of Dynamic Pricing Mechanism .............................................................. 6 Infographic 2: Analytical Algorithm.................................................................................................... 8 Infographic 3: Comparison of Dynamic Pricing Mechanism ............................................................. 9 Infographic 4: Top 5 Brick-and-Mortar Retailers Most Frequently ‘Showroomed’ ......................... 10 Infographic 5: Top 5 Online Retailers Most Bought from (after ‘Showrooming’)............................ 10 Infographic 6: Proportion of ‘Showrooming’ Customers Eventually Buying from Amazon.com..... 10
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I. Definition and Evolution Pricing is one of the most important strategic decisions for businesses in order to gain market advantage, and is increasingly getting considered as more of an art rather than science given the intuitive, judgemental and psychological aspects that get woven into devising an appropriate and winning pricing strategy. Additionally, pricing is not a static decision anymore, especially for industries like retail, as prices tend to get revised multiple times not just in a week but in a day across varied product categories, particularly in case of online retail that is backed by a strong technological platform. However, the real challenge lies in not pricing the product right anymore; but pricing the product 'consistently right’ in order to achieve the dual objectives of a typical retail business: generate revenues (and thereby enhance or maintain the market share) as well as a healthy bottom-line. Multitude of factors such as cost of procurement or production of a product, expectation of profit margin, equity of the brand, availability of substitutes and complementary products (and their pricing), competitors’ overall pricing strategy, definition and availability of various SKU sizes by the retailer or its competition affect the pricing of a particular product, making it increasingly complex in today’s era. This paper delves into the pricing world of retailers and their customers, and helps address some of the pressing issues faced by them.
Migration to Dynamic Pricing Over the years, retailers have evolved in terms of their understanding of customers and their ability to ‘customize’ price for a particular customer or customer segment or price discriminate profitably. Additionally, technology has been a great help; its advancement and ability to make sense of the massive data churned out every day has further bolstered these abilities of the retailers. Here’s a quick look at the price discrimination strategies employed by the retailers: 1. First-degree Price Discrimination a. It exists when a seller is able to sell the entire quantity of a product (/s) held for the highest possible price that the buyer(s) is willing and able to pay. Almost auction-like in the format, this discrimination ensures that the entire surplus of goods that the seller has, gets transferred to the buyer(s) b. An instance of implementation of this strategy would be when a high-end retailer is pricing a limited edition of collectors’ items or when a salesman in a used-car showroom is assessing a customer’s income appetite and pitching a custom price range based on that c. While this strategy is implemented at large by most online retailers, according to Alessandro Acquisti (Assistant Professor of Information Technology and Public Policy at Carnegie Mellon University), it is the least appreciated strategy by consumers as online merchants who use a customer's purchase history and data on comparison shopping behaviour to determine prices are especially vulnerable to bad publicity and consumer alienation
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2. Second-degree Price Discrimination (Block Pricing) a. It takes place when a seller charges different prices for different quantities of produce sold. ‘Buy-two-get-one-free’ offers, special pricing for bulk purchases (or purchases over a certain quantity of produce), etc. denote this type of pricing discrimination b. It is made possible because of the fact that different quantities are purchased by different types of buyers, with their varied demand elasticities c. Since disparate behaviour is displayed by different buyers when given a bulk or volume discount for the same product, many retailers have ended up embracing this strategy and today, implementation of this strategy can be seen in various optimal forms in the marketplace 3. Third-degree Price Discrimination (Dynamic Pricing) a. This is a practice of charging different price to different consumers for the same product at a particular point in time b. An example of implementation of this strategy could be when special discounts are offered to certain groups: say senior citizens, students, military personnel or women in a certain age bracket. Quick service restaurants, cinema halls as well as multiple retail outlets are seen implementing this type of price discrimination at varied levels of efficiency c. In case of online retail, this discrimination thrives on the premise that using personal information about the customer will help define a successful pricing strategy. Abounding usage of internet that gives retailers an opportunity to amass detail about customers’ personal information and buying habits helps implementation of this strategy easier and more economical too
Early Consumer Reaction Consumers these days have a lot of information about products, their prices and companies selling them. They have been aided by internet, which has opened the door to them to enjoy ‘comparisonshopping’, making the marketplace extremely transparent and faster. There are different types of customers in the market: some are savvy internet users who indulge in comparing prices on different online fora, some have apps downloaded on their smartphones announcing best deals for the day, some have had themselves registered on price comparison websites like http://www.camelcamelcamel.com or http://www.digitalfolio.com, and some, albeit a small portion, who are yet to understand the all-pervasiveness of internet! The market is full of discerning customers looking for the best bargain, but for some of them monetary value for the time spent in comparison-shopping is too high for the small discount they may be able to achieve! Some customers are brand conscious and may be willing to pay a higher price for the brand association, while some may be willing to pay higher for a more personalized, customized offering. Given the diversity of customers, retailers, especially online retailers, are left with no choice but to upgrade their technology backbone and improve their consumer data analysis skills. An average retailer today is forced to understand the age and income profile of the customer, his / her brand
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consciousness, as well as his / her negotiation appetite in order to change the pricing strategy and, perhaps, also the promotion mechanism targeted at the customer. Needless to say, technologydriven customer profiling and segmentation is important. Brick-and-mortar retailers, known for their fairly standardized pricing framework like HiLo (High Low pricing) or EDLP (EveryDay Low Pricing), desire the pricing flexibility of online retailers with savvy technological platforms. But not all is as easy as it seems in the dynamic world of dynamic pricing either as some of the savviest of the retailers have had their fingers burnt in very recent past: 1.Amazon (y. 2000) a. In September 2000, Amazon experimented with prices of more than half of its top 100 DVDs by attempting to sell them at different prices to different consumers b. Difference between the DVD prices of two customers was about $15 c. Some customers noticed this practice, leading to the news being spread everywhere, and creating a negative impact on Amazon’s reputation d. Amazon was forced to take a defensive step to retain the clientele and refunded or adjusted the differential price premium 2.Coca-Cola (y. 1999) a. Coca-Cola tested dynamic pricing in their vending machines where prices fluctuated according to the temperature of the surrounding environment b. For instance, price of the soft drink was higher where temperature soared and lower where it got colder c. It did not go down well with Coca-Cola’s customers however, and Coca-Cola was forced to abandon the idea 3.Apple (y. 2007) a. Apple iPhone was introduced in June 2007 at a price of $599 in the United States to the consumers who bought it on the launch-day b. Within two months of the launch, Apple cut the price to $399. Early purchasers of iPhone complained, and Apple was forced to announce a cash discount of $100 and a further discount of $100 on the next purchase made by the aggrieved Apple customers
Despite these initial hiccups, most retailers have now mastered the subtle art of price discrimination, which to their benefit, most customers either do not notice, or even if they do, accept it as part of their overall retail experience.
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II. Development and Strategy It would be interesting to understand how development and implementation of Dynamic Pricing takes place today in almost what seems like 24*7 regularity while one knows that changing the price of a product was known to take months or weeks till the very recent past, and also resulted in incurrence of a significant cost - where change and redefinition of prices was achieved by associates of the retailer going to competitors’ retail outlets, understanding their pricing strategy and promotional schemes so that necessary adjustments (such as bargaining with merchandise vendors for lower pricing, bettering supply chain management as well as inventory management to reduce costs, launching quantity discounts or bundling up complementary products, etc.) could be made, leading to the revision of prices downwards. Advancement in internet technology over the years, however, has made it possible for retailers to access the same data in real time and also at a fraction of a cost, especially in case of online retailers where strong technological backbone allows not just loading of own pricing but also monitoring the pricing of competitors’ websites and making suitable changes to own pricing seamlessly. Given that online retailers own and manage a virtual shop, their pricing in most cases is more competitive than that of their brick-and-mortar counterparts, and they even manage to beat online portals of the brick-and-mortar retailers, thanks to the advantages of scale and maturity that they have learnt to operate with, over the years. In addition, technology has allowed sellers to collect detailed data about customers too, which include their buying habits, preferences, negotiation tendencies, monthly and annual spending limits, and even holiday buying behaviour. Online retailers have started using analytical tools on the enormous amount of data collected from millions of customers over millions of transactions (over last few years) to generate significant insight on their customers (and customer clusters) and better their pricing strategies. In addition, Analytical tools that sit on top of this technology and databases have made it possible to deploy algorithms, and monitor all the inputs that go into defining the price of a particular product, for a particular type of customer in a particular location; and then modify it multiple times a day where required! Following inforgraphic is one such example, drawing comparison between sears.com, bestbuy.com and amazon.com: Infographic 1: Comparison of Dynamic Pricing Mechanism A study was conducted by decide.com for The Wall Street Journal to understand dynamic price war amongst online retailers. Decide.com tracked price of a particular make of microwave oven as available from three different online retailers (amazon.com, bestbuy.com and sears.com). As seen, Amazon.com changed price of the microwave oven nine times in one day as against 2 times by bestbuy.com and no change by sears.com
Source: decide.com; wsj.com (September 05, 2012 Article)
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Key Determinants Online retailers tend to use multiple factors to determine the price of a particular product. Some of these factors are as below:
1. Price of the competitor Retailers generally try to attract priceconscious customers by offering them the lowest possible price as compared to their competitors. A buyer also compares price of the product available from different retailers before making a purchase decision. Hence, it is only natural for retailers to continuously monitor the prices of the competitor and match them whenever possible 2. Inventory of the product Inventory of a product available (with self as well as that with competitors) is an important factor for pricing the product as well. This primarily stems from the fact that ready availability of a product for immediate shipping is one of the most important considerations for most buyers a. Inventory with self - tracking this is important as a retailer with high inventory may choose to offload a large part of it at a discounted price, especially in case of perishable or ‘infashion’ items b. Inventory with competitor - tracking this is important as low inventory with the competitor may mean possibility of selling own inventory at a higher price 3. Customer demographic Different customers may pay different price for the same product depending upon their individual preferences, demand elasticity for the product and
their own negotiation capabilities. Some of the factors tracked under this section are: a. Buying history (‘average cart- value’) customers with a higher average cartvalue may tend to expect better pricing or discounting options b. Purchasing power - a loyal customer with higher purchasing power may be indifferent to nominal price differentials, however a value-seeking customer for a particular product may be looking for the best bargain c. Presence of competitor in the vicinity of customer – presence of a brick-andmortar retailer in the same vicinity as the customer may propel an online retailer to match the price or charge lower d. Geography of the customer – customers from remote geographies (with limited retail options) may be charged higher than city dwellers. Tracking of system ip or geographic location, in such cases, is thus important 4. Time of the day Retailers vary price of the product with passage of the day. Some of the retailers provide deep discounts at some particular time of the day in order to increase sales. Analytics provides retailers with insight to arrive at the most favorable time to provide the highest discount
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Role of Technology Technology has provided online retailers with an ability to harness data, sift the data more important to them and then monetise the same by generating useful insights. However, analysing data belonging to millions of customers via their millions of transactions may not be possible without strong analytical framework. An indicative framework typically deployed by most online retailers in order to implement and run ‘analytical algorithms’ is as below:
Infographic 2: Analytical Algorithm
Source: Secondary research, Sutherland analysis
While both online and brick-and-mortar retailers can implement data analytics in their respective organisations, online retailers are able to cash-in on the benefits of dynamic pricing a lot more given the sophistication of their technology platforms and an ability to implement pricing changes and corrections (almost) in real-time
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Expert-speak on Implementation Infographic 3: Comparison of Dynamic pricing mechanism
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III. Mitigating Attempts by Brick-and-Mortar Retailers Brick-and-mortar retailers are feeling the heat due to lower prices offered by online retailers. However, given the limitations imposed by their business model, not many are able to change price of the product as frequently as their online counterparts. Consumers have increasingly started using retail establishments to have a look and feel of the product before looking for a good deal online - a trend often cited as ‘showrooming’. Needless to say, in most cases the order is placed online, on the portal that offers them the lowest price. A survey by Harris Interactive in November 2012 indicates that almost 43% of the shoppers in the US have ‘showroomed’. Almost half the people surveyed have showroomed either at Best Buy or at Walmart, and more than half of the showrooming gains have gone to the online retailer Amazon. Here is a look at the brick-and-mortar stores that are ‘showroomed’ the most, and at the online retailers who seem to benefit the most from ‘showrooming’.
Infographic 4: Top 5 Brick-and-Mortar Retailers Most Frequently ‘Showroomed’
Infographic 5: Top 5 Online Retailers Most Bought From (after ‘showrooming’)
Infographic 6: Proportion of ‘Showrooming’ Customers Eventually Buying from Amazon.com
Given that brick-and-mortar retailers’ top-line is affected by ‘Showrooming’, they are increasingly seeking innovative options to sell to their customers and continue running their stores. Some of the measures deployed by them are as below:
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Adoption of ‘Favorable Technology’ To communicate with customers in real time, brick-and-mortar retailers can either use shopping cart fitted with electronic tracking and information system device or can create smart applications for smartphones and tablets
1. Dynamic shopping cart Retailers can fit their shopping carts with electronic tracking and information system device that displays customized information in real time for a particular shopper. The device can also be used for suggesting products to a shopper on the basis of his past data. For instance, a regular customer may be made aware of shampoo plus conditioner offer based on his / her past shopping history 2. Mobile app Making shopping cart dynamic is expensive and requires careful handling, which may not always be possible. Instead, retailers can take advantage of increasing penetration of smartphones and media tablets. For instance, they can get mobile applications created, which can be downloaded by customers on their mobile phones. These applications can provide same level of ‘customized experience’ for a particular customer in terms of offers and promotions, at a much lower cost than a dynamic shopping cart. Researchers at IBM are currently developing an ‘augmented reality-based system’ that makes it possible for consumers to use camera of their smartphone and tablet to pan over a product on the shelf and receive customized information about the product while shopping in a physical store, suggesting that soon enough this experience may well be available at one of the nearest retail outlests.
Discounted Procurement Cost for Generating the ‘look & feel’ A retail outlet provides customers the ‘look and feel’ of a product and helps create brand awareness. Also, sales staff of a retail outlet makes buyers more educated about the product, which the buyer gets for a lower price when he/she switches over and buys online. Hence, brick-and-mortar retailers should negotiate with manufacturers to provide them with a concession for the ‘showrooming’ they offer, possibly in the form of discounted procurement cost or better trade terms.
“What we aren’t willing to do is let onlineonly retailers use our brick-and-mortar stores as a showroom for their products and undercut our prices without making investments, as we do, to proudly display your brands.” - Gregg Steinhafel, CEO, Target
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Exclusive Sale of Product Only Through Brick-and-Mortar Outlet In a move to avoid direct competition with online retailers, brick-and-mortar retailers are getting into agreements with manufacturers to create products exclusively for them. These products would not be sold through any other retailer, be it online or brick-and-mortar. For example, clothing brands such as Missoni and Jason Wu create items only for Target. Toy retailer Toys R Us sells many products that are not available anywhere else. Many brands, additionally, tend to fear that low online price of products devalues their brands and tampers with the image the brands hold. Adidas, for instance, feared that its efforts to create an excellent customer experience across its own stores was getting jeopardized by the online sale on marketplaces like eBay.com and Amazon.com, leading them to withdraw from using these two as a sales channel since January 2013.
Harmonization of Taxes of Online and Brick-and-Mortar Retailers “We have a 5% to 10% price disadvantage compared with online rivals, with some customers using its stores to pick products and then ordering them online to avoid sales tax.� - Scott Mason, Vice President, Lowe’s Cos.
In US, retailers are required to collect only sales tax in states where they have physical presence. Though the law requires consumers to self-report an online purchase and pay tax, the consumers rarely do so. Hence, the consumers who did not report an online purchase save on additional sales tax they need to pay to brick-and-mortar retailers. This additional savings of customers is estimated to cost the US government $23 billion in tax revenue loss each year.
With an aim to increase tax revenue and also to provide a level-playing ground to online and brickand-mortar retail outlets, Republican and Democratic lawmakers in the US reintroduced a legislation that could force online retailers to collect sales taxes, hence favoring the brick-and-mortar stores.
Price Matching As an immediate measure to retain customers, brick-and-mortar retailers (Best Buy and Target) matched prices quoted by online retailers (Amazon.com) for the customers who demanded it, albeit only for a limited period (mostly during holiday shopping). As price matching was done over a limited period and for a limited number of customers, the companies were able to resist profitability leaks. Price matching is, however, not a sustainable option as long as online retailers are at a cost advantage as compared to brick-and-mortar retailers. But a sporadic implementation of this mitigating strategy may help brick-and-mortar retailers retain some of their prized customers.
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IV. Conclusion
Adoption of better technology that is driven by Analytics along with open-mindedness to embrace newer practices to determine the most ideal sales price have helped online retailers march ahead of brick-and-mortar retailers. The measures adopted by brick-and-mortar retailers in response to the challenge posed by the online retailers are (collectively) weak and not likely to generate competitiveness for them. While consumers do not like to be treated differentially in terms of prices, it seems they are coming to accept it as part of life, especially as they are also to gain from the lower prices they may be offered, thanks to the price-war on which the online retailers seem to have embarked upon - not only with the brick-and-mortar retailers but also with other online retailers. In months to come, it will be interesting to see how the brick-and-mortar retailers continue to fight the low-price onslaught unleashed on them by their online counterparts, and continue to survive in order to give the customers the ‘look and feel’ of the products, something that has been their core advantage till now, albeit at a high corresponding cost. But then, that is one strategic advantage that online retailers cannot quite replicate, as yet, continuing to make the physical store an endearing experience for most buyers.
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