Leaving Money on theBy Amy Cortese | Posted 03-01-2002
Trends: Twists on Online Data
Last summer, after running a print ad for a women's midriff T-shirt, Nordstrom got an unexpected heads-up from its online customers. Women shoppers were flocking to the store's Web site to check out what marketing executives at first thought was the T-shirt itself. But when they looked closer, they realized the shoppers were actually asking for the jeweled navel ring the model was wearing in the ad. Not for sale at the time but clearly in demand, Nordstrom execs scrambled to make the ring available online. Then, using its online data about customers to test various prices with a variety of different buyer groups, they priced it to move. The ring rang up fast profits: a lesson in how the Net can make you smarter about both products and price.
To be sure, the Net boom has cooled considerablybut not without upending the staid world of pricing for businesses old and new. Upstarts such as Priceline.com, whose name-your-own-price model once threatened to shift pricing power to buyers, are now only shadows of their former selves, and scores of online bidding B2B exchanges have folded after burning through millions of dollars. But the revolutionary ideas and technologies unleashed by these pioneers live on. Even as the dot-coms crashed, the Internet quietly redefined the way even traditional businesses price goods, in profound and lasting ways.
Now, amid recessionary pressures, company strategists are looking to the Net not just to cut costsbut also to harness their warehouses of customer data, faster computers and new kinds of slice-and-dice software to price their goods more strategicallyonline and off. "Today's economy is pushing people to find every opportunity they can to improve profitability," says Craig Zawada, associate principal at McKinsey & Co. in Pittsburgh. "In the 1990s, most companies attacked cost. Pricing remains one of the few untapped levers." Adds Rashi Glazer, codirector of the Center for Marketing and Technology at the University of California at Berkeley's Haas School of Business: "In a recessionary environment, everyone starts focusing on cost, but the real news is pricing."
Indeed, paying more attention to pricing may be the best thing a company can do in a flat or eroding economy (see chart). Even small adjustments to price can have a big impact: A McKinsey study found that a 1 percent change in price could result in an 8.6 percent change in profitability. By comparison, says Zawada, tinkering with costs has much less impact. A 1 percent improvement in fixed costs generates only a 1.7 percent increase in operating profits, while the same 1 percent improvement in variable costs (including raw materials, labor, etc.) begets a 5.9 percent rise in operating profits. "Price is the largest lever on profitability," he says.
By understanding promotions better, for example, a specialty retailer might be able to drop the price of a $5 item by 10 percent and increase weekly profits by $14,000, says Eric Mitchell, founder and president of the Professional Pricing Society, an association of marketing and pricing executives. Used selectivelyknowing, say, which customers are likely to pay more and whenIT-powered pricing strategies can have a big impact on the company's bottom line. "Price elasticity is all," says David Trounce, a pricing expert with Mercer Management Consulting. "Technology is giving businesses everywhere the option of measuring price elasticity for the first time in an inexpensive and fast way, and many are just starting to take advantage of itfrom promotions to discounts to sticker strategies."
DHL Worldwide, for example, is using customer data and new price analysis software to boost revenues on express-shipping services. "Before, five out of 10 calls to our call center actually booked shipments, so our goal was to improve that to eight out of 10," says Aman Adinew, senior manager of pricing and yield. Armed with customer data, call-service reps were able to tailor prices to individual customers. The result? Shipping revenues are up this year by at least 10 percent, Adinew says.
Ford Motor Co., meanwhile, also is reaping benefits. According to a McKinsey study, Ford expects its digital pricing strategy to significantly improve the yield from the nearly $10 billion it spends annually on promotional pricing. Historically, discount financing and cash-back offers were broadly offered to every customer over a given period of time. The Net, though, is enabling Ford to better track individual customer behavior, and let the company more finely target tailored promotions to specific groups of people. "Differentiating price to target various groups is hard to do offline because visitors to a physical store are a statistical mystery," says McKinsey's Zawada. Online, though, once a customer's segment is identified, a segment-specific price or promotion can be offered immediately, online and off.
But it's not simply about cutting prices to move products. It's also about pricing your products to reflect their different values to different customer groups. And in some cases, that can mean charging more. "Most people think of low price, but it's also about capturing the full perceived value of your product," says Glazer.
In fact, many companies routinely underprice their products, says Robert Drescher, former CEO of Optivo, a San Francisco-based maker of pricing software that closed its doors in October, partly due to its over-reliance on struggling dot-coms as clients. Drescher remains a digital price-strategy believer, and tells of a consumer electronics firm that used Optivo software to test prices for a camera it sold online. The company's two competitors had the same camera priced at $499 and $429 on their Web sites, and its reaction was to match the lowest offer. But the camera cost the company $416, so margins were painfully small. After using the pricing software to test demand for the camera at various prices, the company settled on a price of $479and the impact was significant. Although there was a drop-off in volume, overall sales increased threefold and profits went up fivefold. "Knowing the trade-off between price and quantity allows you to make these decisions," Drescher says.
In the financial services market, where smart pricing is an imperative, credit card pioneer Capital One continues to show the way. It built the firm on technology that can identify the most profitable customers, and then tailor prices to reel them in. The Falls Church, Va.-based financial services firm attributes its 30 percent a year average earnings growth to its information-technology strategy, which exploits the Internet and data mining to respond to changing market conditions and demand. Capital One continually tests the market through mailings and Internet offers to find the right mix of rates and features to appeal to various customer segments: The company is known to conduct more than 64,000 tests a year. On the Internet, the company can analyze a prospective credit card customer and make them an offer in less than 30 seconds. That has helped the company gain some 2.5 million online accounts and add 43 million customers since 199510 million last year alone. Capital One's earnings grew 30 percent in 2001 when most companies were struggling to achieve flat results.
To be sure, Capital One is on the cutting edge of the fledgling pricing revolution. True one-to-one marketing, where companies can tailor prices and promotions and configure products for specific customers at specific times, is still a long way off for most firms. But it's clear that companies married to a conventional view of pricinga sticker price that doesn't change in response to market conditions or business goalscould be at a distinct disadvantage down the line. Says the Pricing Society's Mitchell: "Everyone's done everything they can on the cost side to ride the recession; now they're looking at the top line."
The growing interest in digitally driven pricing strategies can be seen in the surge in new price analysis software companieswith names like Zilliant, KhiMetrics Inc. and ProfitLogicthat promise to help companies reap more profits through pricing. Membership in Mitchell's organization has been growing 25 percent annually and now counts 1,000 members from 400 companiesincluding pricing executives from such companies as Dell Computer Corp. and Capital One.
Indeed, strategic pricing is built on good information and good information systems. "Wal-Mart set out to build a computer, not a store," says Glazer. "Kmart's demise is really a reflection of Wal-Mart having better information and using it to be smarter about pricing."
That's why pricing now demands the CIO's attention. Because pricing systems must be integrated with traditional ERP systems and supply chain software, "you want to get the CIO involved," says Mitchell.
Leaving Money on the
Leaving Money on the Table
Pricing as a strategy is not new, of course. Airlines and hotels began perfecting the art of yield management three decades ago. The goal: to fill as many seats and rooms as possible while charging the highest prices the market would bear. Airlines long ago developed sophisticated software programs to predict demand and set prices, resulting in as many different price points per flight as passengers. But now, thanks to the Internet, the state of the art is changing prices on the fly in response to real-time customer data being captured.
Still, strategic pricing is a relatively untested concept outside the airline, financial and retail industries. In a survey of its members by the Professional Pricing Society, 30 percent of respondents said they priced new products by mirroring their nearest competitors, and another 22 percent set new-product prices to recover costs and tack on a profit. Only 18 percent said they did customer research to determine the value of the product or service to potential customers. And when it comes to Internet pricing, 40 percent said they simply mimic the pricing of their offline sales channels, and 28 percent responded that they don't have an Internet strategy at all.
Why so many laggards? Part of the reason is that the dot-coms, initially not under much pressure to make a profit, ignored their potential for strategic pricingand offered few lessons on how to do interactive pricing well. There was an early assumption among many early e-tailers that they had to compete on pricea preoccupation that led to some famously brutal price wars and directly brought about the demise of many Internet pioneers, says McKinsey's Zawada. Many Internet companies pursued tactics that were ultimately self-defeating, including competing on unsustainably low prices, setting identical prices across all customer groups and failing to change prices in response to changing demand, even though that would have been easy. The result: E-tailers spent marketing dollars in ways that had little direct bearing on profitability. Many e-tailers failed while Americans increased online spending 66 percent in 2000, to $44.5 billion, according to a recent report by the Boston Consulting Group. Adds McKinsey's Zawada: "A lot of that was because they did not use their two-way information power with customers to price strategically."
The lesson? Interactivity is squandered for many companies unless they also use it to manipulate price. And when it comes to pricing, there is much more wiggle room than one may think. In a recent study, Erik Brynjolfsson, codirector of the Center for eBusiness@MIT and professor of management science at the university, found that prices for books and CDs could vary as much as 47 percent across Internet retailers. "Price isn't necessarily the most important thing to online shoppers," he says.
Further, while it's easy to compare prices online with so-called shop-bots and other Web-based technologies, few consumers now take advantage of themfewer than 5 percent of Internet households in a recent McKinsey study. Amazon.com Inc., for example, rarely offers the lowest price for books or music, yet is the number-one online retailer in those categories.
The key, according to pricing experts, lies in integrating online and offline channels. Zawada notes that people used to think about e-commerce as being separate from their business, and many spun off their online operations. But today, it's all about clicks and bricks. "The value is in viewing this as multichannel. Companies should use the online insight they gain for offline pricing," he says. Companies should use the Internet as a "testbed" and "roll the learning across the channels," Zawada says.
The Internet is just the beginning. Some stores are starting to experiment with wireless networks and location-tracking devices. Stop & Shop, the Quincy, Mass.-based grocery chain, is testing "smart carts" in its stores that make use of wireless and location-based technology. Customers can attach a wireless tablet to their shopping carts and scan in their Stop & Shop loyalty cards for access to personalized electronic coupons, shopping lists and details on previous purchases. Marketing vice president Curt Avallone says that eventually, tracking technology in store ceilings could pinpoint a customer's whereabouts and guide shoppers to promotions on items within eyeshot or in the next aisle. The smart carts also have the ability to cross-reference special offers with personal data.
But companies must proceed with caution when experimenting with pricing strategies, to avoid seeming too intrusive or to discriminate unfairly against certain customers. Amazon.com learned that the hard way last year, when its move to offer some customers a deeper discount on DVDs than others erupted into a public relations nightmare.
The ideal strategy? To capture the value of the product or service for a particular customer or customer segment. "There are opportunities to do this in a way that doesn't put the brand at risk and still get the insight," says McKinsey's Zawada. In these profit-pinched times, the bigger risk may be doing nothing at all.
AMY CORTESE writes for a variety of publications, including The New York Times and Business 2.0. She was previously software editor for BusinessWeek and a vice president at Wit Capital. Comments on this story can be sent to firstname.lastname@example.org.
Books and Papers
- Strategy and Tactics of Pricing: A Guide to Profitable Decision Making
By Thomas T. Nagle and Reed K. Holden. Prentice Hall PTR, January 2002
- "Pricing as Entrepreneurial Behavior"
By Minet Schindehutte and Michael H. Morris. Business Horizons: Indiana University Kelley School of Business, JulyAug. 2001, pp. 4148
The Web site of the Professional Pricing Society, a nonprofit organization of pricing and marketing professionals
How some execs set prices now
- 40 % match online prices to those offline
- 30% set all prices by matching rivals
- 28% have no Internet pricing strategy
- 22% set all prices only to recover costs and tack on profit
- 18% do customer research to determine value to buyer
Source: Survey of professional pricing society members
Price changes have the biggest, fastest impact on profits compared with other factors
- + 1% price= profits up 8.6%
- - 1% variable cost = profits up 5.9%
- + 1% volume = profits up 2.8%
- - 1% fixed cost = profits up 1.7%
Source: McKinsey & Co.