Dynamic pricing

Five modules of dynamic pricing

Dynamic pricing plays a crucial role in boosting both consumer price perception and retailer profitability. Many retailers sell about one-fifth of their assortment at very low prices to shape their price image and remain competitive. These key value items (KVIs) are usually top sellers, traffic generators, or highly-searched SKUs whose prices consumers tend to remember. Key-value categories can account for up to 80 percent of an average retailer’s revenue but only half of its profit. The retailer therefore needs to make up margins in the rest of the assortment—the “long tail” items. However, identifying KVIs isn’t as easy as it sounds, and setting and validating prices for long-tail items is difficult precisely because of the sparse historical data on such items.

Dynamic-pricing solutions help retailers overcome both of these challenges. Generally speaking, a robust dynamic-pricing solution should consist of five modules, all working in parallel to generate price

• The long-tail module helps a retailer set the introductory price for new or long-tail items through intelligent product matching—that is, the module determines which data-rich products are comparable to new items (which have no history) or long-tail items (which, as mentioned, have limited historical data).
• The elasticity module uses time-series methods and big data analytics to calculate how a product’s price affects demand, accounting for a wide variety of factors including seasonality, cannibalization, and competitive moves.
• The KVI module estimates how much each product affects consumer price perception, using actual market data rather than consumer surveys. This enables the module to automatically detect changes as to which items consumers perceive as KVIs.
• The competitive-response module recommends price adjustments based on competitor prices updated in real time.
• The omnichannel module coordinates prices among the retailer’s offline and online channels.

While a best-in-class solution includes all five modules, retailers can often begin with only the KVI and competitive-response modules. These help retailers nimbly respond to competitive moves on key items. Retailers can then add the rest of the modules over time.

Developing a world-class dynamic-pricing solution starts with a thorough understanding of the retailer’s business context and objectives, and then translating those into mathematical “recipes” that can be executed repeatedly. Careful selection of the inputs, as well as the sophistication of the underlying analytics, will largely determine the accuracy of each module’s calculations. The tool needs to be flexible and adaptable enough for businesses to customize the inputs and features based on their particular objectives and existing capabilities, which greatly increases confidence in the outputs. And of course, whether category managers and pricing managers will ultimately use the solution in their daily work depends partly on how intuitive the interface is and how easily it integrates into the retailer’s existing systems and work flows.