Priced to Sell: Balancing Supply and Demand Through Dynamic Pricing
What could it mean to your company to ensure that everytime something was sold it was at the right price to maximize profits, considering all of the relevant issues? Issues like product availability, lifecycles, competing prices, supply chain costs, and other important factors can now be systematically evaluated through a new breed of software called dynamic pricing or revenue optimization. This new software translates into big bottom-line results, too - as much as 20-30% improvement in profits.
An Old Idea in a New Industry
While dynamic pricing systems have been used for a number for years by airlines and similar industries to maximize the "yield" of perishable commodities, like passenger seats, what's new is using the idea to sell products. In the realm of products, a lot has been written recently about the use of dynamic pricing ideas to power e-commerce exchanges and auctions. While these e-commerce applications certainly benefit from dynamic pricing tools, we are not strictly talking about them here. Instead, we are talking about the more common and routine pricing decisions that companies make by the thousands every day, the ones that occur almost anytime there is a customer interaction of any type. What we are talking about is how to manage not only revenue with pricing decisions, but also how to positively influence the entire company, particularly how to balance supply and demand. Following are two examples that may clarify how different it is from traditional approaches to pricing:
Setting Prices for Specific Models and Options
A major computer manufacturer uses dynamic pricing to set prices for specific models and options. Adjusting prices is something every computer company does, but this one reviews every price for every model every week. Also, it sometimes raises prices for specific items, while most companies only lower them, as a model gets older and older. What is also different is that pricing decisions are partly driven by looking at available supplies, not just of finished computers, but also of basic components and added options. When supplies are higher than planned, it lowers prices more. Conversely, if component supplies are constrained, it may hold prices at higher levels, or even raise them. In other words, prices are set to sell what it can make. Making these complex decisions on a weekly basis, for hundreds of models and options, takes powerful systems that can make recommendations that consider thousands of factors. Doing that by hand is simply impractical and it gives this computer maker a distinct competitive advantage.
Making Dynamic Offers to Consumers Right at the Point of Sale
Another more mundane example requires even more dynamic tools. One quick-serve restaurant chain is currently piloting the ability to make dynamic offers to consumers right at the point of sale. Instead of simply giving coin change for their order, in some cases the consumer is offered a special price, equal to their change, for an additional item: a bag of fries, or a drink, for example. Since increasing the average ticket price in the restaurant is a powerful lever on profitability, everyone wins and sales can increase by six to eight percent. To make such a decision they consider the costs of items, their inventory of them and its age, together with compatibility of items already on the order. All of the thinking is done right inside the cash register.
As these examples show, there is a wide range of possible applications for dynamic pricing. In a sense the ideas described above represent the ultimate in a market-based, supply versus demand economy. What's more important is prices are adjusted specifically to manage demand for specific products, not only to raise revenues, but also to better ensure that the right balance is achieved among supply, demand, and price. The companies that can do this end the day with less waste, less obsolete product, and fewer unusable raw materials, in addition to being more certain that revenues have not bee "left on the table." Which companies can benefit most from these pricing ideas?
Is Dynamic Pricing Right for Me?
There are at least five dimensions of a business that need to be considered to define the opportunity and potential approach to dynamic pricing:
o Uniqueness of the product - The more common a product, the less tolerant buyers will be to prices above the perceived "market" price, yet the more important it is that informed decisions are made about long-term price commitments.
o Life span of the product - The shorter the lifetime of a product the higher the cost of making mistakes about anticipated demand, either missing revenue opportunities for high-demand items, or being stuck with too much obsolete product.
o Frequency of expected price change - Some markets, particularly for custom-made products, are attuned to prices being quoted case-by-case; while others expect published prices to persist for some time, potentially limiting flexibility.
o Bundling of product and service - The more components of product and service are joined in a transaction the more complex decisions are and the more opportunity there is to segment customers according to their needs.
o Customer risk sensitivity - The more disparity of risk tolerance among customers, the more likely it is that there is value in customer segmentation, and because highly risk-adverse customers want longer term pricing, the greater the need for sophisticated analysis of those decisions.
In general, the more complex and more frequent are pricing decisions, the more important it is to have the type of intelligence that pricing software can provide. The truly good news for many companies is that the software to make these complex decisions is commercially available and is being tailored to address an ever-broader range of pricing situations. Three companies in particular focus on solutions for dynamic pricing: Talus (now part of Manugistics), PROS Revenue Management, and Maxager. Of the three, Manugistics has taken the boldest steps to incorporate pricing decisions into its complete end-to-end supply chain management solution, calling it EPO, Enterprise Profit Optimization.
Conclusion
There are still a few gaps in these solutions that are important to complex manufacturers. Forrester Research identified them as:
o Inability to consider upstream capacity constraints among suppliers
o Difficulty in acquiring and aggregating an entire market's demand data
o Imbedding a customer's lifetime value in pricing decisions
Of course, there are also challenges, as always, of changing a company's way of doing business. However the pay-off can be very big. AMR Research estimated that U.S. products companies could create $95 billion in profits with dynamic pricing, surely making it one of the important topics for America's CEOs, particularly if their competitors are already doing it.
