Software That Delivers Pricing Power
When Northern Group Retail, a Canadian chain of women's and children's apparel stores, split from Foot Locker (FL ) in 2001, it faced the daunting task of setting up its own computer systems. It spent most of its loot on essential tech projects, says Michael Stanek, Northern's chief financial officer. The retailer didn't have a lot left over for bells and whistles, but it did sign on to use software from Cambridge (Mass.)-based ProfitLogic, which promised to improve the profitability of marked-down merchandise.
The results have been striking. Nearly two years after installing the software, Stanek figures the technology helped Northern reach its goal of a 4% gross margin improvement. Northern also is carrying less inventory and is seldom out of stock on popular items.
Last December, when the business planned to put children's outerwear on sale, Stanek says ProfitLogic's software advised waiting several weeks. The difference was $100,000 in profit that would have been lost had the retailer stuck to its original plan. On average, ProfitLogic figures its software can improve a retailer's gross margin by 5% to 15%.
These kinds of improvements are too good to ignore. Indeed, all large retailers have an initiative of some kind -- from experimental stage to advanced -- to improve the way they price their merchandise. As a result, a niche industry of "smart pricing" has emerged. Today, software and infrastructure outfits sell a range of products aimed at squeezing the most out of prices -- from the day products are put on the shelf to the moment they hit the discount bin.
Surprisingly, taking a scientific approach to pricing is a relatively new priority for retailers. The computing power to comb through their vast troves of transaction data has only recently become affordable. But pricing is clearly an area ripe for financial improvement, says Scott Langdoc, retail analyst at AMR Research in Boston "If you can recoup more dollars by reducing or marking down products less frequently, you'll receive more margin long term," he says. Langdoc estimates the market for smart-pricing technology will be in the ballpark of $300 million to $450 million in 2007, up from about $75 million in 2003.
One of the most appealing approaches is so-called markdown optimization. This is considered low-hanging fruit -- the kind of technology change that can yield quick results -- by wringing as much profit out of marked-down merchandise as possible, with little disruption. The leader in this sector is ProfitLogic, which has 22 retail clients, most of which do a big business in apparel where merchandise is particularly prone to markdowns. ProfitLogic's software takes all the myriad pieces of information generated by each cash-register transaction and, by applying sophisticated number-crunching, "finds patterns of consumer demand in the data," says Scott Friend, president and co-founder.
J.C. Penney (JCP ) is a prime example of what markdown optimization can do for a retailer. In 2000, the department store, after years of losing market share, set out to turn itself around. One key step was to centralize its inventory management, so it also signed on with ProfitLogic. During the 2002 holiday season, J.C. Penney discounted considerably -- but still managed to turn in better results than many other department stores, says IDC analyst Chris Boone.
While ProfitLogic has become the markdown specialist, Friend recognizes that his industry is headed toward one-stop shopping -- software providers that can improve all phases of a product's price. Retailers are anxious to price goods at the right level long before they end up in the clearance section. That means deeper and more complicated tech changes. To provide this capability, ProfitLogic recently acquired Spotlight Solutions, a competitor with promotions-optimization software, which uses a retailer's sales history to figure out which items to put on sale. The idea is to promote items that will spur additional sales.
Several companies, including Khimetrics, DemandTec, and i2 are establishing themselves as experts in setting initial product prices and promotions optimization. So far, these software makers are working with retailers like grocery chains and drugstores, which have less of a markdown business but are highly price-competitive day-to-day. "The value [of these technologies] on margin improvement and sales can be as dramatic as with markdown optimization," says Langdoc. So far, these software makers don't compete directly with the likes of ProfitLogic, which is known for its markdown tool.
Certainly, discounts aren't a big factor in supermarkets, but daily price competition is. In recent years, big grocers have come under intense pressure from Wal-Mart's (WMT ) superlow prices. To better compete, many have turned to technology to improve their pricing and promotions. Albertson's (ABS ) has adopted Scottsdale (Ariz.)-based Khimetrics' entire suite of pricing software, working to incorporate the new pricing system throughout its 2,300 stores.
In general, retailers notice the financial impact quickly, says Tim Manning, Khimetrics' vice-president for marketing. "We see return on investment exceeding 200%." Manning declines to discuss specific improvements made at Albertson's, but he says in general that its clients see gross profit margin improvements in the range of 3% to 5% and sales increases of 1% to 3%.
Some software makers are beginning to connect pricing trends to earlier points in a retailer's buying and planning stages. For example, Minneapolis-based retail software maker ReTek (RETK ), which is known more for its demand-forecasting software, has recently added capabilities to optimize prices as well. "Now, we can manage price, promotions, and markdown all the way through," says Ali de Kock, product manager for ReTek's pricing division.
Some 100 retailers use ReTek's demand forecasting, and about one-fifth have adopted its pricing-management software. In 2003, ReTek reported earnings before interest, taxes, depreciation, and amortization of $3.7 million on $181 million in revenues.
For retailers, the goal is to make product pricing a larger part of the decision-making process at the supply-chain level. Kevin Sterneckert, general manager of the retail division at DemandTec, whose clients include Radioshack (RSH ) and Longs Drug Stores (LDG ), says its pricing software has the added feature of allowing collaboration between retailers and their suppliers on issues like timing of orders.
Exchanging information is tricky from a competitive standpoint, but Sternerckert says his outfit has it set up so retailers and suppliers are comfortable with the process. "Results can be shared live to help the manufacturer and retailer understand how customers will respond," says Sterneckert.
Not all retailers are on board yet, but they soon will be. The more success stories among those using the technology, the less any retailer can afford to do without pricing optimization.
By Amy Tsao in New York