Pricing and revenue management: Retailers should look at the lessons learned from the airlines industry 20 years ago

Posted by JC Bennavail on

After the "price optimisation" hype of 10 years ago, one can only see that most retailers have not invested in any of the price solutions proposed by the different software vendors, although their operations became significantly more complex and their respective markets much more competitive. Contrary to companies operating in other mass market and service based sectors such as air transport, hotels, retail banking or telecom, our experience shows that only few retail companies have developed and implemented integrated pricing and revenue management processes and dedicated tools aimed at best piloting their performance and achieving their goals.

 

To illustrate this paradox, let’s compare the typical pricing and revenue management processes and tools of a mainstream airline company with the ones from a grocery retailer.

 

Similar markets profile and complex product offering

Both businesses operate in highly competitive and low margin mass markets. The ranges of products or services they offer are very large and the corresponding number of price variables can reach several 100,000s. Many prices changes occur regularly (dynamic pricing) to particularly take into account costs fluctuations, competitor prices variations, or changes in the products’ assortment. In addition, retailers and airlines do rely on frequent promotions to boost the demand.

 

Differences in their respective pricing and revenue management practices

In the last 30 years,  airline companies put in place specific and integrated pricing and revenue management procedures supported by purposely built decision support systems (yield management), aimed at forecasting future sales with respect to the current and future prices and ultimately assisting them in piloting their financial performance. It is interesting to recall that yield/revenue management methods and tools were implemented by airline companies in the mid 80’s following the deregulation of air transport in the late 70’s and the subsequent increase in competitive pressure and the ultimate arrival of low-cost new operators. The early attempts in the 80’s of some historical carriers to “price-out” (aggressive blanket price reductions) some of their competitors failed. The airline companies, which did not adapt their pricing strategy and practices to the market transformations and did not implement revenue management methods, either merged or simply went out of business. Today, pricing and yield/revenue management expertise are certainly recognised as a core asset with which airline companies can successfully pilot their performance.

 

On the contrary, with the exception of technology focused online retailers such as Amazon or eBay, many retailers do not seem to have fully “redesigned” from the ground up their pricing and revenue management processes and made the necessary investments in the suitable expertise and tools, to fully take on board the market and customers behaviour evolutions. Some of the typical symptoms which exemplify the characteristics of an underperforming pricing and revenue management process can be listed as:

 

  1. Pricing and revenue management process by default not by design

Pricing, promotions planning and revenue management processes are not documented and evaluated. KPI’s or benchmarking scores (e.g. sales forecast accuracy, price compliance rates, success rate to achieve targets, etc.) are not regularly calculated to assess the efficiency of the procedures and tools used as well as the quality of the decisions made.

 

  1. No ownership of the pricing process and tools by senior managers

Often senior managers do not take full ownership of the approach, methods, tools, business rules and procedures making up the pricing and revenues management process, whose performance and reliability is not measured and monitored. The pricing function is seen more as an administrative/reporting function than a key lever to pilot performance.

 

  1. Reactive pricing

A pricing process solely focused at evaluating past performance and only reacting to either competitor prices or costs changes for justifying the retailer’s own price moves. The inability of anticipating future demand variations characterising “Reactive Pricing” leads to making underperforming and/or overreacting price changes decisions. Price decisions should be based not only on analysing past performance but also on estimating future revenue and margin calculated from reliable sales forecasts. This can be described as “Proactive Pricing”. The management team is inherently handicapped by having to play the pricing “game” with a systematic and debilitating delayed price move.

 

  1. Simple “cost plus” method to pilot margin rates and profits

Margin rates and profits are only piloted by applying for each product a given margin coefficient to the cost (cost plus). Such a simple approach cannot evaluate the profits variations from either a unit margin change (e.g. price increase) and/or a sales volume increase or decrease, and it cannot optimise the trade-off between high volume/low margin and low volume/high margin products.

 

  1. No reliable sales forecasting process and tool

No implementation of a retail specific demand forecasting tool, taking into account the impact of price and costs changes, promotions, cross-effects, calendar events, seasonal variations over the forecast horizon. Still today, a majority of retailers use last year 12 months sales as a poor surrogate for estimating their future sales volumes, although the products assortment, competitive environment, own and competitor prices, etc. were very much different between then and now.

 

  1. MS Excel - The only pricing tool

MS Excel seems to be the sole pricing tool for many retailers. Many sheets are developed by the pricing team, without much validation of the approach and pricing methods used. The limitations of MS Excel are well documented. To mention just a few: It does not support the implementation of a reliable sales forecasting system or advanced price calculation engine (e.g. RBP) ensuring compliance with both price positioning and financial rules; it does not scale to high volumes of data; it is not multi-user; as the maintenance of numerous sheets requires of lot of manual and repetitive work, it is error prone and time ineffective.

 

  1. No integration of the pricing and promotion evaluation processes

Revenues and margin projections are not systematically and regularly (e.g. weekly) updated, taking into account the impact of price changes, together with planned promotions or changes in the products assortment over the forecast horizon.

 

  1. Price positioning rules and financial targets are not managed together

The lack of reliable retail focused sales forecasts, which formalise the relationship between sales volumes, prices and costs, revenues and profits, prevents the pricing team to proactively validate the coherence between the price positioning rules (pricing strategy) and the financial targets over the forecast horizon.

 

In April 2014, Mr Dalton Philips, Morrisons' boss, likens the shift in the UK grocery market to the changes seen in the airline industry, when new disruptive players - the budget airlines - came on the scene. “The lesson is that once you see this disruption and fragmentation, the clock is not going to be turned back….  And those who felt this was a passing fad or part of the economic cycle and failed to adapt, paid a heavy price."

http://www.bbc.com/news/business-27230767

 

Until recently, large retailers have tried to fight-off adverse market conditions and fend-off much stiffer competition by “investing” massive amount of cash in blanket price reductions programs. For example in the UK:

 

 

 

 

  • January 8, 2015 – “ Tesco confirms wave of price reductions”

http://www.ft.com/intl/cms/s/0/8c09f5f4-96a8-11e4-a83c-00144feabdc0.html#axzz3nsePJea4

 

 

However, although a change of the pricing strategy was required, these considerable and somewhat indiscriminate price cuts, had the prejudicial effect of triggering severe price wars, dragging the whole market down, with no benefits gained. A typical example of knee-jerked “reactive pricing”. Today, the business situation of the UK major retailers do seem to have improved, as illustrated in the Telegraph article referenced below.

 

 

“Three of Britain’s four largest supermarkets cannot afford to make any more price cuts, with sales and profits set to fall for another 12 to 18 months according to a new report by Moody’s. In findings that highlight the pressure on the grocery industry, the credit rating agency said that only Asda has the financial capacity to make more cuts. The “Big Four” of Tesco, Asda, J Sainsbury and Wm Morrison have already committed hundreds of millions of pounds to lowering prices to try to stop falling sales and the rise of Aldi and Lidl. However, although the price cuts have helped to bring back customers and boost spending in supermarkets, it has damaged profitability and not stopped Aldi and Lidl growing. The Moody’s report comes after Sainsbury’s reported a 2.1pc fall in like-for-like sales but claimed the market was in better shape than expected. Analysts at BESI said Sainsbury’s boss Mike Coupe was “appealing for calm” and trying to persuade his rivals not to embark on further rounds of price cuts. Sven Reinke, senior analyst at Moody’s, said: “In a rational market we would expect the pace of cuts to slow because of the impact on the ‘Big Four’s’ margins, which have halved since fiscal 2013/14. “However there is a risk that some market participants will continue to try to defend their market shares by further substantial price cuts, provoking further countermeasures by other ‘Big Four’ retailers in the form of yet more cuts. “Apart from Asda, which arguably has the strongest financial resources of the ‘Big Four’ because it is part of the world’s largest retailer Walmart, none of the other three players really has the capacity to engage in many more rounds of price cuts.”

 

As it happened for the airline industry 30 years ago, retailers will have to develop and implement pricing and revenue management methods, processes and tools, which will give them the ability to pilot their performance, within a much more global and competitive market.

Leave a Reply

Your email address will not be published. Required fields are marked *