August 02, 2004   |   Jason Compton — Trying to protect margins and brand premiums? With the right planning and execution, companies are finding that price optimization software can ease the path to smarter sales and increased profitability.

By eliminating inefficiency, overdiscounting, and inconsistent application of pricing policies, price optimization can improve bottom-line results without strong-arming customers. "Optimization is really about setting the optimal list price that takes into consideration margin, target revenue goals, and market share goals a company has," says Kosin Huang, a senior analyst at The Yankee Group. "It's really about understanding customer elasticity."

In a March 2004 Yankee Group study, 48 percent of respondents in a pool of more than 450 companies indicated that they already use some form of price optimization technology, with another 25 percent planning to buy within the next year. Top adopters include firms in the communications, airline, and chemical manufacturing segments.

But many of these systems are ad hoc implementations from existing CRM or analysis systems, and few adopters are considered masters of the discipline. According to Laura Preslan, CRM research director at AMR Research, fewer than 3 percent of companies are effectively managing, communicating, and enforcing prices today.

At their best, pricing optimization systems provide better customer segmentation (and increased understanding of the value each customer provides to the business), better deal-building engines, improved communication with management and pricing analysts, and better markdown strategies. The improved visibility and reliability of price optimization can reduce reliance on long-term contracts to provide stability in complex markets.

Price optimization is of greatest value to retailers looking to optimize their markdowns, and companies with complex deal structures that give significant pricing and packaging discretion to salespeople, or require specific signoff and approval by sales management. According to Preslan, much of the problem with price execution today is cultural, as salespeople are traditionally rewarded for high volume transactions, rather than highly profitable packages. Technology can reinforce the actual business impact of a deal beyond the gloss of the units-shipped column.

Industry analysts break down the pricing space into subdisciplines of execution or enforcement, optimization, and analysis. Execution focuses on distributing pricing data and rules, and validating that they are being consistently applied across the enterprise. This ensures that the pricing schemes derived by optimization software can actually be implemented in the field. Pricing analysis focuses on measuring the success of optimization plans, generating data that feeds back into the process and helps continually improve the pricing strategies.

Retailers are currently served by optimization leaders like i2 and ProfitLogic, execution specialist CAS, and cross-discipline providers KSS, KhiMetrics, and DemandTec. In broader industries optimization is handled by companies like PROS Revenue Management, Rapt, Zilliant, and Manugistics. Execution specialists typically come from the CRM/ERP space, including Siebel, Oracle, and SAP. Companies like Metreo, Selectica, Vendavo, and Revenue Technologies span two or three disciplines.

Despite the enthusiasm of some early adopters, the total world market for price optimization is considered too small to measure accurately. According to Preslan, price optimization has no true market leader at this time, because it is a fledgling space and there are no formal revenue studies.

Pricing optimization may not come into its own until it becomes a component of larger customer strategy systems. "I definitely see over the course of the next five years the suite vendors, ERP or CRM vendors, starting to get into play," Huang says. "Should [they] acquire one of these companies? It would be very natural to do so."

Huang strongly urges companies serious about pricing to look to pricing optimization technology to provide continuous improvement, rather than engaging with consultants or even on-staff analysts for one-time events: "If you change prices, the market and competitors react; then you react and the cycle continues. Any other company that understands pricing is a dynamic concern will eventually need to take the technology route."