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Data Driven Pricing Strategy

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For many years, the science of price elasticity measurement was a solution in search of a problem. At the same time, traditional revenue management was a science with a relatively narrow appeal among …

For many years, the science of price elasticity measurement was a solution in search of a problem. At the same time, traditional revenue management was a science with a relatively narrow appeal among airlines, hotels and similar businesses. Elasticity analytics and revenue management have now intersected in the form of price optimization, driven by real-time competitor data available via automated price shopping. It can work within a much wider range of industries than those traditional travel niches and is a key method to deal with the extreme price transparency created by the Internet and mobile devices everywhere. Best of all, it allows any business to gain an understanding of its true competitors, rather than relying on a few preconceived notions of who the competitors might be. Bill Kotrba, VP of Industry Strategy for JDA Software explains.

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  • 1. Th ought Lea de rshipThe Data-Driven Pricing StrategyCommon Sense and the Latest Technology Unite to DriveBusiness PerformanceBy Bill Kotrba, Vice President of Industry Strategy at JDA Soft wareand Pelin Pekgun-Cakmak, visiting professor at Georgia Tech Universit y S queezed between savvy customers and cutthroat competitors ready to go to war over prices, businesses today face a new reality of pricing transparency. No matter the industry, the pressure on price levels remains unprecedented, and it isn’t going to let up anytime soon. Just as businesses began to grasp how Internet search engines put comparison shopping a click away, mobile devices changed the game all over again. The Internet made it possible for customers to instantly find the lowest prices — and now with mobile devices, the lowest prices can instantly find customers. Mobile and social media alerting have turned price transparency into price hyper-transparency. If businesses aren’t careful about being sucked into the pricing hype, they may do serious damage to their own profit margins by unnecessarily matching a competitor’s unrealistic price. But price transparency is here to stay, and organizations cannot afford to ignore competitors’ rates when setting their own. So, how can companies survive this high-wire balancing act without resorting to blindly matching every price in the marketplace? To turn transparency from a threat into an opportunity, organizations must take a data-driven approach to identify and consider the right competitors at any given time. This requires putting aside gut-feel and preconceptions — and taking a more disciplined, quantitative approach that measures customer responses to price changes, competitors’ price changes, competitive attributes and recurring patterns like seasonal trends.
  • 2. Th ought Lea de rship relative to a full-service competitor down the street. A quantitative comparison revealed that the economy property did not need to price as low as it had been to win business away from the fancier property. Creating a comp set starts by examining the attributes of a potential competitor’s products or services and identifying those that most closely align with the company’s own offering. In the case of hospitality, this might include location, amenities such as a swimming pool or furnishings, customer service and so on. One of the common approaches for identifying a comp set based on attributes is score-based benchmarking1. Starting with a company’s own property as a reference point, assigned a baseline score of zero, the potential competitor’s individual attributes are then scored with positive or negative values. For example, if the competition has a swimming pool and the baseline company does not, then the competitor might be assigned a “+2” score in that category. Conversely, if the competitor does not haveDeveloping the Right Competitor Set turndown service and the baseline company does, theNot all competitors are created equal. Nothing throws more competitor might receive a “-2” score. Add all the attributivemoney down the drain than price matching against an scores for each competitor, and those competitors whoseorganization that is not a true competitor. Unfortunately, total scores come closest to zero are those who best alignidentifying “true” competitors can be a real challenge as candidates for the attribute-based comp set.when comparing historical price and sales data againstconventional “wisdom” within an organization. An attribute-based comp set can also be described as a “comparable set,” i.e., properties share the same traits andComparing known market shares and revenue results to a operate similarly2. However, the key to deriving an accuratecompany’s own historical price data will often show that a comp set is identifying the closest substitutable optioncompetitor thought to be significant actually has very little from the customer’s perspective. This provides a moreimpact on market share or influence on product demand. nuanced and accurate comparison matrix as opposed toThe bigger the gap between what gut-feel identifies as simply sorting competitors into broad categories suchthe competition and what the data says to refute that as “economy” or “luxury” based on product attributes. Inassessment, the more important it is that a company start a recent hospitality study by Cornell University, a clusterlistening to the numbers. A wrong choice can lead to analysis of the average daily rate (ADR) of properties in onecostly pricing decisions down the line and missed revenue urban area in the U.S. has revealed that upscale propertiesopportunities. That’s why the development of an accurate were directly competing with economy properties due tocompetitor set, or comp set, is fundamental. And by the discrepancy between their intended product type andutilizing publicly available price information captured from customer perception on their competitive position. Thisthe Web, it’s also become easier. When properly quantified, study further alludes to the fact that identifying the correctan accurate comp set is the key to identifying a business’ comp set should consider not only product attributes butown optimal price and can enable advanced software tools also pricing and demand patterns3.like price optimization. Price optimization can find thepricing “sweet spot” by identifying opportunities to priceabove or below the competition and ultimately generatethe most revenue. 1 “Revenue Management, A Business Process Approach” by V. Edwards, AlbertaDeveloping the comp set in a systematic manner can Hospitality; “Harnessing the power of value proposition” by P. Mayock, HotelNewsNow.com, April 2010.decrease common pricing mistakes that result from 2 “Do you have the right comp set?” by G. Hartmann, HotelNewsNow.com,following conventional wisdom or gut feel. For example, June 2010.JDA Software has encountered hospitality clients with 3 “Product Tiers and ADR Clusters: Integrating Two Methods for Determiningeconomy properties that were excessively under-pricing Hotel Competitive Sets” by J. Kim and L. Canina (2009), Cornell Hospitality Report, Vol. 9, No.14.
  • 3. Th ought Lea de rshipMarket Reference Price is Key properties due to an added service or a better location. It is possible to calculate a specific price differential andTraditionally, pricing decisions were almost always still evaluate the two competitors. For example, strengthbased on what customers were willing to pay in the past, positioning enables a company to factor in that a specificcombined with comparisons to local competitors. Hyper- competitor is commonly $50 more than its own rate,transparency has changed all of that. As the competitors’ so before computing the market reference price, thatprices fluctuate more rapidly than ever, a company must competitor’s rate is adjusted down by $50 to make thebe nimble enough to change with them — or not change properties comparable. By doing so, the comp set canat all if that is what an optimal pricing strategy dictates. continue to be refined for more accurate results, as thisAccomplishing this requires both an accurate comp set will often change the mix of competitors.and an estimation of customers’ willingness to pay giventhe prices that the comp set is charging, which we refer Strength positioning isn’t the only special factor that mustto as the market reference price. This price represents the be considered while developing the market referenceprevailing comparison point that customers have in mind price. In industries such as hospitality and transportation,when weighing alternative choices and prices. seasonal changes may also affect the competitor set — and therefore the market reference price. In these cases, it isA market reference price, based on an accurate comp set, critical that a company analyze price-shop trends based onis a critical input to the process of identifying the price that season, which may include weekday vs. weekend patterns,generates maximum revenue and profit. Fortunately, this to statistically identify which competitors have pricingis where transparency and e-commerce make this process strategies most similar to the company’s own and adjusteasier than it used to be. Screen-scraping tools available comp sets accordingly. Without making those adjustments,from companies like Rubicon Group, QL2 Software, the company is likely to make incorrect pricing conclusionsRateGain, etc., collect automated price shops from the throughout the ebb and flow of the year.Internet making it easy to gather competitor pricing andeffectively establish a market reference price at specificpoints in time. For example, a digital picture frame may It Starts With Clean Datahave a list price of $149, but if four competitors price it While automated Internet price shops have certainlyat $140, $136, $134 and $130, respectively, a customer’s provided a significant amount of intelligence uponperception of the product price would be on average which to make informed decisions, it is important to$136. In this case, the market reference price can be also remember not to follow this data blindly. Very oftenestimated as $136. screen-scraped prices will need to be cleaned up based on a number of factors. For example, there may be holes inA market reference price should take into account the the data when there is no available product or service fordynamic nature of prices over time, comparing the price a particular price shop. If a hospitality competitor sells outof a service or product across alternatives, and ultimately of rooms on a certain date, then there is nothing to baseoffering insight into the elasticity of demand (i.e., demand assumptions upon. In these cases, it is crucial to createmeasured as a function of a company’s own prices and viable assumptions to algorithmically fill in these gaps assimultaneous competitor prices for comparable products accurately as possible.or services). In other instances, there may be pricing outliers thatStrength Positioning and Seasonality decisions should not be based upon. These include deep discounts or statistically erratic prices. In those instances, itIn most instances, calculating a market reference price is also pays to have logic built into the system that can scrubrarely as simple as the case of the digital picture frame. the data so it doesn’t skew the results.While making these comparisons and refining comp sets,often a stronger or weaker competitor might still standas a substitutable option in the customers’ eyes. These “We’ll Match Any Price – Unless Ourcompetitors may be better or worse than the baseline Elasticity Models Say We Shouldn’t”company in one or more characteristics. These attributes It’s not a great marketing slogan, but it is an extremelycan be associated with a certain price differential to valuable business practice. Armed with a properly quantifiedadjust the competitors’ prices when calculating a market competitive set and the latest price optimization technology,reference price using strength positioning. a company can learn which prices and competitors are relevant and which ones can be ignored.Returning to the hospitality example, suppose there areseveral factors that create a differential between two
  • 4. Th ought Lea de rshipWhen a company stops chasing those irrelevant competitors, About JDA Software Group, Inc.it will also stop leaving money on the table. This extramoney in the cash register is a direct reflection of the real JDA® Software Group, Inc. (NASDAQ: JDAS), The Supplyresults that come from this new competitive posture. Chain Company®, is a leading provider of innovative supply chain management, merchandising and pricing excellenceBy understanding the correct set of real competitors in solutions. JDA empowers more than 6,000 companies of alla specific market, automated price shops can provide sizes to make optimal decisions that improve profitabilitya market reference price — a point of comparison that and achieve real results in the discrete and processenables revenue-maximizing responses to changes in manufacturing, wholesale distribution, transportation,competitor prices. The question is no longer how much to retail and services industries. With an integrated solutionscharge, but how much to charge relative to the measured offering that spans the entire supply chain from materialscomp set given the elasticity of demand and a number to the consumer, JDA leverages the powerful heritageof other factors such as demand forecasts, remaining and knowledge capital of acquired market leadersinventory, business rules, etc. including i2 Technologies®, Manugistics®, E3®, Intactix® and Arthur®. JDA’s multiple service options, delivered viaFor many years, the science of price elasticity measurement the JDA® Private Cloud, provide customers with flexiblewas a solution in search of a problem. At the same configurations, rapid time-to-value, lower total cost oftime, traditional revenue management was a science ownership and 24/7 functional and technical support andwith a relatively narrow appeal among airlines, hotels expertise.and similar businesses. Elasticity analytics and revenuemanagement have now intersected in the form of priceoptimization, driven by real-time competitor data availablevia automated price shopping. It can work within a muchwider range of industries than those traditional travelniches and is a key method to deal with the extreme price Bill Kotrba servestransparency created by the Internet and mobile devices as vice president ofeverywhere. Best of all, it allows any business to gain an industry strategyunderstanding of its true competitors, rather than relying in JDA Software’son a few preconceived notions of who the competitors Pricing and Revenuemight be. Management Group. He is responsible for overseeing strategicAbout JDA Pricing and Revenue business initiatives for the leisure travelManagement Group and hospitality industries.JDA Pricing and Revenue Management Group, a globalbusiness unit within JDA Software, is a leading providerof Price Sensitive Revenue Management™ solutions thathelp companies improve profits by balancing supplyand demand through innovative forecasting, pricing andrevenue management. For more than 25 years, companies Pelin Pekgun-Cakmakin the travel, transportation, hospitality and media is a Visiting Assistantindustries have benefited from the ongoing innovation Professor in the H.and deep domain expertise from JDA. To learn more about Milton Stewart School of Industrial andJDA Pricing and Revenue Management, please visit Systems Engineeringwww.jda.com/revenuemanagement. at Georgia Institute of Technology. www.jda.com | info@jda.com | +1 800 479 7382