New Mission for CIOs: the Art and Science of Pricing

Cutting spending is nice; companies can always find something to do with the savings. But increasing product prices–if customers don’t balk–brings in pure profit. The simplest way to price a product is to cover your back-end costs and tack on a predefined profit margin. But that formula ignores customer demand. And in this age of social media, tablet commerce and shopping by smartphone, customers demand that they not be ignored. Just as important, if companies don’t figure out how to exploit a fleeting chance to fulfill a sudden customer need while pricing their product just right, they leave money on the table.

Whatever singer Katy Perry wears to the Grammys, for example, may inspire teen girls to buy knockoffs. So “fast fashion” retailers could temporarily notch up prices on–we’re guessing here–sequinned minidresses.

Good pricing combines experience and gut instinct with data analysis, internal costs and external customer behavior. But to get there takes new technology and a new attitude.

“Pricing should be a CIO’s issue by virtue of being an officer in the company,” says Luis Rodriguez, senior vice president of IT at Dial Global, a radio syndication network that merged wth Westwood One in October. “But also because the business may not know there are more advanced ways to look at it.”

Usually the CMO or CFO manages price optimization projects to try to increase profit margins, calling on the CIO only because IT has the keys to the corporate data, says Mark Ferguson, a management professor at the University of South Carolina. Ferguson studies how businesses formulate pricing strategy. It’s rare, he says, for a CIO to instigate the process.

But that’s changing. Airlines and hotels have long used data analytics for yield management, studying and influencing what customers do so the company can extract the most profit from transactions. Now businesses as diverse as Coca-Cola, Aspen Skiing resorts, and garbage hauler Waste Management are doing it, too. But they are going further, combining statistics packages, revenue optimization software and insights picked up from unstructured social media interactions.

They want to do two things. First, beat their rivals to niche opportunities that can bubble up and recede in a matter of weeks (Perrywear). Next, refine a long-term pricing strategy to avoid a vicious cycle of discounting and to stave off commoditization.

“The financial returns associated with pricing initiatives far exceed any other IT initiatives. The benefits are substantial and sustainable,” says Puneet Bhasin, CIO of Waste Management, a $13.5 billion trash and recycling company. “It becomes a competitive edge.”

Making Profitable Decisions

Bhasin created a decision sciences group within IT where mathematicians and statisticians mine data to model, for example, the relationship between the value of a product or service and its acceptable price. The company uses Oracle databases that hold 20 terabytes of pricing data that is manipulated with SAS analytics and business intelligence tools.

One essential question: How elastic can prices be in a given market at a given time? The company wants to price each product “where it’s fair to the customer and at the same time, the company is making a reasonable profit,” he says.

Waste Management reports that it saw an extra $218 million in 2010 from higher prices on its core trash collection and landfill operations. That’s about 2 percent of revenues. And when it tallies its books for 2011, it expects that its new pricing strategy will have produced another 2 percent gain.

With such good results, the company remains committed to a plan of price increases that are 0.5 percent to 1 percent above the consumer price index, even in a down economy that has competitors cutting prices. The overall goal is to increase revenue by $3 billion to $5 billion in the next few years through these pricing projects and other initiatives, Bhasin says.

Waste Management doesn’t seem a likely candidate for a sophisticated and nuanced pricing plan. Garbage pickup, sorting paper and plastic, landfill maintenance–these are not sophisticated and nuanced services. Yet by getting employees to see Waste Management as a logistics service provider, the company has sparked creative thinking about products.

For example, attaching sensors to dumpsters at construction sites has improved the speed and accuracy of scheduled pickups. Truck drivers know exactly which containers to visit and where they are on the grounds. Having the sensors automatically signal when the dumpster is full makes pickups go even more smoothly. That’s worth extra paying for, Bhasin says, and the decision sciences group aims to find out how much.

The Human Factor Still Matters

There’s no doubt that pricing is a touchy subject. In September, after numerous customer complaints in 2010 and 2011, the Minnesota Public Utilities Commission suspended a tiered pricing program by CenterPoint Energy, an $8.8 billion utility. Under the program, customers who crossed a certain threshold of natural gas usage paid more for each additional unit of gas than the unit before. That angered some people, including senior citizens who need to run home medical equipment. CenterPoint says it simply wanted to encourage conservation and is due to propose an alternative pricing system next month.

How customers view your prices is as important as what you charge, Ferguson says, recalling Coca-Cola’s aborted test of variable-price vending machines in the late 1990s. The machines were programmed to change the price of a can of soda based on conditions such as location and weather. “The way it was portrayed was Coke machines would raise prices when it’s hot outside,” he says. “If they just said they would lower prices on rainy days, it might have come off differently.”

Though analytics suggest pricing programs that look good on paper, judgment still matters, says Javier Polit, CIO of Coca-Cola’s bottling investments group, an $8 billion unit within the company that sends soda, juice and other drinks to retail locations.

Polit declines to comment on the vending machine saga, but says that in his bottling business, regularly sending employees to retail outlets helps the company not only collect data from shelves but also get a feel for what’s going on. Maybe they notice a new iced tea being stocked by a competitor or that foot traffic seems slow. Both the computer and the human are important. “This is not about technology but insights,” he says.

As part of a large effort to improve sales-force effectiveness, a project called Coke One gives marketing, sales and other departments analysis tools to finely segment the customer base and “ensure consumers continue to have access to our brands at the right price,” according to the company’s latest annual report. Polit is particularly interested in learning about brand loyalty. That is, how Coke drinkers respond when a competitor makes a pricing move. If Pepsi drops its price by seven cents per can, does Coke lose customers? How about at 10 cents? The answers differ even by zip code. Knowing that, Coca-Cola can adjust prices granularly and maintain or increase market share, he says. “For us, it’s not about increasing price this quarter to make more profit. We do not want to lose share or volume,” he says. “We’ve been in business for 125 years and we want to be in business for another 125 years.”

Different Customers Get Different Prices

Everyone says they want to understand the customer, but do they? Detailed analytics can help companies treat customers as small, special groups of people, says Ferguson, the management professor. For example, rather than doing a monolithic nationwide promotion on its entire product line, an automaker may tailor offers by demographics, geography and economic conditions. In Sarasota, Fla., home to retirees who like to pay cash for their American-made cars, General Motors may try to outrun Ford by offering $3,000 back on its Cadillac DTS–and throw in a $500 sweetener for anyone who trades in a rival Lincoln Town Car, the number one model driven by people over 65. Meanwhile, a zero-percent financing deal may work better for the Chevy, popular among younger drivers who typically don’t buy cars outright with cash.

Coca-Cola erects up to nine displays in a grocery store, including at the entrance and at self-checkouts, so soda can easily be grabbed as customers come and go and at any place they might pause. The number of cases sold dropped 1 percent in 2010 compared to 2009, the latest period for which figures are available. But profits on that merchandise went up 27 percent. The right price can keep sales results steady, even when volume goes down. That’s not because you’re gouging customers but because you’ve paid close attention to which kinds of customers are willing to pay how much, Polit says.

Sometimes holding a price up feels wrong but is the right thing to do, says Paul Major, managing director of IT at Aspen Skiing, which runs four Colorado ski resorts.

As the recession took hold in 2008, Aspen considered dropping prices to retain more customers, as many airlines and hotels did at the time. Instead, the company kept many products’ prices steady but offered new perks, such as a free fourth day of skiing for a customer who bought a three-day lift ticket.

“The actual prices of our products did not go down, so [there was] no perceived price erosion,” Martin says, “but perceived value was high because of getting free days.”

If Aspen had cut prices dramatically to keep sales volume high, profits would have been hurt, he says. Under the program it ran that season, profit per ticket did slip, he says, but not a lot. The free days also brought additional revenue to the company’s hotels, stores and restaurants. “In addition, there was no discount hole to climb out of as business improved,” he says.

Depending on the industry, prices are set on stickers or by negotiation. And at many companies, there is no true price of a product, just one that a salesperson thinks will close the deal. Price optimization often comes across as software telling a salesman what to do. When a gonzo sales staff lives and dies on the line which is dotted, a la Alec Baldwin’s character in the movie Glengarry Glen Ross, a computer suggesting prices may not be welcomed. As Ferguson notes, “This becomes political.”

Depending on the market, attempts to match products to customers at a profitable price, sometimes in real time, can generate thousands of combinations. “That’s a problem best fit for computers,” Ferguson says. “Airlines learned that very early, and that’s what’s happening in other industries.”

Even if your products or services are sold mainly through negotiation rather than price tags, analytics will work, he says. Start collecting data on bids won but also on those lost, so the sample isn’t biased. Look at customer attributes such as frequency, budget, service calls and satisfaction, and measure how much of the product or service they buy over time. You’ll find patterns in who’s willing to pay a little more and for what.

As usual, the technology part is easier than the culture change, CIOs say. Cloud computing, for example, lets a company process huge amounts of data offsite more affordably than buying its own big servers and software. Analytics tools have become more powerful and easier to use in the last several years.

Going Beyond Gut Feel

Stepping up to an empirical, data-based approach to finding the right price can easily offend an internal sales group with a deep belief in its own pricing prowess. And quantifying which promotions work best may ruffle the feathers of the CMO and his staff, who may not have had access to such data before. If a 20-percent-off coupon cannibalizes future sales or attracts customers who would have bought anyhow, marketing looks bad.

What’s critical to emphasize during all this automation, says Rodriguez of Dial Global, is that technology can enhance even the greatest of instincts.

Metro Networks, a division of Dial Global, recently installed revenue-management and inventory-optimization software to find the most profitable places to schedule ads, based on several moving variables. Two key factors: how much airtime is available for the target audience and how in-demand is that audience.

As the presidential race intensifies, advertising time on radio programs that deliver certain demographics will carry a premium. If Barack Obama wants to reach southern voters age 21 to 40, he might want to buy some Saturday night spots on “Country Gold with Rowdy Yates,” a Dial Global show on 100 stations. An experienced ad sales manager will have her own ideas about how much to charge, but the revenue-management system also considers customer requests for over 75,000 ads a week, such as that the ad not play on religious stations, that it run only on Mondays, or that it not air near a rival’s ad. The more such constraints Dial Global can accommodate, the more valuable its airtime becomes, CIO Rodriguez says, adding that the system can now accurately handle 20 to 30 variables, more than even the smartest salesperson can handle.

As Waste Management built its pricing strategy, Bhasin adds, the company made sure that IT, marketing and sales understood and respected each other’s roles. Representatives from each group sat on planning and implementation committees. Salespeople and IT devised the algorithms that IT codified.

Bhasin also puts together pricing tests to see how customers respond to changes, to show sales what works. A control group will be quoted prices for garbage hauling or recycling services based on Waste Management’s old cost-plus-margin formula; another group gets a tailored price that incorporates demographic, geographic and economic trends.

“These are real customers and real prospects,” he says. “What a sales rep is looking for is assurance that whatever price they are quoting is a fair market value. We try to demonstrate that.”

After that, salespeople are given a range of prices they can quote a customer for a given product or service. The system monitors how each prospective deal plays out, including whether a salesperson deviates frequently from the range. If she does and keeps winning business, the algorithms may be adjusted. If she does and keeps losing, “we have a talk,” Bhasin says. “I’m not saying decision sciences pricing is always right,” he says. “However, when you net it out, it does better than supply-side pricing or pricing based purely on gut feel.”

Bring It to the CEO’s Attention

Pricing has up to four times more impact on profitability than other investments, according to a study by Deloitte. A 1 percent price increase can boost profits by more than 12 percent, Deloitte found. “With so much money at stake, it’s hard to understand why so many companies neglect pricing,” the report says. At companies where pricing strategy isn’t elevated to the C-level but is left to sales or even accounting, inconsistent pricing emerges, Bhasin says. Or, worse, employees change prices in reaction to market events when riding them out might be more profitable.

A business-minded CIO with views into every department should bring pricing to the CEO’s attention, Bhasin says.

“Pricing strategy touches every aspect of Waste Management’s business, including what products and services are bundled and sold, and to which market segments.” Because pricing can dictate a company’s future, he adds, CIOs must take it on.

Polit, who sits on the sales force effectiveness committee at Coca-Cola’s bottling investments group, says CIOs involved in pricing strategy raise their own profile. But he warns that pushing technology over human judgment is trouble. The best pricing strategy isn’t art or science, he says. It’s both.

Contact Senior Editor Kim S. Nash at knash@cio.com. Follow her on Twitter: twitter.com/knash99.