Measuring Pricing Effectiveness: Key Metrics (Part 1 of 2)

    

Pricing Solutions have been around for many years in retail, and commonly the question is asked: Well, do they work?

Unfortunately, the answer is not easily determined because it has been challenging to decide what is meant by success and even harder to measure success. Measurement needs to be built into pricing projects from day one, and these measurements need to align with the pricing activities.

First, let’s talk about what success means in a pricing project. Most will look to pricing success being all about profit; margin rate increases mostly. While certainly an important aspect of pricing, margin is more the beneficial result of effective pricing, rather than an effective measure of pricing. Margin is like an A in school – it points to success, yet it is the result of all the learning - not a goal in and of itself.

So, what does matter in pricing? The best success is if pricing actions are accomplishing their objective with the objectives ranging from revenue, sales/market share, margin, or sell-through. Pricing actions must have a strategic goal; driving improvement to that goal is success. Often it is the directional success that is the most important, especially when undergoing change. For example, a class of products may have a goal to drive market share through sales units increase without eroding margin. Perhaps the objective was set at a 5% increase in sales units at the same margin. Accomplishing only 3% with no margin erosion, shouldn’t be viewed as a failure, but as a successful step, especially if this has never been done before. Perhaps there are more sales to be had, or perhaps the goal was a tad too ambitious. What is important was the accomplishment of the strategy. Similarly, for other products, the goal may be clearing inventory ahead of a seasonal transition. Measuring sell-through at a reasonable margin rate is the appropriate measure.

A few lessons here: Rarely is one goal sufficient; it is easy to beat sell-throughs if margin or revenue is ignored. Margin is easy to get if competitiveness or market share is not an issue. Also, always measure pricing against the trade-offs implicit in pricing, such as revenue vs. profit or sell-through vs. margin or sales units vs. revenue. The other key lesson is that success is situational. Just as different products play different roles in the assortment, different pricing goals should too. Pricing goals must be relevant to what you are trying to accomplish.

Measuring success might please management, but how does it help make pricing better? That is the key question posed by those in pricing departments. Measuring success should also measure how well the pricing process and solution is working. To this end, it matters what type of pricing is being measured. Initial pricing is typically concentrating on driving a certain selling rate appropriate for new goods and generating customer excitement. Weekly sell-through or sales check-out is a good measure. Base pricing is often about matching a product’s demand with its price. Some products are traffic drivers, so unit sales are appropriate. Others are margin drivers, and profit measures are relevant. Often it is the balance of the category measures – revenue and profit that are best. Promotional pricing is all about the trade-off: did the price offer (usually a reduction) combined with the marketing spend yield worthwhile results? This is best measured with an ROI, where the investment is the promotional spend + marketing costs against the increase in revenue. Sometimes, when pricing is about growth, its best to keep the classic basket measures: increase in basket size, increase in baskets, and increase in shoppers. For clearance or liquidation pricing, inventory management and seasonal end sell-through become key measurements – and making sure to balance that against the margin.

So far, standard performance measures have been used. There are more specific measures for a better pricing system scorecard. A few favorites:

  • Average Unit Retail: A nice intuitive measure to understand how the prices are reaching the sales floor. Often a sales weighting ($ sales / units sales) is a great out the door measure but might be worth looking at inventory weighting to see what discounts are needed.
  • % of inventory / sales by discount or price range. For most retailers, it important that the sale floor represents a desired value measure. Some retailers want little discounting; others want a lot. Keep tabs on what the price offer is across the sales floor to effectively accomplish a product weighted distribution of the discount or price. Sometimes comparing this to the inventory weighted price distribution can be useful for tracking efficiency.
  • Capture Rate: Especially for seasonal or fashion goods, the concept of capture rate, which is also the $ sell-through rate can be a nice overall measure because of its direct measuring of pricing efficiency coupled with comparability across different products and locations. This measure tells in a simple % rate how much initial value is being extracted through sales and price overall the lifecycle of a product.

In part 2 of my blog, I’ll discuss the Process of Measuring pricing effectiveness.