The price of success

Business is full of fads. And whatever the latest idea, there’s always a phase in its evolution when you become heartily sick of hearing about the first pioneering company to actually get it right. In the case of make-to-order and just-in-time inventory management, it was Dell Computer, while Cisco Systems, you’ll recall, was lauded for its ability to close the books a matter of hours after the quarter’s end.

So expect to become just as sick of hearing about one of the following: Pohang Iron & Steel in Korea, Fairchild Semiconductor of Maine, or J&B Wholesale of Minnesota, all of which are implementing profit optimisation.

“We struggled to understand the real costs of serving our customers,” says Kurt Anderson, chief information officer at J&B Wholesale, which, despite the “wholesale” in its name, also operates a factory preparing portion-controlled beef and pork products for the retail and food service industries – delis, wholesalers and retailers – in 11 states across the Midwest.

The trouble was, says Anderson, that it became hard to tell how profitable each customer’s business was. “The gross margins looked good, but on a customer-by-customer basis, we never really knew if we were making money or not,” he says. However, he claims that profit optimisation software enables the company to focus much more on net profitability – the bottom line figure that really counts.

Welcome to the profit optimisation bandwagon. Which is, at first glance, a notion that’s more than a little strange. Profit optimisation, surely, is what Americans call “job#1”: something so fundamental that a business does it unthinkingly, just as humans eat and breathe. Not so, argue a handful of up-and-coming software vendors – and they may have right on their side. When it comes to profit optimisation, early signs are that businesses can actually use a little help from computers.

How so? Think back to basic economics: supply curves, demand curves, elasticities of demand and elasticities of supply. It all works out very nicely in the classroom, of course, but the real world is much messier.

There are competitors, for a start, which may or may not behave rationally – or even ethically. Likewise customers. And suppliers, too.

A company’s management can usually make a pretty reasonable fist of untangling these complexities, but few would be so rash as to claim absolute perfection.

If prices rose by 1%, the extra revenue could flow through to the bottom line – or customers might desert in droves. A 1% cut in prices might come straight off the profit figure – or cause such an increase in demand as to swamp the salesforce.

Promotions and the like help to shed light on how customers might react, but they are far from an exact science. Plus, of course, there’s the competitor dimension: if you drop your prices, what will your competitors do?

US software company Manugistics turned to pricing and profit optimisation as a way to differentiate itself from competitors which had encroached on its supply chain management market. Over the past couple of years, it initiated a clutch of development programmes, which it bolstered with acquisitions, including that of Georgia-based Talus, which had patented a number of pricing optimisation algorithms it had spent seven years developing.

Manugistics had developed similar algorithms itself, but the patented Talus ones were compellingly better, says Greg Cudahay, executive vice-president of pricing and revenue optimisation technology. Also, acquisition was the best way to get hold of the technology quickly – and keep it out of the hands of would-be competitors. “You can’t just put a bunch of PhDs in a room and come up with this stuff to order,” he says. “We can look at actual buying behaviours in the market, and how customers respond to a whole variety of factors that influence their purchase decision.”

This real world influence clinched a deal with US electronics company Fairchild Semiconductor, which is using Manugistics’ technology to deliver “real-time pricing” for its 50,000 customers. Fairchild’s ambition is to adjust component prices to balance demand and supply at the most profitable point. “The software’s ability to incorporate market conditions is unique, and we expect this to bring a new dimension to our business,” says Herb Rau, engineering project manager at Fairchild.

Manugistics reckons companies using its software generate bottom-line increases of between 2% and 8% of revenues. Analyst AMR Research, in a recent report, quoted comparable figures: a rise of between 3% and 5%.

That’s a healthy dollop of profit, especially in low-margin industries, such as supermarket retailing and automotive components.

However, this kind of dynamic pricing has something of a bad press to overcome. The two industries most associated with it – airlines and hotels – are hardly watchwords for shareholder value. No wonder, then, that an area that a year or so back was termed “dynamic pricing” is now being re-branded as the more exciting-sounding “profit optimisation”.

But it isn’t only a re-branding exercise. Profit optimisation is supposed to be about more than merely flexing prices to maximise sales and, hopefully, profitability – because it is interested in changing costs, too. Recognising this, Manugistics’ original price-based approach has been radically extended to include a supply curve dimension, and re-branded “enterprise profit optimisation”. With both the demand and supply curves factored in, true profit optimisation comes a step closer.

“Manugistics is the company to beat,” says Julie Fraser, principal and director of market strategies with Industry Directions of Cummaquid, Massachusetts.

“Talus was the other company in the market that everyone was watching, and now that it is part of Manugistics, it is in an even stronger position.”

Not that Manugistics’ competitors are giving up quite yet. Indeed, up to half-a-dozen smaller companies are making a strong showing, says analyst John Hagerty, of the Boston, Massachusetts office of AMR Research. The problem, he explains, is that there’s very little homogeneity in their approaches. “People are coming at the issue from widely different angles,” he says. “Some from the pure price point of view, some from the demand-management perspective, and some – bizarrely – from the activity-based-costing point of view.”

In part, this diversity reflects the needs of the target market each company has identified. Build-to-order manufacturers, for instance, have different needs from the sell-from-inventory manufacturer routinely bidding on dozens of requests for quotations each week. Retailers and wholesalers will be different again.

But also, the diversity reflects serendipity. “Although we originally built a suite of products that are designed for both retailers and CPG manufacturers,” says Dan Fishback, president and CEO of California-based DemandTec, “our sales and marketing efforts have in fact almost entirely been directed to the retail market.” In other words, when one door is open, don’t bother pushing at another.

Fellow Californian start-up Metreo, is another vendor that analysts think is worth watching. This is because the company has staked out a capability in both price planning – analysis, in other words – and price execution, via links to CRM and ERP systems.

Metreo’s focus is on delivering “faster, better prices”, taking into account a huge number of competitive and market-based factors – if necessary, on a city-by-city basis, says John Dionisio, vice-president of marketing.

Prices are “better”, he explains, in the sense that, using Metreo’s technology, they are more finely judged to take into account market conditions and competitive strengths; and “faster” in the sense that automation eliminates the need for time-consuming authorisation and exception processes. The software also offers what Dionisio describes as “quote-order revalidation”: that is, it checks that the order that has been received contains the same prices as the quotation that went out. “You’d be surprised at how often that isn’t the case,” he says.

However, turning price planning into profit optimisation isn’t easy – after all, to do so not only assumes profits will generally follow revenues, but also fails to take into account elasticities and cross-elasticities of demand.

Cross-elasticities of demand? Think beer and nuts. Or beer, crisps and nuts. Or all those – and pizza. Possibly the most dramatic innovation in the field comes from Manugistics’ upstart supply-chain-management rival, Dallas-based i2. You’ll need a PhD in Economics to understand the sales pitch, but what’s on offer is a profit-optimisation picture that is two-dimensional (or higher), giving companies the ability to fine-tune prices on one product in order to stimulate demand for others. Supermarkets have long been able to see the linkages between promotions in one aisle and demand in another – now, manufacturers can get a piece of the action, too.

As these words are written, Korean-based Pohang Iron & Steel, one of the world’s largest steel companies, is trialling this approach – and it’s only one, of course, of a number of competing approaches that are being tested out on a range of real businesses. The bandwagon, once moving, will be hard to stop – and whichever approach wins out, expect to hear a lot about the company that tried it first. Dell Computer and Cisco, move over.