Anyone who compares purchase and end customer prices in a catalogue could come to the conclusion that the retail profession is a quick way to immeasurable wealth. Afterall, in many retail sectors the margins between purchasing and selling prices really don’t look bad. Ok so the rent for the stores has to be paid, as does electricity, employee wages, and oh yes, insurance. At the end of the cost accounting calculation and after taxes, the net profit is substantially smaller than the total gross margins. And yet most retailers make the mistake of reducing their profits even further themselves. The reason for this is price discounts that are too extreme or too early – a mistake which is entirely avoidable.
Gut feeling and the invisible hand
From a retailer’s perspective, the ideal price for a product is the one that provides the maximum profit. Profit is a result of the selling price and the number of units sold, which in turn is determined by the market, i.e. the link between supply and demand. It is not easy to calculate the ideal price in advance. Those responsible for price planning do not always make objective, data-driven decisions, so that even with a lot of professional experience, pricing potential is wasted. After all, the optimal price per article is dependent on a plethora of factors, which cannot be assessed simply through intuition and gut feeling.
The Scottish economist and philosopher Adam Smith is regarded as the founder of classical economics. He tried to break down this gut feeling. In his work “The Wealth of Nations” he calls the egoism of mankind the guiding principle of the economy. Merchants want to sell as much as possible at the highest possible margins. Customers, on the other hand, want to buy good and inexpensive products. Smith calls this egoism the invisible hand, which guides individuals and thus the economy.
Markdowns are varied and rarely final
A product is offered at different prices throughout its lifecycle, depending for instance on the current market demand and the prices of competitor products. If a retailer offers a price discount in the form of a rebate, this is also called a markdown. Markdowns are the attempt of retailers to react to dynamic developments of the market and increase demand for an article. Typically, retailers use markdowns to ensure that products are sold off by the end of the season or by the end of their product lifecycle. Getting the timing and the level of markdowns right is essential to maximizing profits and minimizing unsold stock. Often retailers make the mistake of discounting prices too much and thus lose profit in the process. Another common mistake is discounting too late because they hope, for example, that apparent slow sellers will make a turnaround.
On average, the German retail industry gives away 25 percent of its potential turnover each year through uncalculated markdowns and out-of-stocks. Excluding the food industry, markdowns cost the retail industry a full 300 billion US dollars worldwide in 2018. As you can see, we are not just talking about saving a few pennies.
Perfect pricing is a challenge, especially for the fashion industry
They say fashion never sleeps. Since fashion trends change several times a year, the textile industry faces an enormous challenge: sales figures from previous years are not reliable indicators of future success. And long production lead times make it hard to fulfill rapidly changing consumer desires. Moreover, the industry has become more competitive as discounters like Aldi and Lidl have entered the fashion scene with their own collections. These supermarket chains are lowering entry prices in many segments. At the same time, they advertise their fashion lines with high-profile fashion influencers and familiar faces such as Heidi Klum and Daniela Katzenberger. In response, retailers are countering with more and more promotions. In addition, omnichannel prices increase the complexity of markdown optimization. After all, no company wants to cannibalize itself across its sales channels.
And even if retailers take all these points into account in their markdown strategy, something as commonplace as an unforeseen change in the weather can throw their neat calculations overboard. Therefore, it is increasingly important that Artificial Intelligence (AI) takes over these complex calculations. Because one thing is certain: 300 billion US dollars should not be left to anyone’s gut feeling.
Deciphering the Invisible Hand with AI
aifora’s AI-powered applications enable retailers to take all these factors into account. Thus, the optimal markdown amount can be determined for each individual article. And this for each location and each branch in real time. The level of automation is freely adjustable, up to the point of complete mechanization. The user can specify in advance the objective according to which the AI should calculate prices. The options: profit vs. inventory optimization. As a result, aifora promises increased sales and profit and a simultaneous reduction in inventory.
aifora‘s solutions for automatic sales, inventory and markdown optimization are also characterized by maximum transparency. At any time, customers can view the data quality on the basis of which the application makes decisions. This makes aifora’s solutions far more precise and transparent than the infamous gut feeling.