The science behind revenue management is vital to many industries, not just retail. How to set the price of a product or service and extract as much profit as possible applies to many industries, including hospitality, airline, transportation, oil and gas, and advertising. It’s the pricing strategy of the retail industry, however, that has made news recently.
In November 2011, J.C. Penney brought in a new CEO—former Apple executive Ron Johnson—to make changes to the brand and its operations. Laura Heller, a contributor to Forbes even called her story on the changes, “Why J.C. Penney Will Be the Most Interesting Retailer of 2012.”
Under Johnson’s leadership, the retailer implemented a simplified, three-tiered pricing strategy that slashed the prices of popular merchandise by at least 40 percent, offered "Month-Long Value" discounts on select items, and promoted clearance deals during the first and the third Friday of every month (when many shoppers get paid).
The idea was “to keep prices low on the basics shoppers look for frequently and introduce new merchandise on a routine schedule.” Forbes referred to this strategy as “a shocking move for any retailer, let alone a department store where hi-low pricing and promotions have long been the norm.”
Shortly after Johnson’s appointment was announced, J.C. Penney’s stock was trading at $41.55 (Jan. 31, 2012). Fifteen months later, the company’s stock was trading at $14.55 (April 2, 2013). Johnson—along with his new plan—was out. The new high-profile strategy of eliminating sales and discounting not only didn’t work, but it was a complete failure.
Sadly, J.C. Penney has turned into a public example that illustrates the serious danger of a flawed product pricing strategy.
"One of the central—and simple—problems in the theory of revenue management is that a vendor is endowed with some finite inventory that he must sell over some fixed sales horizon; no inventory replenishment is permitted,” said Vivek Farias, Associate Professor of Operations Management at MIT Sloan, in his most recent operations research. “The vendor’s customers are price sensitive and arrive randomly over time. The vendor is thus faced with the task of dynamically adjusting prices over time so as to maximize expected revenue earned over the course of the selling season," concluded Farias.
J.C. Penney tried to solve that problem by for the most part eliminating price adjustments. Clearly, that didn’t work.
The science of revenue management, or product pricing, is both tactical and strategic. From a tactical perspective, it uses analytics to properly adjust prices in order to earn maximum revenue. The strategic component enables organizations—not just retailers—to fundamentally change the way they run their business, allocate resources, and manage the costing activity in the organization.
For J.C. Penney, their strategic error was a costly one.Vivek Farias
teaches in the MIT Sloan Executive Education course, Developing a Leading Edge Operations Strategy.