Price optimization software offers high returns

Pricing at most companies is a complicated endeavor. It turns out that there are at least 20 companies which have developed software to help address the challenge – through Price Optimization (PO) software. According to IDC, sales of PO software, totaled $86 million in 2003 and are expected to reach $133 million by 2007.

Yahoo! Inc., the Internet's leading global consumer and business services company, is a PO customer. Yahoo!’s pricing is especially complicated with more than 30 million advertising pricing combinations depending on price, type of advertisement, location on the Yahoo! portal, and consumer segment (e.g., 35-year old males or 42-year old housewives). Because the company experienced frequent sold-out periods, executives began to question whether existing pricing captured market willingness-to-pay in an accurate manner. Yahoo! also had a poor understanding of how selling one of its products would affect sales of its other products. And Yahoo!’s salespeople too often made up pricing on a customer-by-customer basis.

Rapt Inc. (www.rapt.com), a pricing software company based in San Francisco, CA, provided a solution for Yahoo! -- consisting of the following elements:

• Rapt performed a pilot, which identified an opportunity for revenue increases of 4% (roughly $15 million per month);
• Used Rapt’s Price Director product to set prices which Yahoo! now uses for all its non-search ad inventory; and
• Yahoo! has required it entire sales force to use a common rate card, based on Rapt, as its central system of record for pricing.

Rapt’s software helped Yahoo! increase its advertising revenues. After purchasing Rapt’s software for a price that AMR Research estimated between $2 million and $4 million, Yahoo! increased its $600 million in advertising sales by no less than 5%. I estimate that Yahoo! has earned at least a 10-fold return on its investment!

Rapt grew out of Tom Chavez’s, Rapt’s CEO, experience, between 1995 and 1998 helping Sun Microsystems set prices for its hardware. Pricing was a high stakes game at Sun but was performed mostly on ‘spreadsheets and gut feel.’ Chavez believed that there had to be a better way to address pricing issues. He wanted to determine how to set prices so that demand was in synch with supply projections and competitive products were subverted, and to understand the affect pricing had on customer migration to new products and cross-selling of new products.

Chavez collected data from Sun on who bought which products at what prices as well as competitive pricing data from IDC and others. He also obtained supply forecasts and melded all the data together into a mathematical model that could be used to set prices in a way that would increase Sun’s revenues. Chavez found that once he began using this technology, he got powerful results.

After several efforts to obtain internal support to turn the technology into a company, Chavez decided to go out on his own in 1999 – with Sun as his first customer. The current customer base includes Microsoft, Hewlett Packard, Yahoo!, and Seagate.

As noted above, Rapt is not alone in helping companies benefit from price optimization. Here are three others:

• Metreo, a Palo Alto, CA-based pricing optimization software vendor, helps companies identify hidden costs or "profit leaks" in their transactions -- highlighting areas where prices are too low. Metreo helps companies set prices that boost margins and market share, communicates and implements them in each transaction. Metreo’s customers increase their profit margins between 1% and 4% within months of installing its product. An unnamed global manufacturer recently generated a substantial return on investment in Metreo software by raising its prices on money-losing customers and “firing” unprofitable customers who would not accept its price increases;
• PROS (Pricing Revenue Optimization Solutions) Pricing Solutions is a Houston, TX-based pricing software firm founded in 1985 to capitalize on effective airline industry pricing strategies. PROS’ 100 clients in 29 industries have increased their revenues between 6% and 8% as a result of using PROS software which delivers better demand forecasting and segment-specific pricing by booking lead time, flight date, connections, time of day, service class, and customer preference. PROS claims it is profitable with revenues of $30 million; and
• Zilliant, an Austin,TX-based provider of revenue optimization software, helps its clients improve profits an average of 10%. The Zilliant Pricing Suite (ZPS) allows companies to increase revenue and margins through more effective customer segmentation, segment-specific price setting, effective discount guidelines, more insightful price analysis, and more profitable deal analysis techniques. GE Transportation International Pool (TIP) and GE Modular Space (ModSpace) used Zilliant software in 2002 to pinpoint the best prices and to let managers act and react more quickly. According to GE Equipment Management division’s CFO, Michael Towe, GE TIP/ModSpace’s cycle time for matching prices with deals dropped 97% while deal response time fell 50%. According to Towe "The investment has more than paid for itself."

After years of boosting profit through cost cuts, companies are looking for ways to raise revenues. PO software could fit that bill.