When Amazon changes its product prices multiple million times a day, it's tempting to imitate this behavior, making your own pricing as dynamic as possible. The art and science of setting prices has always been a fine balance, but it's a whole new challenge now that buyers can compare prices with a few taps on their phone and the competition's product is a screen swipe away.

Consumers are a lot more aware, and their loyalties fickler, than they've ever been. To keep up, retailers must manage prices in an everchanging environment – with inputs varying in real time while taking constantly churning inventory, location, buyer preference, and competitor behavior data into account. If not, retailers risk wasting significant sums on prices or promotions that don't drive the right engagement because of a lack of analytical capability to project, forecast, or track margin lift.

As a result, artificial intelligence is increasingly being leveraged through pricing optimization applications. According to one estimate, global retail spending on all kinds of AI is expected grow to $7.3 billion per year by 2022. Even large, traditional retailers, including Kohl's and Walmart, have made investments in AI-run pricing software with the expectation that it will deliver large sales and margin gains. However, many, if not most, retailers are struggling to get the returns they'd hoped for. In fact, plenty have had to reverse course, ripping out expensive installations and going back to the old way of making decisions.

What is the right way forward then? Price optimization implies there's an analytically right answer. However, there is usually more than one right answer depending on your goals and how pricing fits into your overall business decisions. While price optimization can certainly provide support and advice – and it has indeed proven successful in cases – a well-considered and researched pricing strategy is an essential, basic component of managing prices. Ultimately, pricing ownership is a complex organizational issue that should involve merchandising, marketing, and store operations.

Price management, then, is a continuing exercise with clear ownership structures that considers many subjective factors, while price optimization is usually an incomplete approach that cannot replace good long-term strategy. Pricing software can certainly help when implemented on top of a solid foundation, but it needs a clear strategy and a well-designed system of category management and decision-making. Here are some key things to keep in mind:

  1. A good strategy is everything
    A clear and well-articulated value strategy is a critical foundation for making pricing decisions. It's imperative to ensure that the organization – particularly merchandising, but also marketing and operations – understands the role of pricing and discounting across different parts of the business. Retailers must have a clear view of the value-for-money proposition that they hope to deliver and how that compares with key competitors. One retailer saw 240 basis points margin improvement and more than 400 basis points sales growth after launching a well-known AI price optimization tool. Much before implementation, the business spent time analytically predicting how lower prices may impact sales and profitability, synthesizing insights into clear guidelines, and reworking management processes to tightly link data with decision-making support.
  2. Consumer perception will make or break you
    Customers are hyper-sensitive to value for money and will not hesitate to switch loyalties right away if they determine that a retailer's prices are unjustified. Critically, the constantly changing price environment created through dynamic pricing weakens consumer perception of the retailer's value and can eventually hurt their trust. Remember: Positive perceptions are extremely valuable once formed, but negative perceptions are incredibly hard to shake off and can usually only be done through expensive marketing or other investments.
  3. Don't get too inwardly focused
    In the short run, you can increase revenue by raising prices and getting higher margins. But as customers react to higher prices, volume will eventually decline and move to lower-price competitors. And if your competitors maintain these lower prices over the long run, they can increase their profitability on increased volumes as you lose yours – adding to their ability to invest in their own businesses to compete against you.

If multiple competitors in the sector use this approach, they run the risk of matching each other's price increases to create a runaway pricing situation, raising the chances of a disruptive competitor stepping in and making things difficult for everyone.

In short, a weak pricing strategy not only brings your value proposition down but also hurts margins, top-line growth, and ultimately revenue. It may make sense to use pricing optimization software, but don't forget the value of simplifying your workflow through clear guidelines and guardrails. Technology should simply inform, not make, key pricing decisions.