Customer-centric merchandising – a pipe dream or imminent reality?

CUSTOMER-CENTRICMERCHANDISING

DECEMBER 2013

page 1

The next great evolution in retailing“The customer is always right” went the old retail slogan, but for many decades, what the customerwanted – or should want – was actually determined by merchandise buyers at corporate headquarters,not the shoppers themselves. Today’s consumers are much more informed and have higher expectations,requiring retailers to both better understand their needs and then determine what actions should betaken to satisfy those needs better than the competition.

A number of retailers are making great strides with customer-centricity in marketing and customer servicebut merchandising has not made the same headway. Over the years, the buying organization has morphedfrom buying products and negotiating costs to determining where products should be located in thestore and on shelves. This then evolved into category management where the category manager hadresponsibility for setting prices and planning promotions. A further evolution of category managementtook place with the incorporation of customer insights into the category management process to assistwith determining price and promotion policies.

But true customer-centric merchandising doesn’t attempt to graft customer insights onto the traditionalcategory management approach. Instead, it completely rethinks the process by allowing customer pref-erences to guide category management decisions, which in turn facilitates the achievement of salestargets rather than hindering them.

Still, skeptics wonder, if traditional category management has served the retail industry well in the past, whyis customer-centric merchandising so important? The answer is, in an increasingly cluttered marketplace,the one sure way to stay ahead of the competition is to better and more accurately satisfy the needsof customers.

www.loyalty.com

page 2

What’s possible, and what’s notIn the past, price, promotion and assortment planning was done on a category-by-category basis. But,customers don’t think about buying individual items from individual categories. They shop acrossmultiple categories with a host of different agendas.

In today’s increasingly sophisticated market, advanced analytical techniques coupled with powerful, cost-effective computational abilities, retailers can factor in the customer perspective from the earliest stagesof the planning process. These customer insights can play an integral role in determining price,promotion and assortment plans. This comprehensive, bottom-up approach ultimately creates price,promotion and assortment plans that best satisfy customer needs while achieving, with confidence,merchandising objectives and targets.

In addition, this approach also adds analytical rigor to one of the oldest merchandising strategies: usingselect items as loss leaders to drive increased store traffic and larger basket sizes.

Rich customer-level knowledge is the foundation for integrated customer-centric retailing

These customer insights can play an

integral role in determining price,

promotion and assortment plans.

PriorityCustomers

Enterprise Customer Strategy:

Prioritize Investments & Innovation

Tactical Execution: Price, Promotion, AssortmentCustomer Segments & Cohorts

Customer-Level Attributes & ScoresCustomer-Specific: One-to-One Marketing

www.loyalty.com

page 3

Previously, choosing a few items to drive store traffic required a big leap of faith, since there was no wayto prove if the profit dollars lost on the traffic-driving items were outweighed by the increase in profitfrom other purchases. Customer-centric analytics greatly improve the precision and effectiveness ofthis tactic.

Data-driven customer-centric merchandising does not, however, enable a retailer to change the priceof an item on the shelf for each individual customer. While technologically possible, pricing products

for individual consumers is rarely desirable for most retail-ers, due to concerns about being exposed to claims of biasagainst one demographic over another.

Personalized pricing, as it currently exists, works more liketraditional coupons. The twist with personalized pricing isthat individual items for sale are tagged as being important

to certain groups of customers. Then those customers are offered a personalized price on those targeteditems typically through a digital coupon. The discounts are often similar to those on traditional coupons(e.g. $1 off per item), but are usually delivered via email or a smartphone app. As with traditionalcoupons, the special prices are offered to select groups of customers for select groups of items, but ina much more targeted fashion than was previously possible.

Points of entryShort of ripping up the current organizational chart, job descriptions and compensation structures,how can retailers reconfigure their organizations to focus on the customer while still achieving theirfinancial targets? Fortunately, implementing customer-centric merchandising is an evolution ratherthan a revolution.

There are logical and low-risk places to start, and plenty of opportunities to change course along theway. With a well-thought-out plan, retailers can achieve their short-term financial targets while buildingtoward and realizing their customer-centric merchandising objectives. Here are the first 5 steps:

Leverage customer-driven insights. Retailers will rarely have sufficient resources to pursueevery opportunity that is available. Senior members of the merchandising team need to prioritizewhere to best allocate those resources. The first task is to determine where the largestopportunities reside, by category, based upon customer needs and buying behavior.

Implementing customer-centric

merchandising is an evolution

rather than a revolution.

1

www.loyalty.com

page 4

Identify the most important categories. Dividing a retailer’s business into quadrants basedon the categories that have the greatest value to both its best (and most loyal customers) andthe overall business enables senior merchants to assign roles to each category:

Clarify the role that different brands and items play within those categories. Individualcategory managers can make better-informed decisions about brands and items using the samedata and insights that have been used at higher levels of the product hierarchy. This process isnot that different from the traditional one, but it is sharpened by access to hard insights gener-ated from actual customer purchase data.

Determine how the best customers respond to prices, promotions and assortments.Wheninvesting in lower prices and margins, it’s in the retailer’s best interest to make those investments insegments where loyal customers will value them most. Similarly, when category managers aremaking decisions about which brands or items should receive precious promotional space in aweekly circular or on secondary placement displays, they should do so with granular informationabout which customers are most drawn to those promotions.

Translate strategic decisions into actions. Senior executives invest significant resources andtime into developing the right strategies for growth. While a customer-centric outlook greatlybenefits those strategies, even the best strategies have little value if the day-to-day businessdecisions do not effectively deploy those strategies. Bridging the gap between higher-levelstrategies and the lower-level decision-making is crucial to the success of a customer-centricmerchandising approach.

Customer-Centric Merchandising Approach

How important are categories to overall

business and to your best customers?

Retailers need to determine which

categories are the most valued by

their best customers and also to the

overall business.

Val

ue t

o O

vera

ll B

usin

ess

Value to Best CustomersHIGH

OPPORTUNITYBusiness Performance

PRIORITYResource Investments

LOW PRIORITYCost Effectiveness

PRIORITYLoyalty

HIG

H

LOW

2

345

www.loyalty.com

page 5

The power of dataWhen structuring the best methods for maximizing the impact of price, promotion and assortmentresources, customer-generated data serves as an invaluable tool. In each of the following tasks, themetrics derived from such data provide the fuel for optimizing the strategy, serving to enhance theknowledge and experience of key decision makers.

Designing customer-centric price plans. Leading retailers have been using advanced econometricmodels and optimization technologies to set prices for years. But all too often, the customer’s perspectiveis not considered, which results in sub-optimalpricing, promotion and assortment decisions. Byunderstanding how different customer segments respond to various merchandising actions, themerchant can make better informed decisions.

In the example to the right, if a category managerwere only to look at the impact across allcustomers, he or she might decide to invest inlowering the price of ITEM A rather than loweringthe price of ITEM B. But most of the volumeincrease for ITEMA comes from low-value tertiarycustomers, while most of the volume increasefrom lowering the price of ITEM B comes frommore valuable primary and secondary customers.Armed with insights at the segment level, thecategory manager can make smart decisionsabout where to invest in lower prices.

With customer-centric merchandising, items,brands and categories that drive traffic andbasket size automatically receive the lower pricesas part of a complete set of optimized customer-centric prices.

Long term loyalty is all about rewarding your best customers

At first glance it would appear that the retailer

should go with lowering the price of ITEM A,

however ITEM B offers a better choice for long

term customer loyalty.

All Segments(overall lift) 12% 10%

Primary Segment 0% 12%

Secondary Segment 3% 8%

Tertiary Segment 20% 2%

Sales Volume ChangeItem A Item B

www.loyalty.com

page 6

Designing customer-centric promotion plans. A similar logic applies to designing customer-centricpromotion plans. By better understanding how different customers respond to different promotions,it’s possible to develop promotion plans that satisfy customer needs while also delivering maximumvalue for the retailer.

Provided with information on how different customer segments respond to a particular promotion, acategory manager can take the following steps:

1. Keep and expand promotions that appeal to the business’s most valuable customers.2. Where possible, fix promotions that are not productive in attracting either the most

valuable customers or enhancing the business overall.3. When a promotion can’t be fixed, stop running it and reallocate the resources to better-

performing promotions.

By taking these actions, senior decision-makers and category managers can highlight items and brandsthat address the needs of valuable customers while achieving shorter-term financial performance targetswith greater confidence. Category managers can alsopinpoint the appropriate depth of discount needed toattract loyal customers without creating unwantedincentives that encourage unprofitable behavior fromcustomers cherry-picking deals.

Category managers are also better prepared to solicitpromotions from manufacturers that are morerelevant for their customer base, as opposed to simply allowing a manufacturer to push promotionsthat serve their brands. This puts the category manager in a stronger position when negotiating withmanufacturers. Consequently, the category manager can ensure that trade funds are appropriatelyallocated to the right promotions.

Designing customer-centric assortment plans. The traditional method of assortment managementinvolves ranking all items in a category by sales and then cutting the bottom 5 to 10 percent or more.However, this approach falls short for a few different reasons:

• Some low sales items are important to valuable customers. Cutting these items couldlead a valuable customer to look to a competitor for these items.

• Some of the lower sales items have low transferable sales. If items are cut and no reasonablealternatives are offered, all of the value from the cut items will disappear out the door.

• Some of the lower sales items may be part of a group of items that are usuallypurchased together. If you cut these items, then you may lose all the associated sales.

It’s possible to develop promotion

plans that satisfy customer needs

while also delivering maximum value

for the retailer.

www.loyalty.com

page 7

• A category-by-category approach may result in making too many cuts in some categoriesand too few in other categories. Some categories need to provide customers with morealternatives than other categories and, as such, shelf productivity can differ quitesignificantly between categories.

• Taking a Chain or Banner-level approach may miss some of the differences that occur atlower levels of the store hierarchy. An item that performs well in a handful of stores in aparticular district or region may not sell well in other districts or regions.

Today’s customer-centric methods offer a lower-risk alternative by taking the guesswork out of whichitems to cut. Cutting-edge data analytics help prune low-productivity, low-risk items to make room formore productive items. This, in turn, produces better individual category and overall store performance.

Spreading the word. Any retailer that starts down the path of customer-centricity must be able tocommunicate the insights gleaned from customer metrics throughout the organization. Simply providingcategory managers with the metrics alone is not enough. The metrics must be framed in a relevantcontext for all the different kinds of managers and decisions in the merchandising organization. Themetrics also must be easy to understand and simple to use or else they will simply gather electronicdust in the computer files of merchants.

Knowing your customer, today and tomorrowCreating and executing a well-crafted plan for implementing customer-centric merchandising is a keypart of the process. Taking a crawl, walk, run approach ensures that the organization retains a focus onachieving short-term financial targets, even as it reconfigures the decision-making mechanism. Toremain focused, retailers should prioritize their activities within three distinct stages:

Assess the potential benefitsCustomer-centric merchandising requires a commitment from the complete organization, so it’simportant to outline the opportunities that this relatively new approach creates. The benefits ofcustomer-centric merchandising are many-fold and significant in scope and can be groupedinto the following areas:

StrategicPutting customer-driven merchandising insights at the fingertips of merchants enables themto make more-informed decisions that are aligned with customer needs.

CompetitiveTaking a customer-centric approach to merchandising provides a retailer with a sustainableway to differentiate and win in the marketplace.

1

www.loyalty.com

page 8

OperationalMerchants can enforce operational rules in a more timely and cost-effective manner.

Financial• Customer-centric pricing delivers incremental sales of 1 to 3 percent and incremental

gross profits of 2 to 5 percent.• Customer-centric promotions produce incremental sales of 3 to 6 percent and

incremental gross profits of 5 to 10 percent.• Customer-centric assortment replaces under-performing SKUs while minimizing risk and

achieving incremental sales of 1 to 3 percent and incremental gross profits of 2 to 4 percent; italso delivers improvements in inventory turns, lowers working capital and improves cash flow.

Establish a game planAfter understanding what is possible, retailers should develop a defined plan of action. Sortingideas into the following categories will help clarify their importance:

Strategy• Identify the categories with the greatest current and potential value.• Assign incremental resources to the categories that present the greatest value opportunities.• Align targets and incentives based on customer-driven category roles.

Pricing• Generate price elasticities at the item/store/segment level. • Incorporate the customer dimension into identifying Known Valuable Items (KVIs). • Set price policies and execute those policies through price optimization that is simultaneously

run across all categories – incorporating customer segments into the process enables anunderstanding of the impact of optimized prices on individual segments.

• Over time, migrate price optimization rules and objectives to develop price plans that arealigned with valuable customers.

Promotions• Hone in on which categories and segments respond best to discounts, weekly circulars and

displays, and identify which are underperforming.• Where possible, fix under-performing promotions; where it is not possible to fix under-

performing promotions, stop running promotions and reallocate promotion investments tobetter performing promotions.

2

www.loyalty.com

page 9

• Incorporate the customer dimension into promotion planning and direct promotionalinvestments towards promotions that are valued by best customers.

• Proactively drive the trade promotion planning process with manufacturers to ensure tradefunds are allocated to promotions that are tailored for best customers.

Assortment• After optimizing prices, run an assortment optimization to identify the low-risk, low

productivity items that can be removed from the assortment.• Allocate more shelf space to more productive items.• Expand the distribution of high productivity items to additional stores.• Undertake product innovation either internally or with manufacturers to develop new items

to introduce into the assortment – track trial and repeat on a pilot basis.• Monitor the performance of the assortment on an on-going basis, incorporating the

customer dimension into relevant scorecards.• Incorporate assortment optimization into the category strategy and review process.

Organize and executeTo achieve success with any customer-centric merchandising strategy, a retailer must mobilizeits vision, its analytics and its employees in tandem. Here’s how the components should cometogether:

Executive support: If a retailer wants to become truly customer-centric, the senior executiveteam must sign on and fully commit to the undertaking and the roadmap.

Customer-centric foundations: There is a bare-minimum set of capabilities required tosuccessfully transition to a customer-centric approach:• The ability to handle and assimilate large and complex data sets.• Advanced, proven customer analytics and segmentation capabilities.• A reliable, secure and scalable technology platform.• Easy-to-use and highly relevant software solutions that can be deployed throughout the

organization.

Executional ability: For customer-centric merchandising to work, team members need tounderstand the customer perspective and the analytic insights and be able to make decisionsbased on both. Before embarking on the transformation to customer-centric merchandising, it’simportant to determine which kind of merchandising organization is currently in place:• Is the team focused on the complete buying process, from selecting products, managing the

buying cycle and fine-tuning the supply chain?

3

www.loyalty.com

page 10

• Is the team adept at negotiating with manufacturers, driving the cost of goods down,minimizing freight costs and maximizing trade funds?

• Does the team excel at planning and building out the annual and quarterly plans?• Does each category receive the same number of resources?• Where and how do pricing decisions get made?• Where and how are merchandising insights generated?

The above factors will play a major role in determin-ing the shape of the organizational structure to putin place to support customer-centric merchandising.

Consequently the type of organizational structurewill determine the processes that need to be put inplace and how decisions are made. Some of the mainquestions to ask at this stage are:

• Who can make recommendations?• Who can provide input into decisions?• Which parties have to agree before a

decision can be made?• Who has the final decision authority?• Who will actually get things done?

Finally, targets and incentives must be established. Insome cases today, retailers give each category the samesales and profit growth targets (e.g. grow sales by 3percent and profits by 5 percent); in other instances,the targets are adjusted for each category to take intoaccount the ability of different categories to drivesales or profits. In a customer-centric ecosystem, thereare often specific categories that are used as lossleaders to drive overall traffic and therefore aren’t expected to increase sales and profits. Ensuring thatcategory managers have their targets and incentives aligned with the role that their category has beenassigned in the overall customer-centric merchandising plan is crucial to success.

Here are a few common ways thatmerchandising insights are generated,interpreted and used:

• Centralized Approach: Insights are interpreted and acted on by a centralizedteam.

• Distributed: Insights are interpreted and acted on by a distributed team ofmerchants, marketers and store opera-tions personnel.

• Hybrid Approach: Insights are interpretedby a centralized team whose recommen-dations are handed off to the merchantswho make decisions based on the insights.

• Consultative Approach:A centralizedteam acts as an internal consulting taskforce, working hand-in-hand with thedistributed category managers to makedecisions collectively.

www.loyalty.com

page 11

Customer-Centric Merchandising: a pipe-dream or imminent reality?

Retailers have made good progress with satisfying customer needs in many aspects but merchandisinghas not carried it’s full weight. Traditional approaches to merchandising are not going to be sustainablefor too much longer and merchants at leading retailers are going to embrace the customer more whole-heartedly than in the past. It is not an easy transition but it is possible with the right vision, roadmap andcapabilities. And the rewards are significant – truly sustainable competitive advantage will be realized asa result of better satisfying the needs of customers to earn their genuine loyalty. The customer-centricmerchandising train has been stuck in the station for too long – leading retailers are starting to work outhow to get the train going and are starting to reap the benefits.

Customer-Centric Merchandising is the next great evolution in retailing.

www.loyalty.com

page 12

ABOUT

The Author

Graeme McVie is Vice President, Business Development for LoyaltyOne US, where he helpsclients drive improved sales and profits through insight-driven, customer-centric strategiesand solutions. Graeme’s work prior to joining LoyaltyOne focused on applying a data-drivenapproach to helping a wide range of clients develop and implement revenue and growthstrategies across international markets. He has worked extensively with both retailers and

Consumer Packaged Goods manufacturers.

ABOUT

LoyaltyOne

LoyaltyOne is a global leader in the design and implementation of coalition loyalty, customer analyticsand custom loyalty services for Fortune 1000 clients around the world. LoyaltyOne’s unparalleled trackrecord delivering sustained business performance improvement for clients stems from its unique com-bination of hands-on practitioner experience and continuous thought leadership. LoyaltyOne has over20 years’ history leveraging data-driven insights to develop and operate some of the world’s most ef-fective loyalty programs and customer-centric solutions.

LoyaltyOne is an Alliance Data company.

For more information, visit www.loyalty.com.

linkedin.com/company/LoyaltyOne

@LoyaltyOneInc

facebook.com/LoyaltyOneInc

Connect with LoyaltyOne

www.loyalty.com