How AI-powered pricing improves margins and protects consumers

Ethics are an intrinsic and misunderstood part of customer intimacy and AI-powered pricing.

When Levi’s announced in its Q1 earnings call that it had elevated its average unit retail (AUR) by 10% without negatively impacting demand, Wall Street analysts were eager to hear how they had accomplished this feat. Like every other retailer, inflation and supply chain pressures have impacted Levi’s global inputs and logistics. CEO Chip Bergh explained [subscription required] that the company had raised margins by applying “analytics, including artificial intelligence and methodological analysis of price elasticity.”

While AI-powered pricing technology gains maturity and wins converts across a wide array of retail sectors, the public remains largely unaware of how pricing approaches have changed and why. AI-powered pricing has come of age amid a litany of significant pricing pressures such as pandemic-induced product shortages, supply chain difficulties and high inflation disrupting margins and prices. 

Consumers feel the inflation crunch at the grocery store and when refueling gas-powered vehicles. Through March, consumer price index data tracked an 8.5% year-over-year rise in grocery prices. As a result, consumer sentiment, or the measure of consumer confidence (and willingness to spend money) is falling sharply, off 32% year-over-year through March. Despite significant retail cost pressures, these data suggest it’s a poor time to pass cost increases straight to consumers.

Today, 44% of retailers use price optimization tools, according to a March study by RSR Research. (Although that percentage is a bit skewed because most large retailers use it.) Retailers embrace AI-powered pricing because it enables them to grow revenue, improve overall margins and enhance the pricing mix despite inflation, according to the RSR study.

Few customers realize the extent of AI-powered pricing adoption or know how it applies to their purchases. For many people, their first and perhaps only negative experience involved “surge” pricing via ride-hailing, entertainment or travel applications. Apart from that, AI pricing is neither positively nor negatively branded in consumers’ minds. They may not realize how it benefits them as well as retailers or what the technology can do.

The ethics of AI

Some observers fear that AI has the potential to harm consumers. Without citing specific examples, a Harvard Business Review article last year warned that “supercharged pricing strategies can cause real harm to individuals, organizations and societies.” Deploying this technology risks “harming people and inviting customer outcry,” the authors said.

Of course, harm is neither an intended nor an unintended consequence of AI-powered pricing. AI-pricing algorithms are trained to listen to customers and determine the most favorable prices for enabling purchases. AI doesn’t change economic facts — an overpriced item may result in a lost purchase. Consistently overpricing products causes stores to lose customers.

From the outset of the pandemic, consumers and government watchdogs expressed considerable concern about the possibility of price gouging amid pandemic-related product shortages. Many prices have risen steadily — some sharply, especially early on. AI-powered pricing has not exacerbated this problem. Though AI-powered pricing systems could, in theory, accelerate price gouging; in practice, they prevent it from happening at scale. Algorithms, like merchandisers, must follow rules set by retailers. Price gouging was unethical before the dawning of artificial intelligence, and it remains subject to criminal action in both brick-and-mortar and ecommerce settings.

AI-powered pricing systems track consumer preferences, including how customers look at items, and price according to these and other factors such as promotions, store locations or how competitors price the same item. The model assesses elasticity and formulates price recommendations based on these projections. The algorithm can also forecast the impact of a pending price change, providing a safeguard both for retailers and consumers, not to mention the upstream supply chain.

Customer intimacy is a major objective of AI-powered pricing systems. As we’ve seen with “personalization,” if a retailer knows you have a preference for hometown sports teams, it may suggest relevant products, tickets or other services to you. If an AI pricing model knows a consumer always buys certain brand-name products, it may offer a discount or a coupon on a house-labeled product to influence those preferences. In this scenario, the intent is to drive value for the consumer and encourage repeat purchases that lead to improved business results for the retailer.

A nuanced pricing strategy

Today, consumers have a low awareness of AI applications, much less AI pricing. A study of 1,000 US consumers in 2020 found that 43% weren’t sure what AI is or how it is used and most had a lukewarm acceptance of it, according to Blue Fountain Media.

Consumers, like many retailers, are still forming first impressions of the technology and how it is implemented. One area where consumers and retailers may see things differently concerns the sheer frequency of pricing adjustments. For retailers, AI-powered pricing enables them to take a nuanced approach to pricing and margins. 

Conventional wisdom insists that too many changes may erode consumer trust.

Yet, famously, the leading ecommerce retailer does not adhere to this rule. Amazon changes product prices an average of 2.5 million times a day and the average product’s cost will change about every 10 minutes, according to Business Insider.

Observers say Amazon makes frequent price adjustments to ensure that it always has the lowest (or at least highly) competitive pricing on consumer staples. But then it will “actually raise the prices on uncommon products” according to Business Insider, thus improving its margins. Amazon is constantly communicating with shoppers to determine their preferences and understand their shopping habits. The result? Greater customer intimacy, stronger customer loyalty and higher sales margins.

Customer intimacy forms the heart of ethical AI-powered pricing.

While customer intimacy does not guarantee that merchants will make empathetic or ethical pricing actions, arguably it’s impossible to achieve those objectives without a strong base of customer knowledge. These concepts are inextricably linked because understanding customer tendencies is essential to any successful pricing approach — digital or analog. Merchandisers, data scientists and pricing experts know that customer intelligence leads to smarter pricing decisions as measured by higher loyalty and customer value metrics.

Ethics are an intrinsic part of every customer pricing action.

Done right, consumers won’t think twice about pricing algorithms and will instead enjoy personalized offers and prices set squarely in their comfort zone. Done right, customers will be happier and more loyal to retailers who achieve the desired balance of customer value and profitable margins.

Kevin Sterneckert is chief strategy officer at DemandTec.