How decision sciences and data analytics get us discounts at online shopping
Recently, the five big boys ( read e-tailers) of Indian e-commerce (the Indian poster boy Flipkart, Flipkart’s cousin Myntra, Snapdeal, Amazon and Jabong) got clearance from the Competition Commission of India (CCI) against allegations of unfair business practices. The allegations put concerned heavy discounts these e-tailers offer to entice customers and drive out competition.
One of the basic business management principles of ‘for-profit’ companies is to maximize shareholder’s value (generate profit). In stark contrast and counter-intuitive to this principle, these giants offer heavy discounts on products and are bleeding shareholder’s equity. This baffling phenomenon of heavy discounting products is a bit tricky to reconcile with a logical mind. I’m very sure that this convoluted business strategy is just not about saving costs of sales channels or big market evaluations.
Being in the field of business analytics for over half a decade, I tried to decipher this discounting phenomenon and found answers buried into theories of operations management and consumer behaviour sciences. Upon researching the behaviour of e-tailers, I found most of the decision making is analytics-based and is aimed at understanding consumer behaviour to become a trusted partner for their next online purchase.
We, as consumers, are mentally wired to make a purchase decision based on our involvement with the product. Unarguably, the price of a product is one of the parameters, and a very important one, that influences our involvement level.
However, price is not the only criteria. Consider, for example, getting a haircut. Usually, I choose a known barber or ask friends for feedback before I get a haircut. This is because I’m highly involved as to how my haircut will look. On the contrary, while buying a bottle of water I care less as long as it is from a trusted brand. This low involvement behaviour is the result of trust that packaged drinking water companies have created with us over time. If we closely examine my behaviour to choose which water bottle I buy, my behavior has shifted from high involvement to low involvement over time. A decade back I was cautious in deciding which brand’s bottled water to buy since I was not sure which brand’s water is safe to drink.
Extending this argument, our online buying behaviour is also not a factor of price alone. The reviews of a product and its utility described in those reviews, the credibility of the seller, and the discounts offered have become other significant factors that impact our purchase decision. These factors are further backed up with the trust that e-tailers have built with us through secure payment services, and money-back and replacement guarantees.
But the unfathomable question remains. Why are e-tailers doing this (giving huge discounts)?
Operations management has its roots deeply ingrained in creating efficiency. In the retail field, according to me, efficiency improvement can be planned given a high volume of orders. Efficiency improvements ( read profits and market evaluations) in the retail business are evident once we understand that through discounts, high volumes of online orders can be generated. Such high volumes of orders are completely inline to the business model of retail, which finally yields profits to the sellers.
Today, the e-tailers follow two primary business models to manage inventory. Inventory by definition is the unsold product or raw materials that go into making a product
- The traditional inventory model: where the e-tailer stocks inventory and sells it online
- The Dropshipping model: where the e-tailer acts as a marketplace (invite other people to sell products) and the actual inventory is maintained with multiple wholesalers or sellers.
However, irrespective of the business model, someone is carrying the inventory, which is associated with two biggest daemons of business that hamper profit-making
- Cost to carry: Warehouse rent and handling (shipping products) cost often referred to as Inventory holding costs. With an additional cost to order the bulk of products and transport them.
- Depreciation: With time, the product gets outdated and lose value.
If a product is not sold in time then the cost to carry and the depreciation will increase, decreasing its value and resulting in a low profit generated from its sale. This, in turn, increases the money required ( read working capital) to run the business for a seller.
In my opinion, e-tailers have found a way to overcome these two daemons by the biggest tool of modern-day retailing -”DISCOUNT and TRUST”. Consumers are encouraged to make a purchase decision faster if a product is discounted, is positively reviewed by other customers, and is guaranteed genuine by the e-tailer.
On the other side of the coin, e-tailers and sellers do not always lose money by offering discounts. Remember we do expedite our purchase decisions, leading to an increase in the number of orders for the seller.
Operations management describes concepts of “Economic order quantity- EOQ”(to minimize the cost to carry a product before it is sold) and “Linear programming LP” (to decide percentage of optimal discounts) along with many other advanced techniques to calculate how much discount to offer and what quantity must be sold to make a profit. All these calculations are weighted against “Cost to carry” and “Depreciation” that the sellers will have to bear if a product is not sold.
Today, all of such calculations/information is stored for every product sold online or offline, and data analytics is used to predict the discount to be given on any NEW product that goes on sale. This part makes the online game all the more exciting and challenging.
The other advantage of offering discounts, in fact, the most important one, which businesses value the most today is the increase in customers base. This increase in customer base directly increases the number of transactions online, leading to better profit margins and yes…market evaluations. The advantages do not end here.
According to consumer behaviour science, this increase in customer base helps build a deep understanding of what customers really want. Every click that we make on an e-commerce website is recorded in the same way our footprints are when we walk on a beach.
The e-tailers have built such maturity of consumer behaviour understanding that before we call the call centres, they can predict our intention to call and attend us with the right information. Further, e-tailers now predict their revenue based on the actions we do on their websites remember the “wish list” you created online or the “shopping cart”.
Today, data analytics helps organize customer’s browsing patterns and transforms them into meaningful business predictions. One such business application is that e-tailers now help in price discovery (what should be the selling price) of a product, which as such is a big exercise any manufacturer has to undertake before launching a product. Furthermore, the right amount of advertising across various media platforms (online, TV, newspaper, Banners etc.) can be determined by analyzing how customers are browsing a product or similar product category.
These examples of data analytics use are not an exhaustive list of business applications, in fact, the possibilities are endless. The more we know the more we understand why there is a discount on the product that you want to buy online.
Originally published at https://www.linkedin.com.
