Price-optimization software is helping retailers price discriminate and capture more value from shoppers.

A large retail chain had a problem. It sold three similar power drills: one for about $90, a purportedly better one at $120 and a top-tier one at $130. The higher the price, the more the store profited.

But while drill know-it-alls flocked to the $130 model and price-fretters grabbed its $90 cousin, shoppers often ignored the middle one.

So the store sought advice from a new breed of "price-optimization" software from DemandTec Inc. What followed offers us a clue about important shifts that technology is bringing to retail shopping.

After analyzing an array of variables, including sales history and competitors' prices, the software suggested cutting the middle drill to $110.

That might have made the top drill seem more expensive. But drill aficionados still were fine shelling out $130. Sales of that drill didn't change. However, now that the $90 version seemed less of a bargain, the store sold 4 percent fewer low-end drills - and 11 percent more of the mid-range model. Profits rose.

My prediction is that 10-20% of the recommendations made by this sort of software are actually profitable, and that the store manager acts like a gatekeeper by rejecting bad ideas and recognizing good ones. My prediction of a low success rate isn't a criticism of the software! Artificial intelligence is great for augmenting human decision-making, even when humans can't be replaced entirely.

And consumers shouldn't fret that retailers are getting the technological upper-hand. After all, they've got to respond to increased competition and consumer-friendly technology like craigslist, Froogle, and Frucall. I think consumers are getting the best of the revolution so far.

(HT: Nick.)

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