Retailers Have a Pricing Problem
Today’s consumers, with access to economic information through various channels, not to mention what they see on store shelves and racks while they shop, are well aware of the fluctuation in prices.
Earlier this year, in addition to all the attention paid by the press to rising gas prices, consumers were able to see numerous reports on commodity costs that were moving steadily upward. Retailers, while trying various ways to keep a lid on increases, could at least point to commodities to explain the need for higher prices.
What isn’t accounted for and not always understood by consumers is the lag in pricing changes. The most obvious example is at gas stations where sharp drops in the price of barrels of oil are not immediately reflected in what consumers pay at the pump.
Well into the back-to-school season, apparel retailers find themselves in a conundrum, as well. Current pricing needs to reflect record higher costs associated with cotton earlier this year, while news organizations report prices for the commodity have dropped 38 percent in the last month. Current prices, according to a Wall Street Journal report, are 53 percent lower than record high levels in March.
"There’s never been this kind of volatility in cotton — ever," Eric Wiseman, chief executive of VFCorp., told the Journal.
According to The Associated Press, stores are trying to "disguise the fact that you’re going to pay more for clothes this fall." Retailers, are raising prices an average of 10 percent this year, reflecting higher commodity and labor costs.
The report points to a number of ways that retailers have tried to keep the lid on higher prices, including less fabric and substituting cheaper materials for cotton. Stores have also been accused of using some advertising sleight-of-hand to make deals appear better than they are.
"We’re not seeing deflation or inflation; we’re seeing con-flation," Marshal Cohen, chief industry analyst with The NPD Group, told the AP. "Stores are making consumers believe they’re getting more for their money."
Retailers don’t agree with that assessment. Lands’ End recently took prices up on its clothing.
"Consumers are going to notice the price differences," Michele Casper, a spokesperson for Lands’ End, told the AP. "But they are also going to get a lot of added benefits so they know they’re not getting short-changed."
Discussion Questions
Discussion Question: How should retailers be handling the issue of price increases with consumers at a time when commodity prices are so volatile?
Retailers do not need to communicate or justify price increases to consumers because consumers are not interested in hearing the reasons. The market will justify the means and consumers will shop in the stores that fit their own preferences and priorities, on any given day. Consumers that are looking for lowest price will shop around until they find it. But not all consumers place such a high value on price comparisons.
For food retailers, given the secular headwinds facing Walmart recently, particularly with regard to its exposure to foreign currency and international input cost pressures (such as cotton), I think that the regional and national operators need to continue to try to close the pricing gap with Walmart as much as possible.
Guys, it is time to start taking share from Walmart!
Management teams should recognize that Walmart is in a very precarious position, given the inflationary forces affecting the emerging markets and will be doubly so if the renminbi is ultimately allowed to significantly appreciate (we believe that it is inevitable). This is one of the reasons why Sam’s continues to outperform Walmart – Sam’s doesn’t have the same level of SKU exposure to China that Walmart D1 Discount and Supercenters have. Therefore, they don’t have to continuously raise prices on the food side of the business to offset inflation in other categories.
One obvious way to close this gap is through private label programs. National and regional supermarket chains with good private label programs already understand that this will be a key weapon in winning market share from Walmart in the future – particularly if the current state of the economy is the “new normal.” Walmart’s private label strategy is simply incomprehensible to most management teams we speak to in the industry and should be an easy win for more agile, regional focused competitors.
I believe that the biggest market share opportunity for national and regional supermarket chains will be Walmart for years to come.
It’s difficult to expect consumers to accept higher prices on clothing after years of flat-to-deflationary prices. One retailer recently reported a direct causation between price increases and falling demand: For every 1% price rise, they saw a 1% drop in units sold.
Retailers and suppliers are going to have to work harder than ever this fall to maintain retail prices. They may need to take cost out of a garment by using more man made fibers, and they definitely need to find savings in sourcing and supply chain management. But in an atmosphere of high economic uncertainty, raising prices is a recipe for losing market share.
The short answer is–very carefully. The exact approach will naturally vary based on the retailer and its positioning in the marketplace. As has been pointed out we are seeing more PL growth in both apparel and food (note the new Live! Line from Walgreens) as one method to provide the consumer a price point that they are comfortable with.
I expect others will take the “smaller item/less material/same price” approach. This works in grocery but is harder to pull off in apparel especially given the continued size increase of the average person. As noted already others will move from cotton to a less expensive material.
The average person is deeply concerned about the economy and the gyrations on Wall Street are helping. I expect we will continue to see consumers seeking value and that definition may drift downward.
I, for one, don’t believe that consumers spend a lot of time with macroeconomic considerations when making a purchase decision. In the end, it’s a value decision–“is this worth what they’re asking for it?” The pressure point, then, of cost increases is on the retailer.
Some retailers will take value (and cost) out of the product in order to maintain a price point and markup. In my experience, this is a losing proposition, particularly in a market-share environment like the one we’re in today. The consumer sees right through this. Some will make the purchase anyway, but many/most are put off by this and, if nothing else, it damages the brand in the long run.
The alternative is to raise prices, but make sure there is more intrinsic value in the product. In apparel, this means better construction, better trim, more style, etc. The retailer may sell fewer units, but dollar volume can be protected and the brand is reinforced.
What this country needs now is a good 5 cent nickel and a well-anchored flag pole everyone can hang onto and feel secure. Commodity prices and price increases are volatile and they’re daunting and haunting us.
Retailers are in a razzle dazzle mode saying things to consumers such as: “Plenty fresh for plenty less.” Seventy percent off on all carpets. “Buy one suit and get two suits absolutely free.” “Tell us what you want (in brake service) and we’ll let you know what we can do.” That’s some what how retailing is projecting itself but the consumer doesn’t really care why these promotional utterances are so ubiquitous or how they’re being created. Their personal concerns go deeper.
Consumers know things are topsy turvy, that prices are fluctuating. So they try to balance what they have in their jeans with what they need as their “wants” take second place.
Retailers have their private labels to make “price impression” — if that phrase is still applicable. Beyond that, retailers should just go with the flow. Consumers aren’t dumb; they know something sad is going on. They’re frustration is with the disruptive conditions surrounding them not necessarily with the retailer who they have come to rely upon. Meanwhile, life goes on!
A 10-1/2 oz bag of Lay’s Potato Chips is now pre-priced at $4.29. [I remember when the bags were 16 oz and under $2.] I doubt that many consumers ever pay that. My perception is that if supermarkets low balled milk, bananas, store brand bread and ground beef the rest of the pricing would be like water off a duck’s back.
Ultimately, consumers don’t really care about commodity price inflation. They care about what they are paying and what they are getting.
The only way to understand that balance, and to find the right pricing at the right time in the right stores, is an aggressive price testing program that gives a demand-based read on the optimal pricing. Note the word “program” — this cannot be a one-off analytical exercise. It needs to be ongoing, reading and re-reading the actual consumer response to price over time.
Price increases have decidedly had an impact on retail sales this year. That impact is coming from a number of different directions, and the actions that consumers are taking to deal with it, are evident. Price increases in one channel or category line impacts spending in others — e.g. the price of gas increases from $1.90 per gallon to $3.60+, a commodity driven item like cotton briefs, or cost of produce increases in a double digit fashion — leads to reduce spending in other areas.
The BIGresearch Consumer Intentions & Actions (CIA) Survey points to ways in which the Consumer is dealing with the inflationary or “con-flation” view of NPD:
The July survey points out these types of patterns;
24.8% are Delaying Major purchases, 39.6% are reducing dining out, 45.8% are driving less (think “trips” to stores), 35.5% are buying more generics, 38.8% are using coupons more often, 42.0% are shopping closer to home, 22.9% are doing more comparative shopping online.
The consumer “gets it” — perhaps not always happily, and they are and will make adjustments. Retailers have to continue to operate in a trustworthy manner, and, when they see a significant spike, present alternatives to loyal customers.
Retailers could start by knowing what they are talking about. It is unbelievable that a great many retailers still account for their inventories using an archaic averaging system called the Retail Method of Accounting. This system collects all of the products within a category and averages the cumulative markup, applying it to every sale they make during an accounting period.
Given this archaic system, the management is completely shielded from the impact of commodity price changes some of which might be going up and others down. They all go into the average!
It’s time for retailers to discover how much money they are making for every single item, every single commodity group, every vendor, every promo, every country of origin, etc., etc. Only then can they with good conscience bring their case to the consumer for price increases.
To build on Bill’s point – well, sort of – it’s not entirely correct to say higher costs must lead to higher prices…they can also lead to lower profit margins (though there are obviously limits when costs go up by double or even triple digit percentages); the same widespread knowledge that allows consumers to see commodity price increases also allows them to see that most of this recovery has been channeled into increased profits (rather than higher wages or lower prices): on this issue retailers might wish to observe the other Golden Rule …”Silence.”
This article makes a good point about conflation. Misrepresenting the value of products in the eyes of the consumer appears to be going on everywhere. It seems that everyone is lowering their product offering costs by reducing the size of the product (ice cream is much smaller now than just 2 years ago), the materials in the product as well as the quality. This is definitely seen in brand names as well as store brands in retailers everywhere. The consumer loses, while the appearance of the product fools (or cons) the consumer into believing that they are getting a better or the same product for the same money.
I think the volatility of commodities pricing puts a premium on retailers maintaining lean inventories. It won’t matter to what degree retailers try to pass along cost increases, excessive inventories will only put pressure on price points, whatever they are, and undermine the prices (and margins) that retailers are trying to maintain.
An extreme approach is to hold out on any price increases at all cost — particularly if maintaining price image is a top strategic objective. For most retailers, holding off on a price advance might not be feasible. A more balanced approach is to temporarily take price up on only the most inelastic items in your assortment.
Either way, decisions on price advances should be made at the most granular level possible (SKU/zone, perhaps even store). Not all shoppers are created equal, and elasticity varies across geography, category, and shopper segment.
Start with the individual – not the price.
When times get scary, people may employ a single buying strategy: buy at a lower price/quality level or at a higher price/quality level.
But many buy cheaper in one sector, pay more for the same quality in that one; and buy less/none of those.
So what should a retailer do?
Start with EPOS and loyalty card membership and buying data (c.f Tesco ClubCard in the UK). Fuse this with the customer service contact data, attached to the database at an individual level. Add in new research or survey information, also at an individual level. Of course respondents have to give permission to do this (this socio-demographic and attitudinal information will allow use to target prospects).
Using very bright people, develop computer programs that can understand the dynamics at an individual level. Determine if he/she is changing her buying patterns and if so, is she doing so consistently or is she buying lower prices in some areas and maintaining value in others, etc.?
Using volume, value, and margin calculations–and including a variable and calculation for changes created by brands’ initiatives–design and deliver an individualised coupon programme tailored to maximise each individual’s profitability.
Maintain retail prices; your engaged customers will maintain or even grow their margin value using individualised promotions.
It sounds completely impossible: but I understand it’s been done online and some the brick retailers are experimenting if not doing it.
It has been well documented repeatedly, over years, that shoppers do not know what they pay for items in the the store. Their relation to price is more intuitive and emotional, and PERCEPTION of pricing in a store is driven more by the basket total than what anything costs. I know, I know, everybody you talk to, probably including yourself, thinks this can’t be true. So much for accurate self-awareness.
That Harvard Business Review link I cited just a week ago, “Mind Your Pricing Cues,” continues to be a good review, supported further by a lot of more recent research.
The bottom line is that the price, if considered at all in a purchase, serves two roles: (1) to tell the shopper how much they are going to pay and (2) to tell the shopper what this item is worth. The shopper is far more influenced by the second use for price, than is usually recognized.
Retailers’ reckless trashing of the pricing tool has wrought economic mayhem, encouraging a casino-like retail environment, rather than anything approaching the rationality implied by a focus on price. I’m not advocating for this, but if retailers were forced to make their profits from margins instead of trade money, cash management (float,) and real estate, maybe they would be more rational (and knowledgeable about) shoppers.
What should happen is that the millions of people in the trade, whether retailers, brand suppliers or assorted “experts” who presume to advise on these matters, should get their heads out in the sunshine, and stop pretending that the retailers themselves are the world’s authorities on all things shopper. The reality is that retailers are authorities only on trade money, banking, and real estate. That’s OK, but there is no reason to credit them with expertise that they do not have, and do not need to have, to be successful retailers.
Inflation? What inflation? The government doesn’t recognize any inflation. Social Security precipitants have not received an inflation adjustment in three years.
Mobile technologies have given the consumer the tools to compare prices, check inventory availability, and locate mobile coupons all greatly to the benefit of their budget. Associated with this information availability is the expectation that consumers should be better informed about other factors that could affect price, including rising commodity prices. That said, consumers aren’t shopping in apparel stores for commodities. They buy end-products based on desire, need, and value. Smart retailers differentiate their clothing in many ways allowing them to get their return on inventory investment regardless of the price of the components or commodities.