Want to Raise Prices? Customer Segmentation Provides an Answer
Through a special arrangement, presented here for discussion is a summary of a current article from the M Squared Group blog.
In a recent article in The Wall Street Journal, How Companies Can Get Smart About Raising Prices, Professors Paul Farris and Kusum Ailawadi suggest that companies will be forced to raise prices in coming years, since cost of goods and transportation have been rising steadily while prices have remained flat to declining. While cost savings have been beneficial, they’re running out.
With many customers still price-sensitive from the past recession, some companies have tried to "hide" their price increases through a number of strategies: cutting promotions, reducing quality, package sizes, etc. But all of those strategies have been shown to backfire, since consumers have a sense of what is a "good value," and are sensitive to "price gaming" — when a few consumers figure out "the trick," they let everyone know. Then the company has to deal with a negative reputation to go with the pricing issue.
So how can you raise prices right?
Professors Farris and Ailawadi recommend using customer segmentation to target promotions to the right customers.
(Full disclosure: I studied under Prof. Farris at the Darden School of Business at the University of Virginia and we have kept in contact over the years.)
As they write, "After raising prices, companies should rely on discounting to keep their coupon-clipping customers — the ones most likely to jump ship if they think they’re getting a bad deal. That means taking a close look at who their customers are and who should get what promotions."
You don’t have to tailor promotions on a 1:1 basis. "It’s enough to group customers into segments based on things like their purchase history and how sensitive they are to price."
Many retailers segment by using some combination of the following three approaches:
- Analyze historical promotional response at the segment level to find out which segments actually respond to a promotion at all as well as which segment’s purchases are actually incremental, rather than simply replacing existing purchases with a greater discount. If you do not have control groups in your data, examine customers using the promotion versus customers that are making purchases without the promotional redemption.
- Test and control your way into knowledge. Take a subset of your customer database by segment, break that into a test and control group and run an e-mail marketing campaign. Levels of promotion can be tested versus each other and the control group all by building a test matrix.
- Analyze past pricing actions at the segment level. Identify markets where pricing has changed and evaluate customer purchase patterns before and after the announcement of that change.
By varying promotions and discounts, the most valuable, most price-sensitive customer segments can be somewhat protected from the impact of these price actions. The strategy of segment-specific marketing programs also benefits the retailer or manufacturer because it communicates to consumers that they are known and cared for by the organization.
Discussion Questions
What do you think of the merits of using customer segmentation to base pricing strategy? What are the potential challenges and/or risks?
I can’t imagine how raising prices and then discounting them to people who are price-sensitive makes any sense.
The only way to price right is to segment right. Segmentation is the way and it is about the customer’s habits and their locations. Along with this, it is about being up front with the customer in regards to web prices vs store prices. What is your policy? Make sure customers know this.
Price to the region and sub-sets of shoppers. Focus on stock levels and maximize margins.
Price efforts are key, but inventory costs are a killer right now for many retailers’ margins and loyalty.
This assumes that customers segment themselves by response to price—that’s not always the case. Forcing a segmentation rarely gets you a good result when you take specific marketing actions against these forced segments.
I think Nikki and I have been proposing this for several years. It makes much more sense than zone pricing, or other arbitrary pricing policies. Why not reward loyalty?
Coupon clipping is not an activity I participate in, but clearly a large segment of the population does. As long as you can still make money on a cherry-picking customer, then go for it. But you have to ask yourself that question…are you generating volume and no profit? And if so, what’s the value?
Not much.
This is Robin Hood pricing – rob from the rich (and apparently brain dead) to reward the penurious.
Thanks to social media, consumer watchdog groups, etc., the world of pricing has become a much more transparent place.
Imagine how happy shoppers in Segment A would be to learn that they aren’t being offered the best deals because they’ve spent a lot in the past. They’d probably be about as thrilled as customers in Segment B who learned they had been dropped into a pigeon hole for the cheap and/or poor.
Beyond those obvious issues I’m not sure most retailers have data bases, or more correctly algorithms, sophisticated enough to pull this off without alienating some customers and eroding margin return on others.
Many marketers are struggling with one-off, project-based tactical approaches to pricing (and other marketing programs), and fail to gain a cohesive strategy around how to optimize opportunities with the “new” shoppers that have emerged since the economic downturn. Segmentations provide an opportunity for marketers to take a more strategic approach to pricing, an approach based on unique profiles that track actual shopper behavior over time. These segmentations will allow marketers to understand which shoppers are most/least impacted by certain circumstances, such as economic developments, and enable them to continually hone their pricing strategies (as well as products, messaging, etc.) to remain relevant and persuasive to target shoppers.
Offering different prices to different customers can be a successful tactic, but it must be totally transparent to the shopper.
Presenting different prices based on “receptiveness to promotions” and other factors that aren’t obvious and disclosed to shoppers will likely backfire.
Many retailers already have variable prices (based on market competition, store density, geography, time of day, etc…), and when customers discover these “secret” pricing practices, bad things happen. Customers reasonably assume that unsavory and potentially illegal factors are being considered (socioeconomic, etc…).
See orbitz higher priced hotels for apple owners or this WSJ pricing study.
Secret pricing strategies based on obfuscation are no longer going to work. Today’s connected consumer is going to know about your strategy, and if learning about your strategy damages their trust in you, good luck earning that trust back.
This sounds like a valid strategy until you consider that if customers find out what you’re doing, you’re going to have a real trust problem.
This process cannot and should not be done manually, without the tools available today from multiple sources. Trade Promotion Optimization and Price Optimization, along with consumer segmentation management capabilities address all of these challenges effectively. This should no longer be an issue to retailers AND CPG manufacturers that strive to maximize profitable growth by keeping a loyal shopper base.
Every retailer has a different strategy to compete, so there is no single solution to this problem. In my business, you MUST be extremely competitive on the top 200 SKUs, and create demand for the perishables through aggressive buys, and outstanding customer service.
Pricing is a huge issue for Oreos, but not so much for gluten free cereals, and I have to always be aware of what the market will pay for the everyday goods. This makes it tough to get a decent bottom line these days, as wages, insurance, and mandates are increasing faster than sales are.
The answer is to be aware of the local competition, and be flexible enough to adapt to the market pricing as is changes constantly, especially in perishables. Never try to offer different pricing on the same item, except for case discounts, which I offer to everyone, and charity functions, which is a different story. Have a great day!
The sale prices limited to card holding rewards members as well as coupons achieve a significant level of customer segmentation. I know many people who don’t want to sign up for the reward cards due to perceived privacy issues. Many consider clipping coupons not worth the bother. More frugal consumers stay with brand names they trust because with sales/coupons they cost about the same as private label.
Interestingly I have read studies that show the more frugal shoppers generally tend to be those who could afford to pay full price. That may be because they are better educated.
Price segmentation isn’t new. B&M retailers have been doing it for a very long time based on variety of factors. Doing the same thing online is also been around for a while.
What is new is research. Consumer advocacy groups, etc., are now conducting research and then doing news releases that can generate a lot of negative publicly such as what we have recently seen regarding Walgreens. This makes price segmentation on whatever basis more difficult to do without negative consequences.
I believe it comes down to the kindergarten rules, and treating people the way you would want to be treated.
If your primary motivation is solely to derive more profit from your customers, then your primary focus is consequently not on serving them well. They will sense it, and/or find out and their trust in your brand will be damaged.
If, on the other hand, your primary motivation is to serve your customers better, then you may use pricing segmentation to reward your customers, whether it be by bestowing discounts to your most frequent customers, or providing bundles that add value, or myriad other options.
Price transparency in the market is so ubiquitous that you will be found out, for better or worse.