RSR Research: A Return to Pricing 101
By Nikki Baird, Managing
Partner, RSR Research
Through a special arrangement, presented here for discussion
is a summary of an article from Retail Paradox, Retail Systems Research’s
weekly analysis on emerging issues facing retailers.
As RSR prepares to launch
the fourth edition of its pricing report, it’s easy to forget that as far as
price optimization has come, there is still a long way to go. At Retalix’s
recently held user conference, Lyle Walker, VP of marketing for KSS Retail,
reminded me that sometimes the basics need a refresh.
He presented three pricing "myths" and
explained why retailers should be working to blow up these myths internally.
Close enough pricing: When you have a private label brand, sometimes
the mandate is to keep the private label price "close enough" to
national brands — for example, if the national brand can of peas is .99, then
the private label should never be more than 20 cents away. But customers don’t
know your costs or margins, so you have an opportunity to be flexible here
— in fact, some stores may be next to serious price competitors. You don’t
have to kill the margin for the entire product line just to stay competitive.
You might find benefit by varying that price by region or location — either
or both the national and the private label brand.
Margin pricing: Sometimes retailers set margin objectives for their
private label — the private label brand should always achieve 35 percent margin,
for example. But if the private label product is not priced close enough to
the national brand, it sometimes creates a negative connotation for the customer.
Line Pricing: This example applies primarily to products that have
lots of flavors or colors. The temptation is to set the prices so that the
entire line is priced at the same price — all prices of a salad dressing line
are set at $1.29, for example. But a common differentiator for a smaller grocer
against a big chain is that they often carry a wider selection of flavors that
you can’t get elsewhere. So why give away margins on products your competitors
don’t even carry by pricing the entire line the same way?
The main point is
that traditional pricing technologies are designed to automate pricing decisions
across a lot of stores. Price optimization enables you to treat every single
store (if you want to go to that level) as its own demand pool, and gives you
insight into what makes for successful price strategies at that particular
store. There is a lot of value — our surveys on pricing show consistently
that I’m not understating this — in breaking from the one-size-fits-all pricing
strategies of the past.
Discussion Questions: What do you think are the biggest fallacies around traditional
pricing strategies? How well do retailers really understand the margin benefits
from more sophisticated pricing techniques?
There are only three pricing strategies: hold prices where they are, raise them, or lower them. Everything else is an infinite variation on one of those themes.
The problem of course is in calculating which variation to chose from and here retailers have only begun to scratch the surface.
Day part, variable demand, total market basket spend are all ways to set prices in a creative way but they all depend on a retailer having confidence in what they are selling. As long as pricing is a defensive act or a reactive strategy it will continue to be sub-optimized.
Of the three, we find that margin pricing has the biggest negative impact. One of our findings with many retailers is that they still think in terms of margins. We agree margins are a handy way to think but no one has ever put a percentage in the bank. We try to get clients to understand that its penny profit that is important.
True in the article Ms. Baird was referring to PL margin pricing strategies that result in too low a retail price, but we often find the opposite. “I need to make X% margin” is something we often hear retailers state. Unfortunately, that results in a price point that makes the item uncompetitive.
Companies like KSS, Revionics and others may provide the technology, but the retailers set the pricing rules. Have a great system that executes a poor strategy doesn’t produce the desired results. In most cases this means the technology gets blamed and not the rule maker.
In my days at Canada’s largest grocery chain, we used to group all stores into markets. Markets would be partly geographical, partly socio-economic. In a given market, private labels prices were set based on a number of rules: the private label had to be equal to or cheaper than the competition (especially if the item was on a top 50 or top 100 list), cheaper than the national brand, while generating higher margins. We also considered price points (1.99, not 2.09 whenever possible). Prices for commodities (loaf of bread, butter, bag of mild, eggs, etc…), were deemed so critical and competitive, they were set by each store (at the discretion of the manager based on local competitive pricing), not centrally at head office by the pricing department.
We also separately managed two lists: the top 50 and the top 100 items/SKUs. These “top” items create price impressions in the customer’s mind, and had to be priced aggressively, even as loss leaders (we would make up the loss on the rest of the basket).
This is not just a retailer question, it’s also a manufacturer question. I think where we miss the most is that we, as an industry, fail to see price as a communication point for our products. Rightly or wrongly, high-priced products are seen as being better than low-priced products. The key is to determine what the highest price level is that supports your positioning.
I think there are two major challenges which still remain in retailer’s when it comes to pricing. First is the traditional definition of Price Zone. Instead of thinking of price zones as “Price Zones,” retailers must begin to think of them as “Strategy Zones” and allow stores to have multiple strategies based on category. Determining the item price in a particular store becomes based on the strategy for the zone which can be set by product category, and the facts which exist in that location. This becomes particularly helpful for DSD strategies, where stores may be in different cost zones for different DSD vendors. The same margin objective will determine a different price.
The second major thing retailers have to get a handle on is CRM. As more discounts are offered to individual customers, retailers have to be careful that they don’t “give away the store.” They are trying to attract consumers both through the old standard “category killers” and by targeting individuals. It is often difficult to predict or even be aware of the combined effect of these strategies if category managers and marketing departments are working independently. Retailers really need to coordinate these efforts under a “demand management” initiative that also includes inventory data.
I think all three can be damaging (not an option in the survey). We were always taught to think of pricing strategies like a triangle, with aspirational goods at the top and basics/best sellers at the bottom. To that thought, what I find lacking today is the very top of the pricing triangle. Where’s the diamond bra? The Rolls? The $500 sweater?? Where is that incredible piece that gives your brand the cache halo and gets everyone talking?
And I don’t think you should let your “category” deter you from that triangle strategy. No matter where you’re at, customers LOVE the idea of the top, even if they can’t afford it, it’s worth seeing/dreaming. We all would love to have the best, it’s our nature.
The “margins” mentality is a bad way to go all the way around. Retailers should focus in on destination, direct profitability, indirect profitability, and how a brand fits in and what role it plays in the overall assortment.
First–I endorse Lee’s comment about the power of seeing the dream at the top of the product pyramid. This is why most people who subscribe to Robb Report (who can’t afford a darn thing pictured inside it) feel better and richer just having it on the coffee table.
As a disclaimer, let me declare that I’m as far from being a math whiz as it’s possible to get. But I see the word “margin” used throughout this thread and it’s the right word. But it is my understanding that a lot of businesses (RW subscribers excepted) confuse “margin” and “markup” and, in fact, when you ask a proprietor which he/she is using they often don’t really know because they think it’s one and the same. But you don’t get a 30% margin by having a 30% markup. In fact, according to a mathematically astute friend, making this mistake will actually produce 6.9% less of a margin than you thought you were getting. That would be a very costly mistake over a period of time.
Even I get that the money magic is in the margin.
Selling a lower-priced product with a higher margin is often less profitable than selling a higher-priced (e.g., national brand) product with a lower margin. People do not spend the money they save on lower-priced (e.g., private label) products in the store. Optimization algorithms often assume linear relationships between sales and price and cannot account for all the findings in the price psychology area (key price points, context, multiple unit pricing, etc.)
For retailers, pricing strategy is critical to success, but we see far too many examples of poorly developed approaches. There are far too many examples, particularly for regional retailers where pricing is based on adherence to a margin or mark up calculation. We see very wide discrepancies in relation to National brands, both high and low.
In many regular purchases, this signals concern for shoppers–as there is nothing to explain why there are such gaps. All pricing has to be considered as part of the shopping experience. For the retailers who have continued to compete through very challenging times, revisiting their pricing strategy would be a wise investment of time and resources.