Study: Promo Strategy Better for Grocers vs. EDLP
A new paper from the Stanford Graduate School of Business finds that a promotional pricing strategy appears to be a better approach to competing against big boxes than than every-day-low price (EDLP) one.
The study explored market share battles during the 1990s when chains with EDLP models, such as Walmart, Sam’s Club, and Costco, began making rapid inroads into the food channel. The study particularly looked at Walmart’s entry.
"You need a major event to cause a pricing strategy switch that can be observed, and the entry of Walmart into the grocery market provided that natural experiment," said Harikesh Nair, associate professor of marketing at the business school and a co-author of the study, in a statement. The results were drawn from revenue and price-format decisions for every single retail supermarket and Walmart in the U.S. from 1994 to 2000.
The study found that EDLP reduces inventory costs, better coordinates supply chains, and reduces the risk of stock shortages by smoothing the demand variability induced by frequent sales. On the other side, a promo strategy results in higher revenues. Running calculations on the data, promo pricing for the median store yielded $6.2 million more per year in revenues than an EDLP strategy.
The study offers no conclusions on whether EDLP’s cost savings or promo’s revenue boost were more effective in the long run.
But promo proved more resilient to the entry of a bigger EDLP rival. Analysis revealed that the entry of Walmart resulted in a $1.7 million loss in annual revenues for the median incumbent EDLP supermarket, while it resulted in a loss of only $690,000 a year for the median promo store.
Also, switching from an EDLP to a promo strategy required only $2.6 million in costs over four years, while switching from promo to EDLP required outlays six times as large. A major investment included educating consumers about the "legitimacy of the new positioning." For example, researchers noted that the Wegmans chain in New York produced videos explaining to customers the benefits of their switch to EDLP. Repositioning costs also involved resistance to change by managers within the firm and the need to rework channel relationships.
"Now we have empirical evidence to show why most stores chose promo pricing and stuck with it during a competitive shock — it earns more revenues and is too expensive to change," said Prof. Nair.
Prof. Nair offered three findings from the study:
- "If revenues are what you care about, do promo pricing,"
- "If you’re a new entrant, be careful about your pricing strategy, because once you’re locked in, it’s difficult to reposition yourself."
- "Price perception is really important. Customers’ sense of how you price merchandise drives foot traffic to your store and takes a long time to build up. Violations of that will be costly in terms of the loss of consumer trust and the expense it will take to reeducate them."
- Everyday Low Pricing May Not Be the Best Strategy for Supermarkets According to Stanford Graduate School of Business Research – Business Wire
Discussion questions: Do you agree that promotional pricing is generally a better option for grocers than EDLP when competing against bigger-box EDLP models? What consideration should be given to the costs of switching from one pricing model to the other?