How to Develop the Optimal Pricing Strategy…
In setting pricing & promotional plans, using different pricing strategies and tactics for different products can be THE key driver of business performance. This is much like selecting the right club to make the perfect shot on the golf course!
It is important to recognize the various pricing strategies that exist and execute the best one across a portfolio of products.
3 Common Pricing Strategies
As the name implies, a High-Low pricing strategy runs a relatively high “bandwidth” between regular price and promoted price. These deeper discount levels tend to drive higher promotional lifts, and oftentimes such product promotions are front-page traffic drivers for retailers.
This strategy tends to work well on pantry-elastic, impulsive products. A great example would be Snack Foods. Many Snack Foods are so pantry elastic, they rarely survive past the first day in the house!
The nature of consumer behavior within these categories drives a high level of competitiveness. Examples include: Soft Drinks, Cheese, Frozen Pizza, Cereal, Cookies, and Crackers. The battles amongst manufacturers for front page flyer space can be intense within these traditional promotionally sensitive High-Low categories!
Characteristics of Ideal High-Low products –
- Effective Promotions (High Lifts)
- Pantry Elastic
- Traffic Drivers
- Highly Competitive
Example of a High-Low Candidate:
Over the past year, Product A has been sold at a variety of price points between $3.49 and $5.99.
In the graph shown, as price drops, both volume AND PROFIT increase down to $3.99. Volume and manufacturer profit will increase until a critical price point is reached, beyond which further discounting becomes profit dilutive.
2. Every Day Low Price (EDLP)
An EDLP strategy tends to have a constant price point, found somewhere between the product’s historic regular price & lowest sale price. This works best in mature categories with strong brands, that have more consistent and predictable consumer demand. These characteristics can be found in categories that have less-expandable consumption habits, leading to less-effective promotions.
For example, Eggs are a strong EDLP candidate. They are typically a product that would be purchased only when needed (as opposed to impulse-driven). Running promotions would merely subsidize sales that would have occurred at regular price & full margin.
Secondary benefits include ease of forecasting & supply chain / inventory management. It also allows retailers to communicate a message of everyday value on “core items”.
Typical characteristics of products where EDLP works best
- Less-Effective Promotions (Lower Lifts)
- Non-expandable Consumption (Inelastic)
- Secondary or Larger Pack Size (E.g. Club Pack)
- Less Aggressive Competition in Category
Example of an EDLP Candidate:
Product B… Over the past year Product B has been sold at price points between $11.49 and $14.99.
As the price drops, the volume increases moderately. This drives a decrease in manufacturer profit per week, as the volume gains do not offset the investment in price.
Product B would be a good candidate to run an EDLP strategy. Low feature prices on this product would compress margin without generating a high lift. A “fair” regular price would balance retail communication of good everyday consumer value with optimizing manufacturer profitability.
Retailers use of ELDP
A growing number of retailers have migrated towards EDLP strategies with the goal of improving store via communication of everyday value. Walmart tends to be thought of as the originator of the strategy in North America.
Benefits to the retailer…
- Defines store image
- Eliminates “cherry pickers”
- Reduces fixed costs (e.g. Advertising)
- Simplifies supply chain
- Reduces shopper discontent (e.g. finding a product on sale after buying at regular price)
Despite the above benefits to some retailers, due to the psychology of “sale shopping”, EDLP tends to result in lower sales for MANY categories and/or products. This tends to be the friction point between manufacturers (favoring a High-Low strategy) and Retailers (following a corporate EDLP mandate).
3. Hybrid EDLP
A “Hybrid” EDLP approach employs a lower (better everyday value) Regular Price and a higher Promotional Price than traditional High-Low. In principle, this sounds like a viable long-term strategy. In reality, the shallower depth of discount between Regular and Promo price drives significantly lower Lifts. The modest jump in Regular Price sales does not offset the reduction in Promo volume. This tends to leave a gap in BOTH the Manufacturer’s and Retailer’s P&L!
Consider an alternative “Hybrid Portfolio” approach…
Assess a portfolio of products to find those that respond best to EITHER EDLP OR HIGH-LOW. Employ the best strategy for the product and leverage the benefits of each pricing strategy.
A Manufacturer that collaborates with a Retailer in providing EDLP product options to drive store image of everyday value, while maintaining High-Low on flagship, promotionally responsive products should deliver a winning portfolio approach.
It can be difficult to change pricing strategies once a precedent is set. A historic High-Low product often is encumbered with a well-recognized, high frequency, promotional trigger price. Shoppers will wait for this price and seldom purchase at any other price point. While both Manufacturers & Retailers will want to reduce this reliance, and “raise the floor”, they need to be cautious about moving off this price point too quickly and impacting BOTH topline and bottom-line performance.
Oftentimes, the optimal strategy is the same for both Manufacturers and Retailers. It just requires the right Pricing & Promotional Analytics & Tools to uncover it!