Five keys for retail pricing

​A chain of convenience stores was concerned that consumers still perceived them as expensive. It seemed that the continuous price promotions they conducted were not enough to counter the idea that their prices were far above what consumers considered reasonable. What were they doing wrong? Should they perform a general price reduction to please their customers? Or should they increase the aggressiveness of their price promotions? The answer to their questions is summarized in the following five keys for making smart pricing decisions in any retail business:

Ensure the competitiveness of “loss leader” products
Walmart is the quintessential model of the EDLP—Every Day Low Prices—strategy. But this chain does not have the lowest prices across 100% of its assortment. Walmart has identified the products for which consumers show higher price sensitivity and sets competitive prices for them. For the rest of the products, where consumers are less price-conscious, prices can even be above the competition.

Retailers need to clearly identify the products whose prices tend to be memorized and compared by consumers. Their prices must be competitive, as these products drive traffic and sales of other portfolio items.

Maximize margins on complementary products
Complementary products are those for which consumers show lower price sensitivity and do not tend to memorize or compare prices between competitors. They include convenience items, low-spend products, low market penetration, and products with little mass media price communication.

Top retailers strive to accurately identify complementary products. In these, they can recover the margin sacrificed on “loss leader” products, enjoying higher margins than the rest of the assortment.

Be cautious with price promotions
For a 10% promotional discount to be profitable on a product with a 20% gross margin, units sold need to double. Even considering incremental sales of complementary products, the required increase in sales can exceed 50%. Unless the manufacturer covers the promotion cost, price promotions are generally not profitable for retailers.

Price promotions should be limited to new product launches, entry into new market segments, and inventory management. Promotions should not be used as a reaction to competitor attacks or merely to create a perception of savings.

Calculate the break-even point for price changes
A casual clothing store felt they were leaving money on the table with their men’s shirt line. They wanted to raise prices by 10% but were unsure if it would be profitable. Fortunately, they knew the break-even analysis and did not need the exact price elasticity of the product to decide. With a 50% gross margin on shirts, unit sales only had to drop less than 17% for the change to be profitable. Based on experience, they proceeded with the price adjustment, and it succeeded.

In the absence of concrete elasticity data, before making a price change, calculate the unit variation required to maintain gross contribution. If it seems unlikely to reach that threshold, it is better not to make the adjustment.

Measure results and learn from them
A restaurant chain increased the price of its main product during the last quarter of the year in response to higher costs of its main ingredient. When evaluating results at the start of the following year, they concluded that units had not been affected and had actually grown 5% compared to the previous quarter. What they did not consider was that historically, fourth-quarter units are 30% higher than third-quarter units. Viewed this way, units had actually fallen 19%.

It is not enough to periodically measure the results of price changes. It is necessary to isolate variables unrelated to the pricing process to ensure conclusions are correct. Likewise, underperforming products should be identified for future price adjustments.

In summary…
​Price management in retail largely relies on estimating the price sensitivity consumers show for different portfolio products. It is necessary to know which products require competitiveness and which can enjoy high margins without losing volume. Moreover, price promotions should result from strategic analysis, not tactical initiatives that destroy value. Finally, an incorrect evaluation of results can be even more dangerous than not measuring at all. A pricing analytics tool like PGP by prexus ensures these five keys are considered.