How to make pricing decisions when the sales of one product affect the sales of others?
Pricing strategy not only influences the value perceived by customers and their price sensitivity, but also the performance of the entire product portfolio. Many times, the sales of one product directly or indirectly affect those of others, and this must be considered when making decisions.
SUBSTITUTESCOMPLEMENTARY
Substitute products: when sales compete with each other
When two products compete for the same customer need, we refer to substitution. In these cases, an increase in the price of one can generate a drop in its sales… and an increase in the sales of the other.
For example, a gas station sells multigrade and monograde lubricants. The first has better performance and a higher price; the second has lower quality and a lower price. If the owner considers raising the price of the multigrade by 5%, they must analyze how its sales will behave and how this will affect the total gross contribution of the business.
At first glance, if the product were analyzed in isolation, a drop in volume greater than 13% would make the price increase no longer profitable. However, if we consider that part of the lost multigrade sales would shift to the monograde, the loss of contribution per unit is not total: if for every quart of multigrade not sold half a quart of monograde is sold, the net loss is only US$1.50 instead of US$2. This adjusts the breakeven point, allowing for a sales drop of up to 17%. Thus, if a 15% drop is expected, the increase may be profitable.
Complementary products: when sales drive each other
In complementary products, the sales of one boost the sales of another. This is the case of a motorcycle shop that also sells insurance, helmets, and jackets. If the manager decides to lower motorcycle prices by 10%, they must consider not only the impact on motorcycle sales but also the additional sales each motorcycle generates.
Seen independently, motorcycle sales would have to rise more than 50% to offset the 10% price drop. However, if each motorcycle sold generates the sale of one insurance policy, two helmets, and one jacket every three customers, then the gross contribution associated with each additional sale is much higher. With this information, the breakeven point drops to a 27% increase in sales, which makes the decision profitable if sales are expected to rise by 30%.
Loss leaders and portfolio strategy
This analysis shows that sometimes it is justified to sell certain products with very low or even negative margins, as long as they help drive other products in the portfolio. These are known as “loss leaders.” Amazon, for example, sells its Kindle devices with minimal margins to stimulate the sale of books, music, and digital content.
Thinking together
Pricing decisions should not be made product by product. It is essential to understand the substitution or complementarity relationships within the portfolio. By doing so, total contribution is optimized and profitability is ensured, beyond what each product may generate on its own.