Pricing: Defining the right strategy

Pricing: Defining the right strategy

Retailers and manufacturers need to stop seeing price as a tactical lever and move from constant discounting to improve long-term profitability.

Contributors

Related content

People shopping in mall

During the economic downturn, companies competed for market share and volume, which meant frequent price promotions and markdowns. While many markets have since recovered from the recession, corporations still find themselves stuck in a cycle of recession-driven discounting.

Robert Browne, Partner, Strategy Group at KPMG in the UK, says that companies need to now rethink their pricing strategy. The high-low model – marking products up, only to discount them later – not only lowers margins, but damages and devalues brands over time.

“It isn’t a strategy that helps improve the perceived worth of the product in the eyes of consumers,” Browne says. Constant discounting essentially telegraphs to consumers that products aren’t worth the regular price – the sale price is the true price – and he warns that the model can reset prices to a lower level permanently. “For a number of products, customers will now buy only if certain promotions are on.”

Some retailers, he notes, have been making a push away from the high-low model. In the US, electronics chain Best Buy has adopted an everyday low price model. However, it doesn’t always work. JCPenney tried to adopt the same model in 2012 but – showing how difficult it is to break out of such a cycle – retreated to price promotions. “While our prices continue to represent a tremendous value every day, we now understand that customers are motivated by promotions and prefer to receive discounts through sales and coupons applied at the register,” the company said in a statement.

George Svinos, Partner and Head of Retail, Asia Pacific at KPMG in Australia, says retailers are now pressing manufacturers to think more strategically about prices, and to focus on long-term profits rather than quick sales. “Retailers have a lot of precise data about the cause and effect of pricing promotions because of their loyalty card schemes,” he says. “They are finding that sometimes the promotion of a branded product actually cannibalizes their private-label sales rather than creating a halo effect on other products.

“This means retailers are pushing back on branded-product suppliers and saying: ‘We don’t want to do those promotions anymore.’” Browne says the working relationship between suppliers and retailers is right at the heart of the issue. “Suppliers have to get smarter about dealing with retailers and work with them to understand which promotions do and don’t work. If they don’t, they will continue to be at the mercy of retailers.”

Last year KPMG conducted a wide-ranging study of pricing with companies in the UK and the unanimous response is that they all have significant room for improvement. To illustrate this point, over 70 percent of companies said they could increase profits by at least 5 percent if they were able to price products and services more effectively, while 40 percent believed they could generate at least a 10 percent improvement in profits.

But to do so, brands need to treat pricing as a strategic rather than tactical capability. This is especially important now as companies are having to contend with growing competition, increasing price transparency, new consumer-led buying models and technological advances in traditional pricing models.

“Companies are realizing pricing can no longer be overlooked as a capability,” says Browne, who led the KPMG study. “It reminds me of the shift a decade ago with procurement, which transformed from an operating function to a core strategic capability for most businesses. Organizations now understand that to stay relevant and competitive, they need to examine different pricing models, ensure their chosen model aligns with their business goals, and that the strategy drives long-term profitability.”

Consumer-led models

New and emerging

Browne says there are two new pricing models emerging: “One that is beneficial to the consumer, and another that works more in the seller’s favor.” The former includes competitive pricing, driven by increased price transparency and online retailing. Consumers are using mobile devices to check and compare prices between multiple retailers. This is particularly evident in the travel sector, where a slew of new websites – such as Trivago and Kayak – claim to do the comparing for millions of consumers who have neither the time nor inclination to visit multiple sites. These capabilities are now also ubiquitous in retail.

“New technology now enables shoppers to scan bar codes using a smartphone app and see the price at other retailers,” says Browne. Some apps even forecast what the price might be in the near future – potentially delaying or spurring the decision to purchase. “We’re seeing a lot of new technology concepts, such as what mySupermarket is doing with Morrisons in the UK that will help consumers comparison-shop between retailers.”

E-commerce across borders is also contributing to the challenges of competitive pricing. Competition previously resided within geographic borders; now domestic and foreign brands are going head-to-head online. In Australia, for example, where goods are typically more expensive than in most other parts of the world, residents can make overseas online purchases of up to AUD$1,000 (US$867) without paying duty, goods and services tax (GST) and import processing fees.

To ensure that its prices remain competitive with global e-commerce sites, Australian department store chain David Jones, purchased by South Africa-based Woolworths earlier this year, embarked on “price harmonization” as part of its turnaround plan. To date, David Jones has negotiated with 250 international brands that it identified as being in need of harmonization.

“We’ve been working and will continue to work with our brand partners to reduce prices across the store,” the company said in an announcement. “Right now, the prices on hundreds of products from international brands have been reduced by up to 50 percent. Not temporary savings, but lower everyday prices.”

Other consumer-led models have emerged including collective buying, where shoppers use their combined purchasing power to get deals. Groupon is a well-known enterprise-led example, but there have been more community-driven efforts, too: in the UK, energy suppliers found themselves bidding in a reverse auction for the business of 36,000 customers. The households had signed up to a campaign called The Big Switch, orchestrated by activist group 38 Degrees and the Consumers’ Association that aimed to secure them cheaper gas and electricity services.

There are also websites that put a twist on the name-your-price model made popular by travel website Priceline and Humble Bundle, a purveyor of digital assets such as games, e-books and music. Users of online marketplace Higgle, for instance, can name their price if they have enough people buying together. Typically, users of these marketplaces rely on social media to find like-minded buyers.

“Expect to see more examples of groups of customers coming together to use their buying power as one,” says Browne. “This will open up new opportunities for enterprising brands that are willing to be innovative in their approach to pricing and promotions.”

Seller-led models

more information than ever before

Consumers may have access to more information than ever before about the prices of goods and services across various sellers – but retailers have more information about their customers than ever before. “There is a lot of data available in the retail environment through point-of-sale systems, loyalty cards, competitive price checkers and social media,” explains Browne. “It’s a matter of retailers analyzing that data and gleaning insights they can put into action.”

More and more brands are using data to set prices on an increasingly dynamic basis, where prices can change by month, week or day, depending on supply, demand and a multitude of other variables factored in by the algorithm. It is a model that has driven the success of online giant Amazon and is now being replicated by similar retailers across the globe such as Jumia, the largest e-commerce provider in Africa.

Jumia, which was set up by AIG and is funded by Millicom, MTN and Rocket Internet, has seen double-digit growth month-over-month since its 2012 inception. As well as serving its home market, Jumia also sells general merchandise in Kenya, Morocco, Ivory Coast, Egypt, Ghana, Cameroon and Uganda.

“It is the Amazon way of doing business,” says Nicolas Martin, Chief Executive Officer of Jumia. “You develop a pricing algorithm so sophisticated that no one can emulate it. This enables you to always have the most relevant price, and to optimize your price and margin based on the price and availability of competitors’ products.”

The old pricing model, says Martin, lacks the flexibility needed to balance inventory and the inherent depreciation of products. He notes, for instance, the price of a new computer drops about six weeks after going on sale. “No matter what you do, the only way to succeed in online retail is to have the right product, at the right price, delivered conveniently,” he says. “Nothing else matters. If you are not relevant in terms of price, you have no business.”

In markets such as Africa, consumers can be very wary of online payments. Martin says earning consumer trust is an important way for brands to ensure they don’t compete purely on price. It explains why Jumia offers pay-on-delivery (through a fleet comprising mostly motorbikes, which make it easier for drivers to navigate congested roads) and free returns on most product categories.

“Trust has limited impact when it comes to actual price, but it does as part of a consumer’s consideration list: ‘If I don’t trust you, I don’t care about your assortment or your prices’,” notes Martin. “Trust also allows you to charge more for services.” For example, a company’s shipping fees can be higher than the average if people trust and enjoy the quality of the service.

Browne says airlines are a great example of a sector that uses data-driven dynamic pricing in combination with an innovative value proposition. They’ve pioneered a concept he calls “disaggregating value”.

By breaking down the offer into individual components that drive value for customers – such as the ability to check baggage, change flights or reserve seat locations – airlines can charge for them on a per-use basis, since they are separated from the ‘seat price’ on a flight. “For 40 years airlines couldn’t figure out how to make money until they started disaggregating how value is created,” explains Browne. “They figured out their value proposition and said: ‘Let’s price for all these bits and pieces of value.’ They really pioneered ‘smart’ pricing.”

Dynamic pricing is nothing new at retail – restaurants’ ‘early bird’ specials and shoe store end-of-season clearance sales, for example, demonstrate dynamic pricing in its simplest form. But can these bricks-and-mortar retailers learn to better leverage technological advances?

“Does that really apply in the real world of the retail consumer? It sort of does now,” says Browne. “There are lesser versions of dynamic pricing creeping into lots of places that retailers need to be aware of. Trials of electronic price tags that update prices based on inventory, for example, are already under way. If you contrast that to someone coming along with a price gun to change a price on a shelf, you can see how we’re moving light years away from that.”

Uber, a ride-sharing service founded in San Francisco, has hit the headlines because of its pricing model: rates fluctuate due to an algorithm that takes into account the number of taxis on the road and taxis taken with passengers. When demand is low, Uber’s rates are generally cheaper than other cab services, but when demand is high, rates can be several times above normal levels.

The model generated some negative publicity for Uber after journeys during a New York City snowstorm cost some passengers more than eight times the standard price. The company has since said it will cap how much it can raise rates during emergencies. While Browne says that consumers are becoming more used to paying for goods and services on a dynamic basis, he warns that they don’t want to feel that a business is deliberately profiting when they are at their most vulnerable.

“There is a profound psychological issue that is fundamental to all pricing models: no one wants to feel like they are getting ripped off,” he says. “There was an experiment done by a soft drinks manufacturer in which the price of its drinks in vending machines changed based on the temperature outside. It would be logical to think if the temperature rises so would the price, because of greater demand. But customers completely rejected this pricing model, because it felt exploitative.”

What’s the next frontier of pricing? Svinos says marketers have the ability to leverage data analytics to price products on an individual basis. “We’re not there yet,” he says. “At the moment, many retailers are just trying to make certain customers aware of promotions based on their purchasing histories. But once you know someone’s triggers, you can target prices individually without necessarily doing it across the board.”

Demand-led pricing

non-luxury brands are making a shift to capitalize on production efficiencies

One market segment that rarely discounts is luxury goods and services. Svinos says they are the best example of the proactive, value-based model, in which pricing is determined based on how much a consumer values the product or service. To maintain its value, luxury brands such as Rolex and high-end fashion labels always keep prices at a high level. “Louis Vuitton doesn’t have sales. It doesn’t discount because it doesn’t want to disenfranchise customers by causing some to buy goods at full price and enabling others to buy at a discount,” says Svinos. “It is the ultimate in brand protection and pricing.”

Non-luxury brands have embraced the value-based model partly by shifting from mass production to a made-to-order or made-to-build model. “The car industry used to produce as many vehicles as it could to capitalize on production efficiencies,” Svinos continues. “But now the thinking is: ‘Why do I need to build so much stock that I will then have to discount?’ Because typically the only mechanism to move inventory is to reduce the price. Now they are moving to a built just-in-time basis.”

However, marketers still have to find the right price point that will attract buyers, and ensure stock doesn’t pile up. Svinos says this demands that companies also better understand how production and pricing can work together strategically; too often pricing is a reactionary response to inventory levels.

Svinos credits Apple for implementing the just-in-time model, achieved through lean manufacturing and smart supply chain management, which helps maintain prices as demand is always greater than supply. He says the value-based model can also work for a brand such as McDonald’s, which has found the right value price point for its meal products. “It introduces new products every month – this innovation brings customers to the restaurants and generates demand. It’s not actually price-driven at all,” he says. “McDonald’s recognizes that price is not the only lever to move product.”

Spanish fast-fashion retailer Zara is cited as another successful example: it has developed a highly centralized manufacturing and distribution model, which results in new clothes being delivered to stores twice a week. “Zara has adopted a replenishment model that results in not overstocking a store,” says Svinos.

“It doesn’t mean that everything Zara delivers to store is a best seller, simply that if the item doesn’t sell, the retailer doesn’t deliver any more, thereby minimizing discounts in store,” he says. “When Zara does occasionally discount goods, consumers don’t really notice the sales – that’s not the reason why they visit the company’s stores.”

Zara’s model compels the shopper to buy at full price rather than wait for a markdown that might not come, says Svinos. “It has created demand: people say: ‘If I don’t buy it today, it won’t be there tomorrow. I can’t wait.’ It is a demand-led model, not a supply-led one.”

Adapt or be left behind

retailers and suppliers need to become more sophisticated about pricing strategies

Both Svinos and Browne believe that retailers and suppliers need to become more sophisticated about pricing strategies – because if they don’t they will continue to execute reactionary, low-margin responses to competition and consumer behavior even during times of growth. “There is a real opportunity to get more strategic about it now,” says Browne. “Strong pricing capabilities are now a requirement to be competitive.”

Key points to consider

  1. Move responsibility to strategic function: Think of pricing as central to your long-term strategic plans; not as part of your short-term, tactical actions. When reassigning responsibility for pricing, ask yourself: how does the pricing reinforce the brand value of your product or service? How do prices affect supply and demand? And, ultimately, how does your pricing strategy help to drive profit for your company?
  2. Retailers are in the driver’s seat: Manufacturers must acknowledge that retailers are in prime position to understand and determine pricing strategies. Their ability to capture and analyze transaction and loyalty-card data gives them the insight needed to define the prices and promotions that drive the most profit. Online retailers are also able to optimize prices using sophisticated algorithms that consider multiple variables that manufacturers may not be able to see. It’s essential for manufacturers to work closely with their retailer partners to develop promotions that are mutually beneficial.
  3. Consider the role of value: Do you know what value consumers place on your brand, and why? Once you do, you can explore how value can be protected and enhanced by your pricing strategy. Understanding how consumers define the value of your product or service brings you much closer to identifying a pricing strategy that works.
  4. Big data is still king: Making use of the wealth of customer data available is crucial for shaping your pricing strategy. Use it to gain insights into price performance and identify which segments of consumers are willing to pay more for your products and services.

ConsumerCurrents article archive

View articles from the ConsumerCurrents archive.

 
Read more

ConsumerCurrents

ConsumerCurrents provides senior executives and consumer companies insights on topical industry issues, global trends and business planning.

 
Read more

Connect with us

 

Request for proposal

 

Submit

KPMG's new digital platform

KPMG's new digital platform