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Retail Pricing Strategies

NBS-7030B

Retail Marketing & Management

Ratula Chakraborty

Professor of Business Management

Director MSc Programmes

[email protected]

Lecture Outline

Influences on Price

Demand Sensitivity

General Pricing Policy

Tactical Pricing

Case Study: Promotional Pricing in UK Grocery Retailing

Purpose: to examine the key influences on retail price setting and how retailers determine their general pricing policy and specific pricing tactics

Questions for Discussion #1

Why is pricing particularly important for a retailer?

Which UK supermarket chain respectively offers (a) the overall lowest prices, (b) the best one-off special offers, and (c) the best quality goods and service?

Market stalls tend to offer lower prices for fresh fruit and vegetables than supermarkets, so why do so few people use them and instead pay higher prices at supermarkets?

How good are you at bargain hunting? Do you actively shop around for the best deals, comparing one store’s prices against another and do price comparison searches on the internet before you buy goods? If not, why?

1. Influences on Price

Key factors influencing price:

Cost

Consumer Demand

Competition

Government

Influences on Price

1. Cost

Product cost: price paid to the supplier

Service cost: cost of providing retail service (including store operations, logistics, marketing, etc)

Retail Profit:

Gross margin = Retail Price – Product Cost

Net margin = Retail Price – Product Cost – Service Cost

Margin is usually expressed as a percentage of retail price

Influences on Price

2. Consumer Demand

Market demand - inverse relationship between price and total quantity demanded

Nature of the good – e.g. essential v. luxury item

Quality – e.g. high v. low

Value assessment – e.g. search (quality determined before purchase), experience (quality determined after purchase) or credence (quality taken on faith) products

Psychological aspects – e.g. “bargains” v. “rip-offs”

Influences on Price

3. Competition

What are the alternatives and how many are there for consumers?

Substitutes - close or distant? (similar or dissimilar?)

Numbers of competitors - none, a few, or many? (monopoly, oligopoly, or perfectly competitive?)

Entry barriers – easy or difficult for new entrants to enter market?

Example: How John Lewis Partnership tracks the prices of its competitors to maintain its “never knowingly undersold” pricing promise

BBC News, 10/3/2010, 2mins http://news.bbc.co.uk/1/hi/business/8558242.stm

Influences on Price

4. Government

Sales Tax

Value Added Tax (VAT) - currently 20% in UK

Excise duties (e.g. on alcohol and tobacco)

Regulation

prohibition of anti-competitive pricing practices

Ban on horizontal price fixing between rival retailers (i.e. colluding to set high prices)

Ban on vertical price fixing and resale price maintenance (where the supplier dictates the retail price)

Ban on deceptive pricing (e.g. over false “discounts”)

Ban on predatory pricing (to drive rivals out of the market)

Sharp Practices – Misleading Pricing

Fake bargains – examples

Tesco fined over 'half-price' strawberries claim: http :// www.bbc.co.uk/news/uk-england-birmingham-23755528 (2 min)

The truth about supermarket ‘bargains’: http :// news.bbc.co.uk/panorama/hi/front_page/newsid_9652000/9652944.stm (2 min)

Hidden cost of internet bargains and add-on charges: http:// www.bbc.co.uk/news/uk-19310649 (1 min)

Need for consistent unit pricing for comparing prices: http :// www.bbc.co.uk/news/uk-19499889 (2:30 min)

Secrets of designer goods “bargains” in outlet stores: http:// www.dailymail.co.uk/femail/article-2651155/The-truth-outlet-store-designer-bargains-Shoppers-flock-town-malls-huge-discounts-brands-products-arent-seem.html (2:30 min)

2. Demand Sensitivity

The demand facing a retailer is likely to be sensitive to

Changes in the retailer’s own price

Changes in the prices set by its rivals

Changes in the real income of consumers

The degree of demand sensitivity is measured in terms of the elasticity of demand with respect to these three aspects:

Own price elasticity of demand

Cross price elasticity of demand

Income elasticity of demand

The degree of demand sensitivity will depend on the nature of the retailer and the products it sells

Demand Sensitivity

Price Elasticity of Demand

Own Price Effects

Price elasticity of demand – the ratio of sales change to price change:

Percent change in quantity demanded (Q) % Q/Q

Percent change in price (P) = % P/P

where  “delta” means change, e.g. a 1% change in price results in an x% change in quantity

Inelastic demand (between 0 and -1): essentials, e.g. petrol, cigarettes, milk, bread

Elastic demand (exceeds -1): non-essentials

unit elasticity = -1 means total expenditure remains the same after a price change

Demand Sensitivity

Cross-Price Elasticity of Demand

Perceived Substitute Effects

Cross-price elasticity of demand – the ratio of own sales change to rival’s price change:

Percent change in quantity demanded % Qa/Qa

Percent change in rival’s price = % Pb/Pb

where  (“delta”) means change, “a” signifies Firm A and “b” signifies Firm B

Substitutes (positive value): e.g. beer and cider, Coke and Pepsi

Complements (negative value): e.g. computers and software

A zero value means the goods are demand independent

Demand Sensitivity

Income Elasticity of Demand

Income Effects

Income elasticity of demand – the ratio of own sales change to a change in consumers’ real income:

Percent change in quantity demanded (Q) % Q/Q

Percent change in Income (Y) = % Y/Y

where  (“delta”) means change

Normal goods (positive value):

> 1 : luxury / superior goods – cars, jewellery, restaurant meals

< 1 : necessity goods – staple foods, basic clothes

Inferior goods (negative value): e.g. margarine, public transport

3. General Pricing Policy

Four main pricing strategies used by retailers:

Premium (i.e. superior quality and service, but higher prices)

Discount (i.e. emphasis on low prices)

Every Day Low Price (EDLP) (i.e. reliable prices/few promotions)

Hi-Lo (i.e. higher standard prices/offset by special promotions)

Strategy will fit with the strategic positioning of the retailer in respect of its target market: bottom end, mid-market, or top end

General Pricing Policy

Pricing Strategies in Different Market Segments

Bottom-end Mid-market Top-end

(“The Big Middle”)

Number of Shoppers

EDLP

Discount or Hi-Lo Premium

General Pricing Policy

Premium Pricing

Applicable for retailers with a strong brand and service reputation selling to quality conscious consumers

Superior product quality and service – e.g. M&S and Waitrose in food retailing

Pricing to infer quality – e.g. luxury goods like perfumes

Symbolic (“snob”) value – e.g. Harrods or Harvey Nichols

Specialist stores with unique products – e.g. Fired Earth

General Pricing Policy

Discount Pricing

Applicable for retailers with a low cost base aimed at selling to price conscious consumers:

“hard discounters” – e.g. Aldi and Lidl offering limited product range at very low prices

“factory outlets” – selling seconds-quality goods, ends of lines and previous season’s merchandise

“virtual auctions” – e.g. online auction sites like Ebay

“off-price retailers” – special purchases and bulk-discount sourcing, so stocking lacks continuity

Example: The rise of the 99p and pound stores

BBC News (16/8/2011, 3min) http://www.bbc.co.uk/news/business-14540624

General Pricing Policy

Every Day Low Price (EDLP) Strategy

Consistently low prices to provide a value reassurance to customers to generate high sales volumes and make cost savings from economies of scale and better inventory management:

Very competitive prices across entire product range, all of the time – e.g. Wal-Mart

“Value Retailers” – low prices with regular product changes – e.g. New Look

Downside risk is that consumers find the offer boring with the absence of discount deals and special offers

General Pricing Policy

Hi-Lo Promotional Pricing Strategy

High-low price variation over time and within categories to stimulate consumer interest

Loss-leader pricing to boost store footfall

Regular short-term price discounts for value assurance

Multi-buys (BOGOFs, 3-for-2s, etc) to boost volumes

Seasonal pricing – full-price then marking down

Downside risk is higher inventory costs from fluctuating sales levels and that consumers adopt “cherry picking” behaviour and only buy discounted goods

4. Tactical Pricing

Beyond the choice of general pricing strategy, retailers can adopt specific pricing tactics

Four pricing tactics are briefly considered here:

Markdowns

New Product Pricing

Price Lining

Psychological (Odd) Pricing

(Note: Price Discrimination will be covered in the Micromarketing lecture)

Tactical Pricing

Markdowns

Markdowns on the full price are used to clear stock, boost sales and generate cash for new stock:

Clearance Markdowns to get rid of slow-moving, obsolete merchandise

Promotional Markdowns

To increase sales and promote merchandise

To increase traffic flow and sale of complementary products and generate excitement through a sale

To generate cash to buy additional merchandise

Markdowns are important for seasonal goods (clothing), perishable goods (fresh food), hi-tech goods (computers)

Tactical Pricing

New Product Pricing

Two main pricing tactics used for new products:

1. Penetration pricing

Low entry price to penetrate the market, build sales quickly and generate economies of scale (often where a complementary product can later be sold at high price):

Examples: Games consoles, inkjet printers, shaving razors

2. Price skimming

High entry price to appeal to customers willing to pay a premium price to be amongst the first purchasers

Examples: latest fashions, new DVDs and computer games

Tactical Pricing

Price Lining

Pricing a line of related products at different discrete pricing points (e.g. £10, £15, £20)

A line can comprise related products of various sizes, types, colours, and qualities

Emphasis is to encourage consumers to “trade up” in quality terms to higher margin products

Facilitates segmenting consumers according to whether they are price, value or quality conscious

Example: “Good, Better, Best” pricing of own label grocery products in basic-standard-premium quality tiers

Tactical Pricing

Psychological Pricing

Pricing to take advantage of bounded-rationality of shoppers

Odd pricing: A price that ends in an odd number: £2.99

A number of explanations for the practice:

Consumers only take notice of left hand side digits and ignore the right hand side digits

Signals pricing precision so builds consumer trust

Clear pricing points aid in-store price comparisons

Latest trend is towards “round pricing” - £1, £2, etc – used by hard discounters and leading grocery chains

Questions for Discussion #2

In the context of your group coursework:

What general pricing policy will your retailer adopt?

What pricing tactics will be used to influence consumers purchases?

How will your pricing strategy differ from your rivals’?

How will you be sure that you are pricing at the right level?

5. Case Study: Grocery Promotional Pricing

Promotional pricing in the UK grocery retailing sector has increased substantially in recent years

All the main supermarket chains now employ promotional pricing to a greater or lesser degree

The top retailers tend to operate a hybrid pricing strategy that combines EDLP with Hi-Lo pricing

The hybrid pricing strategy ensures that regular prices are kept low but discounts and special offers add interest for consumers looking for bargains

The hybrid approach is particularly effective in appealing to a very wide range of consumer segments

Consumer Spending on Supermarket Offers

Price promotions are a key driver of grocery shopping behaviour and consumer spending

Around 35% of all supermarket spending is on offers

Spending on supermarket offers is over £50bn per year

Nearly half of all spending on offers is on multibuy deals (e.g. “buy one get one free”, “3 for 2”, “2 for £X”)

Price promotions account for around half of all spending on alcohol and soft drinks

Price promotions also extensively used on ready meals, confectionery, snacks, meat, sauces, and yoghurts

Consumer Expenditure on Offers

(% of Total Spend on Food and Drink)

Source: Nielsen - State of the Nation 2014 (GB)

Source: Nielsen Homescan – Grocery Multiples (GB)

Consumer Expenditure on Offers at Top 5 Retailers

(% of Total Spend on FMCGs)

Source: Nielsen Homescan – Grocery Multiples (GB)

Consumer Expenditure on Offers at Grocery Multiples

(% of Total Spend on FMCGs – 2013 v. 2014)

Key factors behind consumers’ increasing reliance on price promotions:

Saving money in difficult economic times

Trying new or different products

Stocking up through bulk buying

Making shopping more interesting

Shoppers’ Addiction to Price Promotions

...but with concerns about overbuying leading to food waste and a general suspicion about prices and whether deals are genuine

Source: Nielsen Homescan Survey (GB), January 2014

(based on respondents making up to three choices from list)

Promotions as a Primary Source of Saving Money

What do shoppers like about promotions?

What do shoppers dislike about promotions?

Consumers’ Likes and Dislikes About Price Promotions

Source: IGD Consumer Unit, 2009

Addiction to Offers: Rising Across Europe

Source: Nielsen Company - The structural transformation drivers in FMCG, 20011

Promotion Sensitivity: Average Across Europe

(% Shoppers Surveyed)

TYPE	DESCRIPTION & PURPOSE
Price reduction	Straight discount, e.g. “50p off” or “25% off” to stimulate sales and encourage switching to higher margin products
Multibuy / Multisave	Discount conditioned on number of items purchased, e.g. “3 for 2”, “BOGOF”, “B1G1HP”, “2 for £X” to drive volume sales
Extra Free	Additional quantity in the pack, e.g. “33% extra free” to reward loyalty and encourage trial
Link Promotion	Cross-product discount, e.g. “Buy a sandwich and a drink for £x” to encourage cross category purchase and drive basket spend
Banded pack / free product inside	Linked sale with free item included, e.g. “free mug with teabags” to encourage trial
On pack offers	Collect points or vouchers, e.g. “swap vouchers for sport kit” to encourage loyalty and repeat purchasing
Sampling	Trial size products to encourage purchase of new products or encourage switching to higher price/higher margin products

Types of Price Promotions

Consumers’ Favoured Types of Price Promotions

Source: Nielsen Homescan – Grocery Multiples (GB) – January 2014

Expenditure on Offers by Type of Price Promotion

(% of Total Spend on Offer of FMCGs)

Source: Nielsen Homescan – Grocery Multiples (GB)

Source: Nielsen Homescan – Grocery Multiples (GB) – Jan 2014

Spend on Offers by Offer Type in Top 4 Retailers

(% of Total Spend on Offer of FMCGs)

Recent Developments in Price Promotions

Round Pound deals (£1, £2, £3, etc)

Buy one get two free (B1G2F)

Buy one get one free later (BOGOFL)

Better than half price

Meal deals

Bulk pack deals

Money off vouchers (on total till spend)

Source: Kantar Worldpanel

Spend on Round Pound Offers at Supermarkets

(% of Total Spend on Groceries, 12 weeks to Jan 2015)

Source: Kantar Worldpanel

Consumer Spend on Round Pound Offers at Asda

(% of Total Spend on Groceries, May 2010 to Jan 2015)

Differences Across Food Categories

High promotion product categories are soft drinks, alcohol, confectionery and meat/poultry/fish

Low promotion product categories are fruit & vegetables and dry grocery

Soft drinks, dairy, deli and bakery products heavily promoted by multibuy deals

Fruit & vegetables and alcohol use an almost even mix of price cuts and multibuys

Expenditure on Offers by Product Category

(% of Total Product Category Spend on Offer in Grocery Multiples)

Source: Nielsen Homescan – Grocery Multiples (GB)

Source: Nielsen Homescan – Grocery Multiples (GB) – Year to Jan 2014

Category Expenditure on Offers by Offer Type

(% of Total Product Category Spend on Offer in Grocery Multiples)

Source: The Grocer, 24 January 2015

Update: Price Promotions in January 2015

Questions for Discussion #3

What do you like and dislike about price promotions?

Why has the proportion of supermarket spending on price promotions risen so much in recent years?

Why might a retailer be attracted to using “round pound” pricing (as opposed to odd pricing)?

Why are soft drinks, alcohol and confectionery so extensively price promoted in UK grocery retailing? Is this good for consumers and society in the long term?

References

Varley, R. and Rafiq, M. (2014), Principles of Retail Management, Palgrave MacMillan.

Berman, B. and Evans, J.R. (2010), Retail Management: A Strategic Approach, 11th edition, Prentice-Hall.

Bolton, R., Shankar, V. and Detra Y. Montoya, D.Y. (2007) , “Recent Trends and Emerging Practices in Retailer Pricing” (http://www.ruthnbolton.com/Publications/RecentTrendsandPracticesinPricing.pdf)

Thank You!