Price vs Point of Difference: The numbers are in

If sales are slow, how do you respond?

The favoured ‘marketing’ tactic of all retailers is discounting; and that includes top-end brands. I can say this without fear of contradiction.

Consultants often suggest that this is a short-term ‘strategy’ that does not address the underlying issue, yet retail operators persist.

I found some good research that addresses this question quite definitively. Unlike many studies, this was not a ‘survey of opinion’, but rather based on a modified Du Pont analysis, including all the fancy statistical safeguards on a large sample of retail businesses. (The only question mark may be whether the American market place is comparable to the Australian one, but I will leave that for you to decide.)

Conventional wisdom is that companies can devise successful competitive strategies around either profit margin or asset turnover. That is; you are either a high margin/low volume business or high volume/low margin business.

Cost leadership strategy attempts to achieve organisational goals by delivering a product or service comparable to competitors' at a lower cost to the customer.

A differentiation strategy, attempts to deliver to consumers some characteristic of product or service that will command a premium price.

In this research, a modified Du Pont model of financial ratio analysis was used to evaluate a large sample of retailers using a metric termed RONOA – return on Net Operating Assets.

The results were interesting to say the least.

Differentiation strategy

The RONOA ranged from 13.5% to about 58 % with a mean of about 29 %.

Cost leadership strategy

The RONOA ranged from -46 % to about 24 % with a mean of about 7 %.

What to make of this?

The results of this study suggest that retail firms that pursue a differentiation strategy outperform those retail firms that use a cost leadership strategy. By a long shot.

In fact, the best performing cost leader is still worse off than the ‘average’ differentiator.

But that does not mean that you can’t pursue a low-cost. You COULD be the one with a 24% return. Just recently JB Hi Fi announced their stellar results.

But the key point is that, when it comes to trying to be a cost leader, is that there can only be one leader (winner). And unless you are going to be that leader, it seems like a race to the bottom.

The better alternative (less risky and more rewarding) is to develop your point of difference. I have written previously about developing your proposition. (With extensive supporting templates – search for ‘mojo’ on this website.)

Sure it is harder than knee-jerk discounting. And it may take longer to get right. But eventually you will be the king of the hill, even if you have to build your own hill.



Make more money (by understanding price elasticity)

The best price to charge is the one where you make the most money (profit). There is a simple formula for this. To calculate the price elasticity, you simply have to have two data points.

How much product was sold at P1 and how much product is sold at Price 2?

Price elasticity (PE) is basically the relationship between the change in quantity and change in price. If you imagine that as a straight line between two points, it is the slope of the line.

 (PE) PE = [(Q2-Q1) / ((Q1+Q2) / 2 )] / [(P2-P1) / ((P1+P2) / 2]

Where Q1 = initial quantity; Q2 = final quantity; P1 = initial price; P2 = final price

• If the PE > 1 (i.e. positive) the product is said to be relatively elastic. An increase in price would result in a decrease in revenue, and a decrease in price would result in an increase in revenue.
• If the PE < 1 (i.e. negative) the product is relatively inelastic. An increase in price would result in an increase in revenue, and a decrease in price would result in a decrease in revenue. (Think products like petrol.) 

To illustrate, assume that:

(a) The product costs $50.

(b) You have calculated the elasticity of a product to be -2.4005.  (This would be a product that is very inelastic – meaning that this product can tolerate price increases without sacrificing quantity.)

The simple formula for the optimum price is this:

Profit maximizing RSP

price elasticity x cost

price elasticity +1

-2.4005 x $50

-2.4005 +1

$85.70 

This means that the price at which you would sell your product to make the most profit is $85.70.

(There is one technical assumption that is unlikely to make a difference, but for the sake of completenes: This calcualtion assumes that the conditions that applied (competitors, discounts, etc) when you collected your price sensitivity data continues to apply after you have set your price.)

Variable Pricing and Price Discrimination

It is not easy to nail the right price points, despite the proliferation of data and increasingly, the tools available.

This is a rather technical subject, but it is worth mulling over if you are a serious student of retail.

First degree price discrimination

1. Individualised Variable Pricing

Retailers would maximize their profits if they charged each customer as much as the customer was willing to pay. (Auction bidding is an example of first-degree price).

Although first-degree price discrimination is legal, it is not always practical

Second degree price discrimination

2. Self-Selected Variable Pricing (Second degree price discrimination)

Markdowns are technically known as second-degree price discrimination – charging different prices to different people on the basis of the nature of the offering.

3. Coupons

Coupons offer a discount on the price of specific items when they're purchased at a store.

Coupons are also considered a form of second-degree price discrimination because price-sensitive consumers are more likely to expend the extra effort to collect and redeem coupons whereas price- insensitive consumers will not.

Coupons are used because they induce customers to try products for the first time, convert those first-time users to regular users, encourage large purchases, increase usage, and protect market share against competition. 

4. Rebates

Rebates provide another form of discounts for consumers off the final selling price. In this case, the manufacturer issues the refund as a portion of the purchase price returned to the buyer in the form of cash.

Manufacturers like rebates because as many as 90% of consumers don’t bother to redeem them (breakage). Retailers like rebates because they increase demand in the same way coupons may, but the retailer has no handling costs.

5. Price Bundling

Price bundling is the practice of offering two or more different products or services for sale at one price. Price bundling increases both unit and dollar sales.

6. Multiple-unit Pricing

This strategy is used to increase sales volume. It is similar to price bundling in that the lower total merchandise price increases sales, but the products are similar, rather than different.

The risk is that customers may stockpile for use at a later time, resulting in no long-term gain.

Third degree price discrimination

7. Variable Pricing by Market Segment

This is an example of third-degree price discrimination and refers to the practice of charging different prices in different stores, markets, regions, or zones (a.k.a zone pricing) – usually in response to different competitive situations in their various markets.