Last quarter many CPG companies including P&G reported increase in profit despite declining or stagnant sales mainly because of the increase in product prices. Sales were slow because of the economy, cost sensitive customers shifted to cheaper and private label options. Profits increased faster than sales growth because CPG brands were able to charge a higher price to brand conscious customers.
Are higher prices alone enough? While higher prices delivered higher profit over last period continuing price increase is not a viable strategy. There are challenges from stores and other competitors. Stores stepped up their battle on price increases and stole customers by increasing private label offerings. Brands cannot continue to ignore sales growth. Take a look at P&G’s revenue and profit numbers and growth over past four years.
Their profit growth has been positive but the rate of growth has decreased since 2006. Mr. Lafley, the outgoing CEO of P&G, has this to say
“You have to see reality as it is. In every recession there are hosts of compensating consumer behaviors as they manage a more modest budget. We have to expand our portfolios to serve the needs of those consumers. I think a lot of that is going to last.”
To this end every business unit a P&G is working on reaching wider customer base with a broad price range of products. They are developing both super-premium products that can be sold at higher price premium than current products and value products that appeal to cost conscious customers.
Nestle, another CPG, has already outlined multi price point products as its strategy. Multi version pricing is exactly the solution for increasing revenue and profits. It is about increasing product lines and keep the customers within your brand family. When the economy turns around it is easier to up-sell to your own customers than acquiring customers you lost to the competition.
But the challenge is every new product line comes with big costs. Even though R&D and productions can be piggybacked on previous lines, the biggest cost item comes from marketing and sales. There are also the risks of cannibalization, new brands steering sales and resources away from current brands and whether or not customers will turn to the premium brands when times turn around. Implementing a multi version strategy without spreading the resources too thin is what sets great companies apart from the rest.
It is almost becoming rote to even read the stories on profit increase fueled by price increase. This time it is Cadbury of UK.
Price realisation, which includes price rises, adjustments in promotional frequency and product and package resizing, has been essential to recover cost pressures throughout the year, particularly in cocoa, sweeteners and oil based materials.
Cadbury increased prices in some cases 15%. The volume growth was only 1%.
Some analysts are wondering about the impact of price increase on future revenues.
Analysts said Cadbury’s revenues this year could be adversely affected by the price increases, which were up as much as 15 per cent in some markets.
Julian Hardwick, food analyst at RBS (LSE: RBS.L – news) , said: “The big question for 2009 is: what is going to be the impact on volumes of the pricing they are taking?”
That is actually the wrong question, addressing the volume instead of the bottom line. The real question is does Cadbury has enough brand value to keep charging higher prices and continue grow its profit.
Of all the talk of deflation, higher prices in branded products are here to stay as brands decide to focus on profit maximization rather than winning the market share battle.
Unlike some of the brands that are improving their profits with price increase, others are reporting losses from heavy discounts. The latest in that line up:
- Sears reported 55% drop in profit and almost 10% drop in revenue from heavy discounting
- Limited Brands reported almost 90% drop in profits and 8.7% drop in revenues, once again due to gross margin erosion from huge markdowns.
It is probably time to start a list of those who are showing profit increase from price increase and those who are losing profit from discounting.
Marketers are usually obsessed with market share and top line growth. In the recessionary times when customers are feeling the pinch and switching to private labels one would expect a price war among the major CPG labels for market share. But exactly the opposite is happening. There are four news stories from recent Wall Street Journal issues:
Of course this increase in profit with increase in price point to pricing inefficiencies until now, marketers have been pricing it below their profit maximizing price, probably focused on market share.
So why will the prices go up with profit despite drop in revenues? With recession, as some customers shift to private labels those who are left and prefer these brands have a higher willingness to pay and are loyal to the brands despite the price. Until now the CPG companies were going after the wider market with lower price. Now they know that they can’t get the price sensitive segment and hence it makes no sense to leave their loyal customers with higher consumer surplus. Hence the increase in price.
But how can profit go up when revenues go down? The price increase is pure profit but when marketers lose sales volume the loss in revenue is not all profit. As long as the marginal profit from increase in price is more than the loss of profit from lost sales, the marketer will gain from the price increase despite loss in revenue.
So the strong brands are increasing prices not decreasing and they are reporting increasing profits despite drop in revenues for some. If you are a investor are you worried about drop in revenues or happy to get increase in profit?
This is an update of an old post, updated for iPad queues.
Once I overheard two parents talking about Obama’s election. It was clear that both were Obama supporters and happily donated money to his campaign. One asked the other, “But did you support him from the beginning”. Then it dawned on me the existence of an implicit pecking order in the minds of consumers of certain brands, Obama, Apple, In N Out, Star Wars.
Does it matter that the other parent supported Hillary before the primary and then decided to throw her support behind her party’s nomination?
Does it matter I did not stand in line to get iPad?
Why does it matter to one segment of customers when the other became the fan of the brand?
I think that the mystique surrounding certain brand makes the early adopters feel that they somehow own it. The low uptake during this phase gave them the aura of exclusivity. As in the early days of Obama or in the case of Apple. But as the brand becomes more popular and reaches the exponential growth phase the early adopters find it hard that they don’t anymore enjoy the exclusivity.
The brands needed these passionate early adopters early on, but they nee the revenue from the large middle even more. Different needs at different stage of product lifecycle. In the end they end up treating all of them as the same.
Hence the early adopters tell themselves stories about being the first to support Obama before he was popular or stand in line for
four seven hours to get the magical new device.
All in an attempt to find the lost mystique, to tell ourselves that we are somehow different and unique from the rest, even though we buy and use the most popular product which is now available to all.
There is a proliferation of made up words that tack on the word onomics to a brand name., all inspired by Reagonomics and Freakonomics. All these initiated by the brands themselves. This of course an attempt to position the brand as most suitable for the current economic conditions. Examples include
- 3conomics (Wendy’s 3 meals under $3 deal)
Does this help the brand to associate with something that is not doing so well?
Why position your brand for tough economic conditions? So are the products the equivalent of what economists call Giffen goods?
When the economy improves will people switch from your brands to what they perceive as better brands?