Pricing Strategy and Stock Prospects

Procter and Gamble   and Kraft, the two Consumer Packaged Goods (CPG) leaders, reported identical revenues and earnings growth in their last quarter. Analysts interviewed by Barrons magazine prefer  Kraft over P&G for one major reason: Kraft’s pricing strategy that is focused on reducing discounting and solidifying pricing power in the face of competition from low priced private label.

Kraft Chief Executive Officer Irene Rosenfeld seemed confident that the days of branded foods being nibbled to death by cheaper private-label goods have come to an end. Rosenfeld says the company has expanded operating margins and plans to continue increasing its “pricing power.”

What about P&G pricing? According to Jason Gere of RBC Capital Markets, discounting and price cuts are not guaranteed to drive volume.

Although the company will likely spend heartily on price cuts, advertising and brand-building in the coming year, it’s unclear whether the strategy will work, says Gere, who rates the company at Market Perform.

Does P&G practice effective price management? Mostly it does, but analyst comments raises questions on some of the components.

  1. Value add to segments: Does P&G has multiple brands that appeal to different segments and keep the customers within their brand family as they trade down?  I believe so. Mr.Lafley, Ex-CEO of P&G, made it clear that P&G will expand product portfolio to cater to changing consumer behavior.
  2. Incremental analysis: What is the incremental profit from price cuts and increased advertising spend? Jason Gere’s comments above seem to indicate there is uncertainty on this aspect.
  3. Customer Margin: Can P&G capture a larger share of customer spend? The decline in organic sals growth indicates challenges in capturing larger share of customer spend at the stores.

Ultimately it comes down to effective price management to drive profit growth and stock prospects.

When good enough is good enough

The New York Times reviewed a few productivity applications for iPhone. One of their recommendation is reQall. This review says,

My favorite stand-alone organizational app is reQall, which David Pogue has already praised in The Times. ReQall really does turn your iPhone into a personal assistant — you dictate all your to-dos, reminders, appointments and other ephemera, and it translates your commands into actionable tasks.

A great review that clearly conveys value to customers. But the very next line goes on to destroy that value,

(I find the free version good enough, but heavy users might want to invest in the $25-a-year Pro version.)

Clearly the application was a superior option but as the review says their free version is good enough for a vast majority of users. I am not faulting the review but rather the way ReQall versions are designed. By offering a good enough free version most customers end up choosing that version even though they might have chosen the paid version.

I have written several posts on multi-version pricing– which is about offering multiple product/service versions at different price points to serve different customer segments. There are many examples of effective usage of multi-version pricing, from CPG leader (Nestle) to a salon. The important design decision in multi-version pricing is the price-feature mix so that customers self-select themselves to the pricing option that ends up maximizing profit to the business.

Mr. Chris Anderson calls this type of multi-version pricing as “freemium” in his new book, “Free: the future of a radical price”. Please do note that multi-version pricing is not new and has been covered extensively in the economics and practiced effectively by many businesses. The freemium model is just an extreme case of multi-version pricing, when one of the version is made free. While offering a free version helps to drive customers to your business,  if not done correctly and without analysis of your customer segments it ends up serving the needs of most of your customers thereby destroying the value created.

Do you know your customer segments and what they value?

Procter and Gamble on Multi Version Pricing

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.

pg_profit

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.

Safeway Moving Up The Value Chain

In February, CEO of Safeway Mr.Steve Burd expressed his dissatisfaction with the CPG brands over their price increases. Almost all major CPG companies increased their prices since last fall when the commodities and fuel prices shot up. Since then their costs have come down but prices stayed up.

As I wrote before, the price increases enabled companies like Cadburys, Nestle, Unilever, Del Monte  and others to deliver 10-14% increase in their quarterly income despite  very small growth and in some cases even fall in their revenues. The brands were able to grow their profits because of the change in customer mix. As more and more of their price sensitive consumers switch to cheaper and private labels all they are left with are the price insensitive and brand conscious loyal customers.

Safeway is a distribution channel with high fixed costs and low single digit operating margin (around 3%). It saw its gross margins fall over the past five years. It was not happy with price increases because for two main reasons, it further cuts into its gross margin as Safeway and relies on these brands to draw in customers to the stores that help drive its revenues. The single metric of retail is monthly same store sales growth. Any stagnation or fall in this number sends bad signal to the stock market.

Safeway then said that it “will chew up the brands” if they did not reduce prices. I questioned this claim then but I admit  Safeway has followed through with its claim by aggressively developing its private label brands.  CPG companies had not had much to worry about a single retailer pushing its private label as the labels are, until now, limited to just that retailer. Now Safeway is moving up the value chain by becoming a CPG company. As a clear competition to major CPG brands, Safeway has signed deals to distribute its O organics brand and Eating Right brand at other regional retailers and at Albertsons.

The additional channels are not much compared to the rest of the market but Safeway has clearly established that it has a clear strategy and can execute on the strategy. The next round of price negotiations between Safeway and CPG brands is going to be much different from the previous rounds.

Ben and Jerry On Redefinition of Pint

Can't we talk this over a pint?
Can't we talk this over a pint?

Ben and Jerrys (owned by Unilever) is not happy with a competitor’s ( most likely Haagen Dazs)  redefinition of pint as 14 oz instead of the standard 16 oz. Haagen Dazs (brand owned by General Mills but Nestle produces and sells ice cream per their  licensing agreement). Both Unilever and Nestle recently reported higher quarterly profit from price increases.  Reducing package size is what Cadbury Plc described in their earnings statement as  part of their, “price realization”.

Should Ben and Jerry’s take a strong position on this?

Multi Price Point Strategy From Nestle’s Playbook

Versioning
Versioning

Update: I learned today from a boom about Cadbury’s that Nestlé sells 1 billion products worldwide. That is at least one billion prices. That is mind boggling. But the number sounds suspect to me considering their total revenue. Can someone fact check?

In the Nestle 2009 roadshow presentation (PDF) there are three slides that read like a lesson on multi-version pricing. One of the slides is shown in this post (advance thanks to Nestle). The numbers are not exact currency numbers but rather a price index showing relative price position. Nestle says in the transcript of the presentation,

You see here an example of PetCare which has shown and proven also to be a very strong resilient and defensive sector in bad times. And you see how we through the brands are allowing the consumer to have different price points. These are all Purina products. You see it in dog food; you see it in cat food how we have spread over different price points the product portfolio and yet using the Purina brands there rightfully.

Nestle is one of the few companies to report profits this quarter. As I wrote in my previous post, one reason is their price increase. Nestle’s multi-price point strategy seems almost so simple and easy that it will not be a surprise if anyone reading this raised the following questions:

  1. If it is this simple why not everyone do just this?
  2. If this works for Nestle why would it disclose this secret to the rest of the world?
  3. If this is so effective why not have more products at different price points, in fact take it to the extreme and have one price per person?

The answer to the first two question is the the same,

  • This works for Nestle only because of the brand equity and the strong brand loyalty of its customers. Neither of these can be build overnight.
  • Pricing and multi version products are aligned perfectly with the core strategy. In the case of Nestle its competitive advantage comes from a tight integration of its R&D, product innovations, comprehensive geographic presence and from its people, culture and values.

Multi-price point may seem easy to copy but without getting every strategic component right simply copying it is not going to help a competitor.

So why not take multi-price point to the extreme? This requires much longer discussion and I will write on it in a later post. But if you have your thoughts on this please share.