Alternative To Unbundling The Sandwich

In my work on unbundled pricing, I wrote about how restaurants can manage drop in customers and their willingness to pay by unbundling their pricing and charging separately for the many extras they provide. There were instances of restaurants charging separately for salad dressings and restaurants accepting cash only to save on credit card interchange they pay to banks.

Of course the other options I left out are more about maintaining price premium which include  multi version pricing, price increases, better marketing to convey value and applying consumer behavior principles to drive profit. One restaurant that is successfully applying all these is Panera bread which delivered 28% increase in profit. The net is Panera bread is practicing the three components of effective price management to drive profit without resorting to unbundled pricing.

  1. Value-add to Segments: On the macro level they are targeting those who are employed and eat lunch outside. Specifically they are targeting those with spending power and making a relevant value proposition.
  2. Panera’s target customer is 25 to 50 years old, earning $40,000 to $100,000 a year.To give those customers a reason to return, Panera has been touting new products with fresher ingredients. (WSJ)

  3. Incremental analysis: When almost every other restaurant is slashing prices and sending coupons to attract customers Panera decided to keep prices steady. As other restaurants found out the promotions came at a very high price and did not generate sales as expected. We can infer that Panera’s decision was based on their analysis of their demand curve and incremental profit from price promotions.
  4. Customer Margin: They do have lower priced options, but make higher total margins on incremental sales. For instance customer tab runs to $9.72 including drinks and other purchases.

One additional thing they are practicing is taking a lesson out of consumer behavior – offering a sandwich priced at $16.99 while most sandwiches are offered at much lower prices. The presence of $16.99 helps to set higher reference price in the minds of customers and helps to sell other sandwiches that are priced at $6.99. Not many may order the most expensive version but are nudged to order the versions that are priced in the middle.

When every other restaurant was dropping prices based on“conventional wisdom”, Panera ran in the opposite direction based on analysis. No wonder their profit movement is in the opposite direction to the rest of the category.

Pricing BART Tickets

BART is facing $100 million budget shortfall and is looking to cut costs. One primary component is the salaries they pay to unionized train and station operators. There is a strike looming if the negotiations do not yield a solution before midnight Sunday August 16th.  I am not going to go into the negotiations, the salaries or whether or not either party is wrong. But I would like to point out the perils of focusing on only one component of profit equation – costs.

BART is a non profit but that does not mean they should focus only on the cost side of the profit equation. They have to focus on the revenue side which includes driving more traffic or driving higher revenue from higher prices. BART faced fall in customer traffic of 11%, and they are arguably reluctant to increase ticket prices as there is fear that this would cause further drop in traffic. The Public does not like ticket price increases as well.

What is missing here is

  1. segmentation of the customer base and defining the economic value add to these segments, identify the price based on this value-add and reference price
  2. identifying the demand schedule – how many people will stop using BART at different price points
  3. what more can be done to monetize these commuters – from selling additional services to selling their attention

In short, BART is missing Effective Price Management.

I am going to address just one aspect here – segmentation. The easiest segmentation is based on  where-to-where and how often they use BART in a week. One such segment is daily commuters from East Bay stations who drive and park in their local station and commute to the stations in the city. Here is the economic value add to this segment.  Now that is considerable consumer surplus!


Adaptive Price Management

When the downturn started in 2008 and retail sales started dropping, the department stores started dropping prices from fear of being left with inventories. There were big sales, with 50% to 70% drop in prices even in high end retailers like Saks. There was one exception, Abercrombie & Fitch, which steadfastly refused to drop prices.

They knew they were not a product for the mass market and there was a small segment they served. For a long time that segment was not worried about price. They were more concerned about the brand and the long term effects of sales on their brand and future pricing power. They were worried about setting low reference price in the minds of their customers and did not want to train their customers to wait for sales. There was more to lose from price decrease than to gain.

However, things got worse for Abercrombie & Fitch. Their operating margin shrank from 20% to barely 4% in less than a year. Their sales fell 30%. Whatever happened to Effective Price Management  that recommends pricing for profit and protecting  price premium to deliver higher profit.

They  correctly following and religiously implementing two of the three components of Effective price management:

  1. Pricing based on value add to segments
  2. Pricing based on incremental analysis

Unfortunately there are two problems that led to profit erosion.

First  problem is effective price management requires the marketer to manage all three components and selectively choose one or two and implement just those. When a marketer optimizes a subset they end up missing the true optimal solution.They were focused on margins from individual items and not on maximizing total margin from the customer. They ignored the third component of effective price management – Focus on customer margin not product margin.

Second problem is the model is not static – you do not decide  your segment, their value proposition, their demand curve once and forget about it. The segments, their taste, value proposition and willigness to pay all change and change drastically due to external events. The New York Times  reports on a market research that found just this shift:

Aéropostale and Wal-Mart, the discount chain, are among teenagers’ go-to stores this season, while more expensive stores — like Hollister and Abercrombie & Fitch — are not, according to a survey of students ages 12 to 17 by Majestic Research.

“Rather than get one top at a Hollister, they can get two or three at Aéropostale,” said Brian J. Tunick, a retail analyst at J. P. Morgan Securities.

When this shift happens then all the previous models on segmentation, targeting and incremental analysis on sales drop and lost profit must all be reevaluated. When the model does not evolve and remains static, it results in decisions that does not deliver under changed conditions.

Effective price management is not about picking and choosing a subset of the three components but implementing all three with right balance to maximize profits. It cannot be done in a, “set it and forget it mode”,  it is a dynamic model that requires continuous tuning to adapt to changing inputs.  Failure to do so will result in sub-optimal results regardless of how optimized the partial model is or how accurate and complete the initial model is.

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.

Lowering Prices To Generate Sales?

Here is another CEO who clearly believes lowering prices does not automatically guarantee  sales increase: Macy’s Terry J. Lundgren.  In his inteview with The Wall Street Journal, Mr. Lundgren  said,

WSJ: Do you think about lowering your average selling price or changing your product blend, as some of your competitors have done?

Mr. Lundgren: Here’s the challenge. We have [a men’s pants brand], and they typically go out the door between $29.50 and $32.50, with all the coupons and everything.

What Mr.Lundgren refers to as “out the door price” is the “pocket price“, the net price after all discounts. The net effect of the discounts and coupons is price leakage that erodes profit, clearly Mr. Lundgren is driving Macy’s to focus on its price waterfall.

Mr.Lundgren’s management serve as the best case study so for on the three components of effective price management:

Knowing the value add to segments:

Our purchasers are women. She’s spending the same amounts but just shopping with a great deal of discretion. Value is the word, even if it’s at regular price. The intrinsic value of what she’s buying is very important.

Incremental analysis: How much should sales rise to compensate for loss in profit from price cuts? (Lundgren is on the direction but he is comparing top-line while he should be doing incremental math on lost profit. There is also numbers error as pointed out by the commenter.)

So we were getting tremendous sell-through at low price points and no margins. And I am not making my pants sales for last year, because my average sale dropped by 30%. It’s really hard to make the math work. I have to have 30% more transactions on this product to break even.

Customer Margin: Understanding that loss leaders are effective only if they help generate incremental profit from customers who are attracted to the stores by low prices of loss leaders.

We and the manufacturer together agreed to mark them (pants) down to $21.99 or something like that. Selling like hotcakes. Every other pants around them stopped selling.

Does your business practice effective price management?

Profit Share – Market Profit Matrix

Your share of the Market Profit!  A 2X2 representation.
Your share of the Market Profit! A 2X2 representation.

See other posts:

1. Marketing metric

2. Market Share Vs Profit Share