When price sensitive customers walk out of your stores, does it make sense to keep them at all costs? Specifically can you keep them by driving down prices? Can price cuts bring back customers who walked out to cheaper alternatives? It is tempting for businesses to run price promotions and reduce prices on key items (loss leader)
More items really cheap don’t bring in more people
While promotions and loss leader pricing do bring in customers, it is almost impossible to keep those customer. If customers are willing to walk out of their customer stores to take advantage of your promotion, what will keep them coming back the next time? Anecdotally, we all know people who do their weekly grocery shopping in three or four stores, just to take advantage of low prices of specific items. Mr.Craig Herkert, CEO of SuperValu, said “price promotions only destroyed our gross margins”. In other words, loss leaders stop being loss leaders and price promotions become just a profit loss.
If there is no unique value you add to your customers or can continue to offer low prices (as Wal Mart does) is it profitable to do price promotions?
Here is the customer profitability vs. loyalty matrix I did some time back:
If your customers are in the lower left quadrant, does it make sense to give them more benefits in the form of lower prices? Your action should be to increase prices for these segments and apply your limited resources on the top right quadrant.
Do you know who your high margin and high loyalty customers are?
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.
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?
I used JCPenney’s as a case study for explaining pricing waterfall and price realization. One could read that chart as ineffective price realization but the only message one should read from that chart is how different promotions affect the pocket price. Why would a retailer be doing this heavy promotion? They could be focusing on “per customer revenue” and using mattresses as loss leaders. For instance take a look at this new pricing chart that reverses the waterfall.
The chart shows not the average revenue but the possible revenue for a single customer who might purchase all the extras. This does not mean every customer makes all these additional purchases. JCPenney probably has years worth of data on customer purchases that tells them the percentage of customers (who buy mattresses) buy the extras and carry a balance on their JCPenney credit card.
The bars in black are high margin sales. Here are the additional revenue opportunities:
Warranty: JCPenney sells a warranty on warranty that comes as a 10 year supply of mattress pad. They give one mattress pad at the time of purchase with the promise of free replacement for the next 10 years.
Bed-In-A-Bag: Customers buying mattresses are most likely to be interested in buying new sheet sets etc.
Room Accessories: Why not change the curtains in the room as well?
Interest Income: Some of the customers who has or open a new JCPenney credit card may carry a balance and hence paying interests.
Together all these components increase per customer revenue from $630 to $1173, still lower than the list price of $1699 seen for the mattress but that could easily be a marked up price that no customer would ever pay. The net is the low sale price on mattress (loss leader) help to improve money spent by the customer during a visit.