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  • 1. advanced seriesFoundationPreserving marginsand boosting demandCONSUMER GOODS & RETAIL 4PROBLEMDRIVENRESEARCH2013 No. 04Pricing managementIE FOUNDATION ADVANCED SERIES ON PROBLEM-DRIVEN RESEARCHfoundation
  • 2. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesEDITORIAL BOARDMarco TrombettaVice-Dean of Research IE Business SchoolManuel Fernández NuñezBusiness Development Director ConsumerProducts & Retail Ernst & YoungMargarita VelásquezGeneral Director IE FoundationFabrizio SalvadorSenior Academic Advisor IE FoundationAlfonso GadeaProject Director IE Foundation
  • 3. foundationDear friends:One of IE Business School’s goals is to be an internationalcenter of excellence for research in all areas ofmanagement.We pursue this goal in close collaborationwith the IE Foundation and the recently established IEUniversity.I would like to present a new initiative of the IE Foundationand IE Business School. We hope it will provide aninnovative way to share the results of the joint work ofour scholars and partner organizations.The initiative,“IE Foundation Advanced Series on Problem Driven Research”,aims to providesupport to organizations facing the new economic structure,featuring unique market rules.Recognizing the importance of retailing for assessing the current situation and the socialexpectations, we have chosen the“Consumer Goods & Retail” series as our maiden work.The IE Business School seeks to create an environment where we can develop the best talent,while at the IE Foundation we seek to close the loop between the school and businesses byfostering sustainable relationships through the organization.We are confident that this initiative will meet the challenge and offer a new perspectiveon the issues.CONSUMER GOODS & RETAIL 3Marco TrombettaVice-dean of Research at IE Business SchoolVice-dean Coordination and Research IE UniversityGreetings
  • 4. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesPROFIT569874 2365 1145566LOSS6985 32556 45789 3244BRANDING6985 32556 45789 3244MULTICHANNELcontents003 221651 165151MANAGEMENT6985 652114 54654PRICING
  • 5. Lead researcherIE Foundation cover letterErnst & Young cover letterExecutive SummaryImportance of pricing managementManaging prices in a downturn2.1 Tactics: Speed is crucial, but so is control2.2 Products: Selective management of product-level prices2.3 Strategy: How low can you go?Multichannel pricing management3.1 Channel-based price differentiation3.2 When to differentiate prices3.3 Price matching3.4 Open-ended questionsErnst & Young viewpointCONSUMER GOODS & RETAIL 5Acknowledgements We would like to thank the Consumer Goods & Retail sector professionals who gave up part of their valuable time to help us with this study throughthe pricing management surveys.01020304
  • 6. LeadresearcherIEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced series
  • 7. Martin Boehm is the Dean of Programs andProfessor of Marketing at IE Business School inMadrid. He previously served as the AssociateDean of Undergraduate Studies at IE Universityand the Associate Dean of the Master inManagement at IE Business School.Martin’sintellectualinterestscenteronCustomerManagement.His research provides managerialimplications on how to build profitable andlong-lasting customer relationships.His primaryconcern is to quantify the impact of various customer management activities ona customer’s lifetime value – the net present value of the stream of future profitsexpected over a customer’s lifetime. At the same time, he develops analyticalmodels to estimate or approximate a customer’s lifetime value. As a consultanthe works primarily with firms in the financial services industry to provide themwith a roadmap for growth.Martinis teachingacrossIE’sMasterinManagement,MBA,ExecutiveMBA,andPhDprograms. Prior to joining the IE Business School faculty, he studied InternationalBusiness at Reutlingen University of Applied Sciences and received a Master ofBusiness Administration from the Australian Graduate School of Entrepreneurship.He completed his academic education with a Doctorate in Marketing which heobtained from the Johann Wolfgang Goethe-University in Frankfurt.CONSUMER GOODS & RETAIL 7Prof. Martin BoehmDean of Programs and Professor of Marketingat IE Business School
  • 8. Among its primary activities,IE Foundation supports the research and the knowledge sharing endeavors of IE BusinessSchool’s professors. Through its initiatives IE Foundation contributes to the positioning of IE Bvusiness School asa center of excellence for innovation, and for the creation of knowledge targeted at its productive environment.The IE Foundation aims to create strong ties and alliances with prestigious,public and private,institutions,particularlythose in the business domain that can help propel our researchers’ initiatives. As an institution that pursuesexcellence,research activities are driven by academic rigor and the utilitarian nature seeking to create knowledge.We aim to push innovation and competitiveness to provide answers to the challenges and needs of society.This publication is part of the IE Foundation’s collection on Consumer Goods and Retail,developed in collaborationwith Ernst & Young.We would like to extend our gratitude to them for their commitment and their vast experienceon this matter.The collection has been designed with the purpose of analyzing the key aspects of the industry through a practice-driven, up to date perspective on key aspects of the industry such as Sustainability, Information Security, Pricing,and Profit Protection. We are in the midst of a major change in the retail industry. The challenge many Spanishorganizations face,is being at the forefront of such change and benchmarking best practices in the global market.The IE Foundation looks forward to helping organizations in this process.We hope that this publication will be of interest to you, and we appreciate your support.IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesRafael PuyolVice-President,IE FoundationMargarita VelásquezDirector General,IE Foundationfoundation
  • 9. Consumer Products and Retail companies are developing their business in a much morecomplex and volatile environment than they have in the past. In this environment,companies’ actions focus on transforming their business processes and protecting theiroperational margins.In its commitment to innovation and value creation,Ernst & Young has propelled researchprojects on the issues that will help companies deal with today’s industry challenges.Our research takes into account different actions regarding price dynamics from a branddifferentiation perspective.Secondly,we take on the negative economic effect of shrinkagewith an analytical approach,to identify its root causes and suggest corrective actions for itsmitigation (profit protection).We also seek ways to preserve the information security of anindustry that operates,with an increasing frequency,in mobile scenarios and technologies.Finally, we propose the adoption of a business commitment perspective, betting onsustainable initiatives from retailers that take into account manufacturers and consumers.These four areas are experiencing a large change in process. Ernst & Young and the IEFoundation are approaching these challenges from an innovative perspective with theintention of putting them into practice and creating value for the business environment.CONSUMER GOODS & RETAIL 9José Luis Ruíz ExpósitoPartner and Head of ConsumerGoods & RetailManuel FernándezBusiness Development DirectorConsumer Goods & Retail
  • 10. Executive SummaryIEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced series
  • 11. CONSUMER GOODS & RETAIL 11Before companies can attempt to improve profit by raisingor lowering prices, they need to know what consumers arewilling to pay. Unfortunately, most executives don’t havethe knowledge to make an informed decision. As a result,management teams often take the easy road; they resort tocutting prices.A sudden and prolonged drop in prices changescustomer and competitor behavior. Companies have to actquickly, even though solid information is hard to come by.However, pricing decisions made now are likely to affectconsumers’ perceptions for a long time to come.In a recession,pricing must be managed on three levels:createa pricing strategy that is aligned with the company’s broaderobjectives and positioning, set prices on individual productsand deploy disciplined tactics to manage the aspects of thetransaction that most affect profitability.As for tactics, successful companies: 1) assess the impact ofpricing moves based on point-of-sale data, and 2) identifyhidden sources of revenue leakage. Discounts offered byemployees in a bid to up market share can lead to hiddenprofit leakage. One way for a company to increase its profit isby managing the“price waterfall,”from list price down to thetransaction pocket price.Prices should be managed selectively at product level.Companies should avoid overly aggressive or broad price cutswhen demand is soft. Prices should be adapted for productsthat are seeing demand fall. Companies need to identifydemand-sensitive “pockets,” such as customer segments,product lines or usage.Prices must be managed strategically. Companies need toconsider where they want their prices to be within three yearsand not rely on continual discounts to sustain volumes.Long-term,continuous discounts hurt the brand.Companies aimingto set prices strategically must try to anticipate what movestheir competitors will make in the future.Different segments are willing to pay different prices.Therefore, price differentiation can be a profitable pricingstrategy. Multichannel pricing has also become a morewidespread strategy among manufacturers and retailers.Different assessments of channel and price sensitivities canenable a company to implement channel-based pricing.Professionals often advocate equal prices across distributionchannels to maintain brand strength. However, the profitopportunities are too big to ignore.A range of factors are squeezing business margins, such as decreased consumer spending, increased market transparency viainternet and low-cost competition from emerging industrial powers, like China. Executives must focus on pricing, becausethey can no longer rely on sales growth and inflated mark-ups. As companies’ most powerful profit lever, pricing is the mosteffective way to boost profits.
  • 12. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced series1. Importanceof pricingmanagementFew times since the end ofWWII has there been such downward price pressure. Part of this pressure is the resultof economic factors (e.g., recession in western economies and Japan), which have dampened consumption.However, pressure is also stemming from new sources.The sharp increase in purchasing power of retailers likeWal-Mart or Mercadona places pressure on suppliers. Meanwhile, internet has increased market transparency,making it easier for shoppers to compare prices. China and other emerging industrial powers are also playinga big role, as their lower unit labor costs have lowered the prices of manufactured goods. The double cycle-price whammy has eroded companies’ price-setting power, causing executives to look all around for ways tomaintain margins.A Global Pricing Study, co-directed by IE Business School, shows that 93% of Spanish companies have facedincreased pricing pressure over the past two years.
  • 13. CONSUMER GOODS & RETAIL 13Main reasons:• Customers demand higher discounts (53%)• Lower-price competitors / new market entrants (50%)Figure 1: Dramatic increase in pricing pressure93%93%90%89%86%83%82%82%81%81%80%71%PolandSpainFranceBelgiumJapanUKUSBrazilChinaItalySwitzerlandGermanyMore aggressive customers and competitors. More than 9 out of 10 companies feel increasedpricing pressure.Source: 2012 Global Pricing Study. Simon-Kucher & Partners, IE Business School, Alimarket
  • 14. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesSpecifically,our study on Spanish companies in the Consumer Goods & Retail sector shows that the majority are operatingin an industry with falling market prices. 76% of those surveyed said that prices in their industry have fallen in the lastyear. 21% even said prices had fallen by more than 10%.Stiffer competition is one of the key drivers behind the declines in prices in various sectors of the Spanish economy. Mostof those surveyed in our study said they are doing business in an increasingly hostile market environment. Competitionis not focused on margins. Rather, companies are fighting fiercely for volumes and market share.Figure 3: How would you assess your environment / company?Figure 2: How have average prices in your sector changed in the last quarter comparedto the year before?Source: own researchSource: own researchCompetitors with aggressivepricing strategies++ Price + Price Breakeven + Profit ++ ProfitCompetitors focused onprofit maximization55%Slight decrease(between 0% and 10%)21%Considerable decrease(between 10% and 20%)21%Slight increase(between 0% and 10%)3%Stable
  • 15. CONSUMER GOODS & RETAIL 15These statistics illustrate the potential impact of optimum pricing on a company’s net revenue.A small shift in prices cancause a large shift in income. Nevertheless,before attempting to increase profit by raising or lowering prices,companiesneed to understand and anticipate how consumers will respond to a change in a product’s price.It’s too bad that so many companies seem to be unable to appreciate a consumer’s willingness to pay the optimumprices. When asked if they were “well informed” about six potential factors in pricing, the executives of a leading USmultinational said:Figure 4: % of well-informed executives about...84%81%75%61%34%21%Variable costsFixed costsCompetitors’ product pricesValue attached to the productHow customers would react to a changein pricesWillingness of a customer to paydifferent price levelsExecutives need to focus more on prices now than everbefore. They can no longer count on the double-digit salesgrowth and wide margins they had in the 1990s to cope witha price deficit.What’s more,many companies just can’t loweroperating costs any further. As a result, pricing is one of thefew levers they can still tap to increase revenues.Those juststarting out now should be poised to reap the full benefitsof the recovery when it comes.Appropriate pricing is the fastest and most effective way toincrease profit.Taking the average income statement of S&P1500 companies, a 1% increase in prices would result in an8% increase in operating profit assuming volumes remainunchanged.The impact is nearly 50% greater than that of a1% decrease in direct variable costs (e.g.,raw materials,directlabor) and three times the impact of a 1% increase in volume.Regrettably,there is also a downside to pricing.A 1% decreasein average prices has the opposite effect, ceteris paribus,reducing operating profit by the same 8%. Executives mayhope that lower prices will lead to higher volumes and offsetthe lost revenue,but that doesn’t usually happen.Continuingwith our study of typical S&P 1,500 figures, volumes wouldhave to increase by 18.7% to make up for the impact on profitof a 5% price reduction. Such a degree of demand elasticityto decreases in prices is rarely seen. A price-cutting strategyto raise volumes and, by extension, profits is destined to failin any market or industry.
  • 16. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesThese executives were well informed aboutthe costs of their products and the prices ofcompetitors’ products. They were well informedabout the products’ value. However, they did notknow enough about customers’ willingness to payor their response to potential changes in prices toset optimum prices. Experience shows that thiscompany is not alone.In the same vein,our research on Spanish companiesindicated that less than half based their pricingstrategies on using the willingness-to-pay function.The majority (67%) follow a simple cost-baseapproach.However,a pricing strategy based on costsresults in either lost profit or out-of-market pricing.Source: own research67%52%44%A mark-up on product costsRelation with competitors’ pricesA function of elasticity or the customer’swillingness to payFigure 5:What pricing approaches does your organization apply to set prices forclients? (multiple choice)
  • 17. CONSUMER GOODS & RETAIL 17Similar research shows that executives view price-related issues as a real headache. It appears that pricescause more headaches or sleepless nights than any other marketing decision.This report is designed to reduce some of Spanish companies’headaches and more pressing issues.Two issuesthat most companies are dealing with are the economic environment and the advent of internet.In the followingpages we offer some tips on how to tackle these two issues.Question: What is your biggest concern?Figure 6: Pricing complexity Prices give marketing directors headachesPricesProduct differentiationProduct qualityNew competitorsDistributionAfter-sales serviceAdvertising4.33.83.53.43.02.92.6Source:The Strategy and Tactics of Pricing - Pricing and the Bottom Line, Martin Boehm
  • 18. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced series2. Managing pricesin a recessionConfronted by weakening sales and excess capacity, management teams often resort to cutting prices. It’s easy tosee why. Price cuts are quicker and easier to implement than, say, introducing new products or improving servicelevels. Customers often respond immediately to lowered prices. A swift uptick in sales can reinforce executives’belief that they did the right thing.But there’s a reason promotional price cuts are sometimes called “management heroin.” Price cuts are addictive.Customers quickly develop a craving for big discounts and an aversion to full prices. Companies grow accustomedto the boost in volume and hesitate to raise prices to previous levels for fear that revenues will crater. In a deeprecession, when the first goal is survival, some businesses have no option but to cut prices aggressively. But evenrelatively strong companies experiment with heavy discounts and then wake up to find themselves hooked.Is there an alternative?The truth is,most companies do need to lower prices in a downturn,whether they sell primarilyto businesses or to consumers. Demand is down, yet fixed capacity and costs haven’t changed much. So the laws ofsupply and demand exert strong downward pressure on prices. Still, the range of outcomes can vary widely in boththe short term and the long term. What matters most is how effectively companies manage pricing.
  • 19. CONSUMER GOODS & RETAIL 19Unfortunately, yesterday’s pricing textbook isn’tmuch help with today’s conditions. A sharp, prolongeddownturn creates a volatile new environment, alteringthe behavior of both customers and competitors.Companies have to act quickly, even though solidinformation is hard to come by. And pricing decisionsmade now are likely to affect consumers’perceptions fora long time to come.Few companies in any industry cansay,“We’ll lower prices today and raise them tomorrow,”at least not without risking a severe customer backlash.In our experience, companies that get pricing rightmanage it at three levels. They create a pricingstrategy that fully supports their broader objectivesand positioning. They set prices on individual productsto reflect value to both buyer and seller. And theydeploy disciplined tactics to manage the aspects ofthe transaction that most affect profitability. A severedownturn presents challenges on all three levels.Pricingstrategy must address stark differences between theright short-term answers and the long-term healthof the business. Pricing of individual products need toreflect dramatic changes in the ways customers makepurchasing decisions.Tactics must be carefully designedand choreographed to let companies execute quicklywithout losing control.In a normal business environment the best course isalmost always to map out your strategy first,then to setprices for individual products, and finally to design thesuite of tactics that will allow you to execute profitably.But in a recession, time is compressed and tacticaldecisions take on new importance and urgency.So,we’llstart there.
  • 20. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesCustomer behavior,market and competitors’actions can all change quicklyin a downturn. Executives find that previous assumptions are obsolete andthey act faster than ever to adapt.But when companies accelerate tactical pricingmoves without accurate information about the real effects of those moves, they can lose control of the pricescustomers actually pay.The most effective companies typically take two steps to avoid this danger:(1) they quicklyassess the impact of pricing moves by gathering lots of fast,fresh point-of-sale data,and,(2) they maximize controlby identifying and managing the hidden sources of revenue leakage. Most companies rely on a host of discounts,promotions and other pricing tactics to boost sales and earnings. In a downturn, it becomes essential to analyzewhich really work and which waste money.The actions flowing from this kind of analysis not only shore up the bottom line, they also lay the groundwork formore effective pricing in the future. One specialty retailer, for example, carried fifty thousand SKUs per store –asmuch variety as a large supermarket- and relied on promotions to drive a significant portion of sales. When theretailer put its promotions under the analytic microscope, however, it found that discounts on some items hadvirtually no effect on sales. It also discovered that some forms of promotional pricing were far more profitablethan others,even if the costs were similar.Customers loved two-for-the-price-of-one offers,for instance,yet wereless impressed with 50%-off sales.The retailer also has relearned the importance of seasonality in pricing tactics. Discounting a highly seasonalproduct –patio furniture for instance- at the very beginning of the selling season typically attracted a large numberof shoppers looking for bargains.Discounting the same item at any other time of the year was essentially fruitless,Speed is crucial, but so is controlTactics2.1
  • 21. CONSUMER GOODS & RETAIL 21because shoppers were more willing to pay full price.After analysis,the store modified or eliminated only10% of its promotions overall.But that 10% yieldeda boost in profitability of 15% to 20%,while salesvolume declined less than 2%.The faster you can gather this data and act onit, the more likely you can stay in touch withchanging customer needs or preferences.One food-products company, for instance,built quantitative tools that analyzedsales data from competitors along withits own operations every week. Managerscould track the relationship between pricepoints and volume and spot the gaps betweenthe company and its competitors. They linkedpromotional tactics to sales volume, compared actual to predictedresults, and adjusted their demand models on a weekly basis. In an industrywhere monthly sales data and quarterly adjustments were standard,the weeklydata helped the company adapt much faster than competitors to changingconditions.
  • 22. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesOur study of Spanish companies showed that the vast majority (88%) collected data on competitor prices.Bothof the examples above provide clear evidence that companies need more detailed analysis of their promotionalactivities. Our study paints a much different picture:Figure 7: Pricing and promotion practicesWe study the impact of pricethresholds and rounding oncustomersWe use data-gathering toolsregularly to determine whetherprices are competitiveWe use data-gathering toolsregularly to determine perceivedvalue among customersWe have pre-defined volume/margin targets for promotionsWe estimate the expected returnon promotions through market/consumer testingCompletelydisagreeSomewhatdisagreeNeither agree,nor disagreeSomewhatagreeCompletelyagreeSource: own researchQuestion:Indicate to what extent the following statements apply to your company.
  • 23. CONSUMER GOODS & RETAIL 23Less then 30% of those surveyed said they measuredthe impact of promotions on profit. This suggestsSpanish companies need to hone their price-settingskills if they want to remain competitive in anincreasingly global market.A downturn increases the pressure on employees tochase or protect volume at any price. Freight termsgiven by the logistics department, credit termsauthorized by finance, free services and accessoriesauthorized by customer care agents -all can createlayers of overlapping discounts and hidden leaks thatdrain away profits. The faster and more aggressivelyyou move on pricing tactics, the more important itis to reassert control.A European machinery manufacturer did just that,with remarkable results. Like many producers ofcomplex products, this company typically realizednet prices that were about 55% of list. But thosediscounts came from a wide range of sources. Aproduct costing €100 might carry several on-invoicediscounts totaling €35. Off-invoice terms or incentivesmight be worth another €10. Managers had no wayof identifying why a particular product was sellingfor less than list, and had little control over whichpeople in the organization were authorized to providediscounts. Front-line salespeople in particular offeredsubstantial incentives without oversight by seniormanagement.To address the issue, the company sent out ashort e-mail survey to its sales force asking abouttheir discounting and contracting practices. Thesurvey results, along with input from the financedepartment, allowed managers to simulate theimpact of promotional activity and establishguidelines to maximize return on investment. Thecompany also built tracking systems to capture off-invoice trade spending and aggregate the data atthe account level to ensure that the company wasinvesting in the most valuable accounts. The resultwas an increase in earnings before interest and taxesof nearly 20%.Maintaining control of pricing execution requiresclear direction to front-line employees about what’sallowed and disciplined processes to find andremedy unauthorized behavior. For big-ticket items,managers need to set clear guidelines for sales scriptsand allowable price ranges.They need to have a well-developed escalation process for decisions that falloutside company pricing guidelines.Managers can also ratchet up discipline by tyingboth sales force and channel compensation to pricerealization. It’s hard enough maintaining marginseven in the best of circumstances; in a recessionno company can afford uncontrolled discounting(see section on “price waterfall” for managinguncontrolled discounts).
  • 24. advanced seriesMany companies don’t get a good grip on the broadrange of factors contributing to final transactionprice. The table below shows price components for atypical sale by a linoleum asphalt manufacturer to adistributor.The starting point is the list price. From this,a discount for order size and a competitive discount aresubtracted, leaving the invoice price.In most businesses, especially those that sell productsthrough distributors, the invoice price does not reflectthe real amount of the transaction.There are still severalfactors that come into play between the invoice priceand the final cost of the transaction. These include:discounts for early payment, for volume purchasesand cooperative advertising. When the lost revenuecaused by these specific elements of the transactionis subtracted from the invoice price, what’s left is the“pocket price”(or final price):how much revenue is reallyleft in the company’s pockets after the transaction.Thepocket price, not the invoice price, is the fair measureof the price attraction in a transaction.The table below shows the revenue in the pricewaterfall from the list price to the invoice price andto the pocket price, or the pocket price waterfall. Eachelement of the price structure represents lost revenue.A 22.7% decrease from the invoice price to the pocketprice is not out of the ordinary. Studies show an averagedecline between the invoice and pocket price of 17%for packaged consumer goods companies, of 18% forchemicals companies, 19% for IT companies, 20% forfootwear companies and 22% for car makers.Companies that do not manage the entire pricewaterfall actively and, as a result, suffer from multipleand highly volatile revenue leaks, miss out on anyopportunity to achieve better pricing.Figure 8: Each element in the price waterfall represents a revenue leak(euros per m2)22.7%off-invoiceThe price waterfall6.00€Manu-facturer’slist price6.00Orderdiscount0.12Competitivediscount5.78€Invoiceprice0.30Discountforpaymentterms0.37Volumerebate 0.35Off-invoicepromo-tions0.20Cooperativeadvertising0.09Freight4.47€PocketpricePRICING
  • 25. CONSUMER GOODS & RETAIL 25Pocket price band: At any given point in time, thepocket price of an article is not the same for allcustomers. Rather, articles are sold within a rangeof prices. This range, for a unit volume of a specificproduct, is called the pocket price band.The followingchart shows an asphalt manufacturer’s pocket priceband for a single product. There is a 35% differencebetween the highest and lowest priced transactions.This pocket price band may seem wide,but much widerbands are commonplace.Understanding the variation in pocket price bandsis essential for a company to exploit the best pricingopportunities of a transaction. Executives that canidentify a broad pocket price band and the underlyingcauses can manage the band better in the company’sfavor. When prices fluctuate in a range of morethan 35%, one could easily assume that appropriatemanagement could improve the price by severalpercentage points, benefiting the company.Figure 9: Elements of opportunity to benefit from a pocket price band(percentage of volume)Pocket prices (€ per m²)5.80€ 5.005.40 4.60 4.005.60 4.80 4.205.20 4.40 3.802.75.010.76.613.4 13.114.210.115.06.13.16985 652114 54654PRICING
  • 26. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesProductos2.2Selective management of product-level pricesFalling demand in turbulent times triggersa cascade of list-price declines and deepdiscounts off list. Yet many companieslower prices too aggressively or toobroadly because they fail to answer twokey questions: Why is demand falling? andwhere is it falling most? Answering thesequestions requires managers to get insidetheir customers’ heads.In a downturn, some consumers andbusinesses cut back because they justdon’t have the money to spend. Many moreprospective customers have the money butfeel uncertain about the future.Both factorsshow up in the price declines that hit thetransportation sector, for example, whereaverage prices fell roughly 13% in the firstfew months of 2009.So,which factor shouldget the greatest attention?Spooked consumers won’t buy more untilthey feel that it is safe to do so, or untilthey decide that prices have dropped asfar as they’re going to. A company needsto understand its customers well enoughto know which of these factors is moreimportant. If your customers can afford tobuy but are nervous about doing so,loweringprices may not be the right way to help themovercome inertia. Rather, companies canfind ways-by combining pricing with othermarketing efforts-to send the message thatbuying is a low-risk decision.Take cars, for example. Plummetingemployment doubtless contributed to thesharp drop in auto sales in 2008 and early2009. But fear of job loss probably keptmany more potential buyers out of dealershowrooms. Cars are a big-ticket item, andmost customers can delay purchases by ayear or two.In response, auto companies typicallyslash prices in a downturn. Most of the bigplayers, desperate for sales, did it this timearound. But Hyundai took a different tack.
  • 27. CONSUMER GOODS & RETAIL 27Recognizing that its customers weren’t likelyto respond to the usual rebates or incentives,the Korean car maker announced a plan thatwould allow customers who lost their jobs toreturn a new car. The reasoning: A fully employedcustomer can afford the full-price car nearly as easilyas the discounted car. But a customer fearing layoffs ismore likely to hold off on big purchases.The strategy is powerfulbecause it addresses what goes on inside a customer’s head,notwhat goes on in an economics textbook. It carries some risks,but it is not as risky as watching sales plummet-and indeed,Hyundai’s sales were up nearly 5% in the first several weeksof 2009, compared with the same period in 2008. Overall autosales, meanwhile, had dropped 40%.Rather than relying on highly visible across-the-board discounting,sophisticated pricers find ways to loweraverage prices in highly selective ways.Almost every company’s business contains“pockets”of real variance indemand- customer segments,geographies,product lines,occasions of use,and so on.In our experience,mostcompanies underestimate how many of these pockets can be addressed effectively through targeted pricing.Faced with a big fourth-quarter sales drop,for instance,L’Oréal recently decided to lure customers with a 20-ml“petite”bottle of one expensive perfume,pricing it at $55,compared with $175 for the traditional 100-mlsize.The move gave customers a size they could more easily afford but actually created a 57% price hike permilliliter-$2.75/ml versus $1.75/ml.
  • 28. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesLarge companies with thousands of products face a significant challenge inpricing appropriately for a downturn.But it’s often possible to apply new pricingrules to categories of products. One European manufacturer of construction-related products, for example, had tens of thousands of SKUs. To simplifypricing, it grouped the products into three“buckets.”Bucket #1 includedproducts that were highly differentiated and that customers valuedhighly. Bucket #3 included commodity-like products over which themanufacturer had little pricing power. In the middle was bucket #2.The company applied cost-plus pricing rules to each bucket, butthe“plus”was higher for the buckets with more differentiatedor more highly valued products.To gather the necessary data,the company relied partly on internal statistics and partlyon its managers, who gathered at workshops to runthrough lists of products,quickly putting them into onebucket or another.This approach to variable productpricing helped the manufacturer raise its earningsroughly 20%.A company’s options during an acute downturnare determined by its strategic and financialposition. A small number of businessesoccupy strong positions on both ofthese dimensions and have trulydifferentiated products or services,which enables them to maintainprice levels.Even then, these companies work hard to deliverhigher value for the same price. That can be as costly ascutting prices in the short term, but it preserves pricing integrityfor the long term.When Amazon launched the Kindle at $399 in November2007 (just before the start of the recession), many analysts thought customerswould balk at the price, especially since the Sony Reader was available for $100 less.Instead, the Kindle sold out. The Kindle 2, launched in February 2009 for $359, continuedto exceed sales expectations.
  • 29. CONSUMER GOODS & RETAIL 29Research carried out years ago showed that a hosieryretailer elicited an “enormous” positive response insales by raising its price from US$1 to US$1.14. Appa-rently, consumers felt the higher price was a sign ofa “higher quality”. Such anecdotal evidence of viola-tions of downward sloping demand curves had beenobserved previously, but dismissed as anomalous.Yet, evidence continued to mount that price mighthave attractive as well as aversive properties. In theeconomics-oriented literature,as well as in the emer-ging empirical tradition in marketing and consumerbehavior,it was becoming increasingly apparent thatconsumers frequently employed price as a proxy forproduct quality. By the end of the 1908s, based on anintegrative review of over 40 empirical studies, theevidence for a robust (though moderate) price-percei-ved quality effect appeared to be incontrovertible.The theoretical basis for this perception, that higherprices were associated with higher quality, was lessclear however, since the correlation between priceand “objective” or actual product quality seemed tobe relatively low. Occasionally higher priced optionswere found to be of lower objective quality than low-priced alternatives in the same category. The prevai-ling wisdom at the time regarding positive price-perceived quality correlations relied on a cognitivemiser argument. Evaluating more direct (intrinsic)information about quality across a bewildering arrayof products, each with its own unique set of qualityconnoting attributes was cognitively daunting, somost consumers adopted a price-quality heuristicbecause it had worked reasonably well in the past.That is, consumers consciously chose to rely on theprice cut to make quality judgments, because such aprocess was cognitively efficient.Therefore,consumers infer low quality from constantdiscounts or low prices. In the long run, constant dis-counts can damage the brand.How low can you go?While most companies cannot easily hold the line on prices this way, it’sa mistake to lower prices without considering the strategic implications.We must ask ourselves: Where should our prices be in three years? How willshort-term actions help us or hurt us on the way to that objective? Aggressive,highly visible discounts, for instance, may cheapen a brand in customers’ minds. Itmay persuade customers that they paid inflated prices in the past. Slashing prices alsomakes it hard to raise prices when conditions improve.The price/quality relationship:How lower prices hurt brandsStrategy2.3
  • 30. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesMaking the right strategic decisions about pricing can often amount to a chess match. Youmust consider the whole board and plan several moves in advance.Understanding the market positions of competitors and profit pools in the industry is crucial.But a static view of competitors doesn’t help; you need to anticipate their future actionsbased on their share of key segments,relative cost position,capacity utilization,and financialhealth.Your industry structure also plays a key role in determining the pricing strategy thatwill ultimately maximize your profits.What can you do that your competitors will be unwillingor unable to copy? As we noted earlier,markets are not monolithic,and there will be pocketsof opportunity created by high share in one segment or low-cost position in another thatallow companies to target the most effective pricing moves. At the same time, companiesmust be careful not to destroy the profit pool in their industry.Consider the case of a company operating in an industry with high fixed costs and weakcompetitors.By cutting prices too much,it might risk initiating a price war that is destructivefor everyone. One large real estate owner, for example, determined that, while it certainlydidn’t want to lose share in a down market, it also didn’t want to gain more than a pointor two.Why? Because any scenario in which it gained significant share in the face of fallingoverall demand would drive competitors to lower prices so much that its own lease ratesand profits would plummet.Pricing strategy decisions can amount to achess match: we must plan several movesin advance and anticipate what moves thecompetition will make.
  • 31. CONSUMER GOODS & RETAIL 31
  • 32. advanced seriesOur survey of leading manufacturers and retailers inSpain shows that most companies (60%) believe theyare in a price war.Price wars have racked industry after industry in recentyears. All too often, there are no winners. No industry issafe. No company, however well run, is immune. Afterall, most price wars start by accident, through someapparently trivial misreading or misjudgment of marketconditions. Rare is the price war that is initiated as adeliberate competitive tactic.In the current market,price cuts are driven by a structuralsituation of demand,although in many cases companiesare still looking more at what competitors are doingwhen establishing prices than at the new price/valuerelationship demanded by the customer.As a result, theharmful effects of the price war may continue to exist.In sectors like Consumer Goods & Retail,this situation isespecially acute because of their unique characteristicsand strategic importance. The best way to deal withprice wars is to avoid them altogether and, if this is notpossible, get out of them as quickly as possible.Pressure on prices:A problem in Spain?PRICING
  • 33. CONSUMER GOODS & RETAIL 33In fact, our survey of leading Consumer Goods& Retail companies showed that most of thembelieve the price war was started by a competitor.This is debatable, since most consideredthemselves to be the price leader.Reckless pricing measures and a strict focus onvolume are two of the main causes of price wars.There is widespread lack of knowledge of howmuch volumes need to increase to make up forthe price cut and an obsession to win marketshare, creating a vicious circle of price declines.Why should we avoid a price war?Numerous studies show that unless a company has a cost advantage of around 30% over another company,competing for the lower price is a suicide tactic. Price reductions are almost always copied immediately.Profits are extremely sensitive even the slightest declines in price levels. Price is the most sensitive lever in business.A real example can be found in S&P 1000 companies. A one percentage-point decline in price can lead to a 12%reduction in profit. Suppose a price war causes a 5% decline in price. Given the marginal contribution of 30% (forthe S&P 1000), that means that volume would have to increase by 20% for a company just to break even.This priceelasticity of 4 to 1 does not happen in the real world (a 2 to 1 elasticity is found if we’re lucky).Causes for unwarranted pricing:Complicated statistical or mathematical models are not required to analyze the causes of poorly informed priceformation due to the effects of a price war in the traditional sense. Most times, companies get caught up in thembecause of misreads or misjudgments of competitor actions and market changes.They are rarely started deliberately.Studying the misjudgments, we see that what is really happening in the market is the following: a company cutsprices without disclosing important collateral information (period of the cut and special circumstances) and theresponse by the competitor is to also lower prices. And so the price war begins and escalates. Competitor A identifiescompetitor B as the one who started the war and vice-versa.Is you company currently engaged in a price war?40%No, we are notin a price war52%Yes, it was startedby a competitor8%Yes, westarted it
  • 34. advanced seriesThe study conducted by IE Business School showed that 35% of Spanish executives admitted that they are incapable of determiningthe right volume growth necessary to offset a 5% decrease in price.The remaining 65% that believe they know the right answercould be wrong 80% of the time.The IE Business School Global Pricing Study 2011 revealed a close relationship between a corporate focus on volume and pricewars. Markets characterized by the large percentage of companies focused on volume rather than profit are more likely tosuffer as a result of a price war. Price wars are, therefore, caused not only by external and uncontrollable factors, but also oftenbecause of wrong strategic decisions.Regarding misjudgments, it is a common belief among company managers that only the lowest-price supplier in a market canignite a price war.They are mistaken:The culprit can easily be the highest-priced supplier.Consumers do not simply only buy onprice; they buy on value (V=Benefit-Price). As a result, a premium competitor can start a chain reaction, triggering a downwardspiral in the industry.PRICINGThere is a correlation between the focus of a business on salesvolumes and price wars.However: for Spanish (and Italian) companies, it seems that volume-orientationis not the only explanation for price wars.Relationship between the focus on volume and price wars.Source: 2011 Global Pricing Strategy. Simon-Kucher & Partners, IE Business School, AlimarketPricewarsFocus on salesvolumeManyHighFewLow
  • 35. CONSUMER GOODS & RETAIL 35How to avoid price warsSome industries run an inherently higher risk than others. Economictheory and our own empirical evidence indicate that when there is alarge concentration of big customers in a market, there is greater pres-sure on competitors.Seven steps have been identified to help avoid a price war:a. Avoid strategies that force competitors to respond with lower prices.Reactions by competitors, coupled with a lack of knowledge or mis-judgments, encourage other companies to react incorrectly or over-react. If you want to gain share, do so gradually.b. Avoid all possible misreads.Interpreting market movements is essen-tial.Invest in understanding the competitors’prices to avoid reactingbefore understanding the reason behind the price cuts and whetherthe cuts are proportionate to the consumer’s demand based on price/ value.c. Avoid over-reaction as a general rule of thumb.One reason price warsare more prevalent now than in the past is that managers view a pricereduction as quick and quickly reversible,when the truth is otherwise.d. Play your value map right.This is another key aspect that is not usuallystudied correctly.By studying the sensitivity of customers and compe-titors’cost structure,the best price can be established.The best priceis the highest price the market is willing to bear.e. Communicate your price effectively.This is another key issue,as men-tioned previously, to prevent misreads. If we have to cut prices, it iscrucial to communicate all the reasons behind it to avoid misinter-pretations that result in price wars.f. Jawbone on pricing. In line with the communication mentioned pre-viously, it is important to influence and explain fully the importanceand implications of pricing.It helps to speak openly about the horrorsof price competition.g. Exploit market niches.While this seems obvious,greater efforts needto be concentrated on exploiting market niches before opting to focuson price as the sole driver of an increase in sales volume.
  • 36. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced series3. MultichannelpricingmanagementThe website of computer manufacturer Dells asks prospective buyers to declare whether they are a home user,small business, large business or government entity.Two years ago, the price of a 512 MB memory module (partnumber A0193405) depended on which business segment one declared. At the time, Dell quoted $289.99 for alarge business, $266.21 for a government agency, $275.49 for a home, and $246.49 for a small business.What explains these price differences? How does Dell benefit from it? Different segments have differentwillingness to pay. Dell optimizes its prices, offering lowering prices to relatively price-sensitive segments. Aninteresting aspect of Dell’s attempt to charge different prices to different customers is that the customers aidDell in its effort. According to a Dell spokesperson, each segment independently sets prices and the customeris free to buy from whichever is cheapest.This example illustrates that the value is in the mind of the person who values it and different minds value aproduct differently.To capture this opportunity, companies will discriminate market prices. Price discriminationis a strategy of charging different prices to different customer segments for the same or similar products. Inany market, different customers value products differently and, therefore, are willing to pay different amountsfor the product.The automobile industry has capitalized on these differences in a very effective manner. Each manufactureroffers a wide variety of models to cater to the preferences of different buyers: from subcompacts to compacts,full-size sedans, SUVs, and sporty cars. Within each category, they also provide numerous options to make theofferings more suited to multiple buyers, who may then pick and choose the options they desire.Similaly, many consumers pay higher prices for electronics items, knowing very well that they will come downsignificantly over time. And, stores like Gap and Old Navy routinely mark down merchandise after a relativelyshort time following the introduction of new items; once again, however, many consumers do not hesitate topay full price.Economic and marketing literature have long recognized that price discrimination can be a profitable pricingstrategy. In a market where preferences are mixed and products are viewed differently, companies can boostprofits by segmenting consumers and setting different prices, enabling them to extract more from consumers.Empirical research indicates that profit can be as much as 34% higher when companies use price discriminationthan when they employ a uniform pricing strategy.
  • 37. CONSUMER GOODS & RETAIL 37Figure 10: Does your company employ price discrimination? (Multiple choice)We offer different brands at different pricesPrices vary depending on the channelWe offer individual and bundled productsWe offer discounts to certain customersegmentsDifferent prices are offered to customersdepending on the geographic areaWe do not engage in price discriminationThere are volume discountsWe offer different prices to customersdepending on the date10% 20% 30% 40% 50% 60%In our survey of Consumer Goods & Retail companies,the outcome was that the majority used price discriminationamong brands. Many also offered bundles with different prices and discriminated prices based on the channeland customer segment.Among the various types of price differentiation, researchers and professionals have looked particularly atself-selection given its numerous advantages, including low cost and easy application, not to mention its highprofitability.In price discrimination by self-selection,a company offers different versions of a product and differentprices and allows consumers to choose the one that best suits their preferences.
  • 38. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesThe increasing popularity of internet has prompted many traditional retailers to become multi-channel retailers offeringconsumers the choice between online and offline channels. More and more, Companies are using sales channels withoutphysical stores to increase or complement current processes for delivering products and services.As multi-channel retailinggradually takes over, customers are faced with a wide range of purchasing and communication options. As a result, it isbecoming more commonplace for customers to use multiple channels to interact with the company.A study by DoubleClick found that 65% of consumers were multi-channel consumers.Similar research by Forrester Researchindicated that more than two-thirds of consumers search for products online, but purchase offline.
  • 39. CONSUMER GOODS & RETAIL 39Is it a good idea to offer multiple channels?Consumers increasingly like to see products onlinebefore setting foot in the store.Going first to internet,they frequently choose what they want before goingto the store. However, once they are in the physicalstore, they usually end up buying some other item.After initial worries that the internet would stealsales from stores, retailers now are realizing thatjust the opposite is happening. Customers who“window shop”online are much likelier to spend moreoverall than those who just go to the store. A studyby Forrester Research recently found that customerswho shop three different ways –in stores, on Websites and with catalogs- spend about four times morethan customers who shop only through one of thosechannels.Similarly,customers who shop two differentways spend two to three times more than the single-channel customer.To take advantage of this behavior, major retailersare looking for new ways to steer shoppers from onechannel to another. J.C. Penney, for instance, says itposts weekly circulars online for customers to use inthe store. It also offers a broader selection of certainitems, like small appliances, in catalogs to encouragepeople to shop multiple ways.Penney says the numberof customers using all three shopping mediums grew30% last year, while the number using at least twojumped 46%.A recent study by consulting firm J.C.Williams Groupshowed that J.C.Penney customers who shop just oneway spend,on average,$150 a year on its internet site,$195 in its stores and $201 with the catalog.But Penneycustomers who shop all three ways spent $887 a year.“Any time a customer comes into the store becauseof the catalog or Internet, there is a high incidence ofthat customer buying something in the store,” saysJohn Irvin, a Penney executive vice president.“This isthe fastest growing change in customer behavior.”The relationship between the use of the channel andprofitability is not restricted to the retail sector.A studyled by IE Business School on the European financialsector produced several interesting conclusions. Theresults showed that multi-channel customers are farmore profitable than single-channel customers. Theresearch also showed different levels of profitabilitybetween customers using two channels and thoseusing three. The results suggest customers shouldbe encouraged to use two channels, but not three, tointeract with the company.
  • 40. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesGiven the vast differences between online and offline channels,such as convenience,risk or transparency,customer preferences are mixed regarding the channel,resulting in different perceptions of the channeland price sensitivities. As a result, operating in multiple distribution channels provides an opportunityto apply price discrimination based on channel, whereby the companies can set different prices for thesame product offered on the online and offline channel and customers can self-select their preferredchannel-price combination.Next,we look at whether multi-channel retailers set different prices of the same product between onlineand offline channels and determine the scale of the price differentials (gaps).We also analyze the factorsinfluencing a company’s decision to engage in channel-based price differentiation, their extent andmanagement (above all the influence of market,retailer and product factors).Consumers use different retail channels in different ways and,therefore,their perception of the channel varies.Studies show that abuyers’willingness to pay for a product through offline channels canbe 8% to 22% higher than through an online channel.Similarly,studiessuggest consumers have a different perception of price between onlineand offline channels.Therefore, price differentiation based on the channel isfeasible.This, coupled with evidence that price discrimination boosts profits, shouldspur companies to following a price discrimination strategy whenever they can.However, industry professionals argue that in order to maintain a strong brand, the company offerhas to be consistent across channels. Varying prices may lead to customer confusion, anger, irritationand a perception of price unfairness. Since previous research has shown that unfair price perceptionsdecrease purchase intentions, practitioners advocate channel price integrity.Channel-based pricedifferentiation3.1
  • 41. CONSUMER GOODS & RETAIL 41Empiricalstudiesin theUSproducedsimilarresults.It appears that stillonlyaminorityofmulti-channelretailers engage in price discrimination based onchannel, the extent and management of whichvary from retailer to retailer,and product categoryto product category. According to a study of overa thousand products, different prices were set forapproximately 20% of the products. For productswith different prices, in around 70% of the casesthe offline price was higher. The highest positiveprice gaps can be found in consumer electronics,such as remote controls and memory devices.The analysis shows that 29.63% of retailers engagein price discrimination based on channel.Of these,18.75% charged higher prices in the offline channel,6.25% always charged higher prices in the onlinechannel,and the remaining 75% followed a mixedstrategy,charging higher prices in either the onlineor offline channel depending on the product. Insummary, we found that retailers in fact engagein price discrimination.Figure 11:If there were a direct channel,would you vary prices betweenchannels?We haven’t studied itWe would usethe same priceThere would be adifference between 1%and 10%28%52%20%Source: own researchThis is shown in our study of the Spanish market. The vast majority of Spanish companies do not engagein price discrimination by channel. Rather, they charge the same price in direct and indirect channels. Only20% of Spanish companies set prices with a difference of up to 10% between channels.
  • 42. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesIt is also interesting to understand the factors determiningthe extent of channel-based price differentiation. Studiesshow that the level of online competition has a significantnegative influence on the occurrence and extent ofchannel-based price discrimination.The higher the onlinecompetition, the lower the probability of a multi-channelretailer engaging in channel-based price differentiation andthe size of the price gap between channels.Further, the number of distribution channels that multi-channel retailersoperate has a negative influence on the extent of channel-based price differentiation, implying thatthe higher the number of distribution channels, the lower the probability of price discriminationgiven the complexity of coordinating the channels.More interesting still is that results show that product type influences the extent of pricedifferentiation. The extent of channel-based price differentiation is highest in the case ofservices, which are less vulnerable to cannibalization due to resale. Among products, wealso see a greater extent of channel-based price discrimination in the case of perishablegoods (food) than durables (appliances), lending further indication that retailersare less involved in price discrimination for products that are suitablefor resale. These results could also explain the large groupof retailers that follow a mixed price discriminationstrategy adapted to the variety of products offered.The results show that many multi-channelretailers engage in channel-based pricedifferentiation and a certain increase in thistrend over time. Nevertheless, retailers stillapply consistent prices for the majority oftheir products. Generally speaking, the 12-16% price differential for products between theonline and offline channels reflects the differencesin consumers’ perception of the channel, althoughthis is relatively low compared to other types of pricediscrimination. Overall, results show there is channel-basedprice differentiation, but that the impact among retailers is still relatively limited.When todifferentiate prices3.2?
  • 43. CONSUMER GOODS & RETAIL 43The number ofdistribution channels thatmulti-channel retailersoperate has a negativeinfluence on the extent ofthe channel-based pricedifferentiation.The higher the level of onlinecompetition, the lower theprobability that a multi-channelretailer will engage in channel-based price differentiation.The extent ofchannel-based pricedifferentiation is highestin the case of services,which are less vulnerableto cannibalization due toresale.
  • 44. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesThe analysis shows that not all companieshave the same motivation to engage in pricediscrimination.The results of studies on the factorsbehind the existence and extent of retail channelprice discrimination suggest that retailers act inaccordance with standard microeconomic theory:for instance, higher levels of online competitionmake retailers less motivated to engage inchannel-based price differentiation. At the sametime, the burden of coordinating effective multi-channel price discrimination still hinders someretailers from capturing the full opportunitiesthat price discrimination strategy can afford.Although the level of price discrimination achievesthe expectations of the microeconomic standardin some product categories (e.g., higher pricedifferentiation for services and perishable goods),the differences in the nature of the products havenot been fully explored yet.Going further,we see that multi-channel retailerscharge on average higher prices in the offlinechannel. This practice is probably driven by thehigher perceived risk of the relatively new onlinechannel and/or the motivation of the company tosteer consumers to the less costly online channel.Moreover,retailers may pursue different operatingtargets for the online and offline channels anduse the offline channel to enhance their visibility.However, there are always exceptions to the rule.Online prices are normally higher than offlineprices in the food sector. There are basically tworeasons for this phenomenon: online food storesoffer a high degree of convenience, saving thecustomer from having to make their weekly tripto the supermarket and instead delivering theproducts to their doorstep. We have also foundthat online food shoppers are typically consumerswho have little time to shop and, therefore, aremore willing to pay a premium price for a deliveryservice that saves them time.This example showsthat the customer’s price sensitivity is the maintrigger of channel-based price differentiation.
  • 45. CONSUMER GOODS & RETAIL 45The results also show companiesnot only use internet as an addi-tional channel, but rather theycan explore this channel further,engaging in channel-based pricedifferentiation.Nevertheless,sincea low online reach helps separatemarkets and encourages channel-based price differentiation, thegrowing popularity of the internetas a place to shop reduces the op-portunities to use this channel forprice discrimination. In any event,as online channels become morepopular, companies could reducetheir number of physical stores.With a lower offline reach, theycan still engage in channel-basedprice differentiation.
  • 46. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesPromising to match competitors’ online prices is becoming the trendiest shopping tactic for four big-box chains, but retailing experts say the plans may backfire and send more shoppers scurrying to theInternet. A few weeks ago, electronics giant BestBuy and discounter Target said that for the first timethey would match the prices offered by the online sites of some rivals, including Wal-Mart and Amazon.The brick-and-mortar chains are trying to combat“showrooming”by shoppers who check out products instores but buy them on competitors’websites, often at lower prices. Both retailers’price-match policiesinclude significant caveats that could wind up confusing and angering customers,retail experts warned.Not only do shoppers have to ask for price cuts, they also may have to prove the existence of a lowerprice to harried store workers.The stores say they are confident the new efforts will pay off. Best Buy said it has done at least one pilotof its price-matching program in a major market and was pleased with the results. Best Buy will matchprices on electronics and appliances –but not other products- from 20 different online rivals. It excludedthird-party sellers like those on Amazon, where prices are the most volatile. Best Buy said its staff mustverify on a store computer that the rival’s price is actually lower at that moment and that the productis readily available. And a salesperson or manager can refuse to match a price if they deem it too low.The key to resistingPrice matching3.3
  • 47. CONSUMER GOODS & RETAIL 47Another risk that retailers run is encouraging even moreshoppers to check the internet to compare prices, acomparison that doesn’t favor the big box stores.A recentsurvey by William Blair found that on average Target’sprices were about 14% higher than Amazon’s, Best Buy’swere 16% higher and Wal-Mart’s prices were 9% higher.The comparison included shipping costs for Amazon, butnot sales taxes. And a salesperson or manager can refuseto match a price if they deem it too low.
  • 48. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesIf manufacturers begin engaging directly with consumers, mostlikely they will rely less on intermediaries for information onconsumers and potential customers. They could even start doing whatintermediaries did before, thereby introducing new price trends in the system. These changeswould shape the dependence structure of their relationships with the channel. Similarly, thedependence relationships will not depend again on a single intermediary to act as a channel.Companies with indirect channels that implement multi-channel marketing will need to minimizethe potential for the channel’s dysfunctional conflict. Any direct sales by the company to the endcustomer can be perceived as an attempt to circumvent the intermediaries. However, from thebusiness standpoint, direct contact with customers can help them identify potential customersand leverage up-selling and cross-selling opportunities.Companies like HP, which have a large number of distributors marketing their products andservices, are faced with this situation. Although HP has taken a number of actions to mitigatethe potential conflicts with the channel –e.g., the prices on its website are higher than thoseoffered by its intermediaries- a conflict with the channel can arise, resulting in decreased salessupport by the distributors. The question is still how to strike a balance between reaching theend customer and not offending partners in the channel.Open-endedquestions3.4?
  • 49. CONSUMER GOODS & RETAIL 49
  • 50. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesHas spent his career in the areas of commercial andcustomer strategy in several sectors, including ConsumerGoods & Retail, where he was a pioneer in the use ofreal time models for smart customers. Has recentlyfocused strategy development in Social Media & DigitalTransformation.He began working at The Boston Consulting Group beforejoining BNP Paribas group as Marketing Manager. He isAssociate professor at Universidad Carlos III in Madrid andESIC and writer of articles for specialist journals.Has a bachelor’s degree in statistical sciences and techniques from Universidad Carlos III ofMadrid and an MBA from London School of EconomicsPablo González MuñozPartner Ernst & Young - Advisory Services
  • 51. CONSUMER GOODS & RETAIL 514. Ernst &YoungviewpointTheneedsandexpectationsofcustomersandconsumersinSpainareset tochangedramaticallyforanumberofreasons:1)the country’s economic outlook,with flagging activity and rampant unemployment,new social trends shaped by stagnantdisposable income and more time dedicated to work –which naturally implies an increase in online time-;2) demographicchanges, whereby purchase decisions will be made by people from the 1970s and 1980s generation -with more individualprofiles and greater demands for personalization-;3) continuous proliferation of new digital technologies,resulting in newcapacities to share information and compare the value of products; and 4) an exponential loss of “confidence” in massadvertising.These new needs and expectations will lead consumers to demand individually tailored products and services that offer“greater guarantees of trust”in the products and services they purchase and to reject surprises.Companieswillneed topersonalizepricemanagement bygeographicenvironment andcustomer typeandset pricesbasedon product category,the impact of loyalty programs and the role of promotion through different channels.All of this mustcome alongside easier and more transparent communication and promotional mechanics for the customer,with simplicitybecoming a key future driver.This heralds a new era shaped by the personalization-simplicity puzzle,prompting companies to:• Continueadvancingon thedevelopment ofpricesegmentationskillsbasedongeographicarea,competition,product type,customer type,and channel mix.• Anticipate the impact of price strategies and tactics by developing engines that simulate their impact on the incomestatement.• Exert greater analytical control in implementing the stated policies to prevent distortions in execution.• Optimize the value chain to prevent operational inefficiencies from being transmitted to the customer via price.All of this is dealt with in this study,which is geared towards practices on which some sector players sector and customerswe have been working are already working.
  • 52. IEFOUNDATIONADVANCEDSERIESONPROBLEM-DRIVENRESEARCHPRICINGadvanced seriesThe IE Foundation is an instrument of IEthat enables students, teachers and staffto further their educational, research andmanagement activities.Priority is given to the training and culturaloutreach of all people and institutions thathave ties with IE.Resources go to funding scholarships forstudents, grants for training and researchfor professors, and funds for updating andimproving IE’s educational structure.The Foundation operates throughout Spain,but also has an international presencethroughout North and South America,Southeast Asia, the Middle East, NorthernAfrica and Europe.www.ie.edufundacion.ie@ie.edufoundationErnst & Young is a global leader inassurance, tax, transaction and advisoryservices. Worldwide, our 167.000 peopleare united by our shared values and anunwavering commitment to quality. wemake a difference by helping our people,ourclients and our wider communities achievetheir potential.Ernst & Young refers to the globalorganization of member firms ofErnst &Young Global Limited,each of whichis a separate legal entity. Ernst &YoungGlobal Limited, a UK company Limited byguarantee, does not provide services toclients. For more information about ourorganization, please visitwww.ey.com