Getting to grips with pricing

As brands face growing pressure from supermarkets, and strive to satisfy cost-conscious consumers, many are finding themselves sucked into a dangerous discounting spiral, writes Jane Bainbridge.

Getting to grips with pricing

In an age where buy-one-get-one-free deals have been replaced by buy-one-get-two-free offers, many brands are facing up to rapidly dwindling margins. While the green shoots of recovery may be breaking through the gloom of the downturn, brands' pricing strategy in an era of mass discounting is top of the agenda.

This, allied to the dual challenge of the rising costs of raw materials and supermarkets dictating retail price points, has led some marketers to lose their grip on pricing, with devastating consequences.

A recent KPMG survey, covering the financial services, retail and consumer goods, telcos and utilities sectors, estimated that UK profits have been dented by more than £20bn as a result of recessionary discounting. In its survey of more than 200 UK business leaders, more than half said they had reduced prices across the board, while 49% had entered into price wars with competitors.

'Companies are finding themselves trapped - consumers' expectations of price are lower and buying behaviours have changed, potentially permanently,' says Martin Scott, partner at KPMG Performance & Technology.

No time for long term

Perhaps more worrying from a business perspective is that more than half of those questioned thought there was insufficient time to create long-term pricing strategies at board level.

'Price is the second-most important marketing issue after the product itself. But some firms leave it to the marketing function, and others to commercial or sales,' says Tim Ambler, honorary senior research fellow, London Business School.

Gus Ormond, director at strategy and marketing consultancy Simon-Kucher & Partners, insists that price is a firm's most powerful profit driver: a 5% improvement in price can lead to a 33% improvement in operating income, more than that achieved by an equivalent improvement in volume, fixed or variable costs.

While Ambler argues there is nothing particularly new about the pricing issues, the subject is gaining a great deal of attention, not least when it comes to the impact of promotions and discounting levels. Almost 60% think they are now experiencing a detrimental impact on brand positioning and market reputation.

Colin Harper, head of insight at the Institute of Promotional Marketing, says: 'We're at the point where 44% of all products are sold at discount, while in health and beauty the figure is 66%. What is normal price?'

So is there a way out of this discounting spiral? Ambler's view is that brands should 'just stop'. 'It's never a good idea, it always damages the brand, and price promotions are a primary cause of killing brands,' he says. 'Discounting is undoubtedly harmful to an advertised, premium brand. Short-term figures are very misleading; you get an impression it's effective when it isn't. It's merely a timeshift of when consumers buy,' he adds.

Supermarkets want promotions, but they can slash a brand's margins, which means that the retailer and brand have to agree on the level at which such activity is funded by each party.

'Promotions cost you money and if the incremental sales are not enough to cover the cut in margin, you'll lose money,' says Ormond. 'I'd assume there are a lot of promotions out there that lose money. If you talk to marketing directors, they all say they can't afford to promote.'

Despite this, Ormond acknowledges the momentum for sticking with price promotions. 'They get you hooked. Once you've done a promotion you have to match your sales, and your sales will drop significantly if you don't have the promotion. Also, promotions are good for market share but not so good for profit-ability. Most FMCG companies are pretty obsessed with market share,' he adds.

Ambler concurs. 'As a marketer, you're in a dilemma: if you do (price promotions) you lose money; if you don't, you lose even more. You have to educate your competitors legally - because you can't form a price cartel - to the folly of (price promotions) and discourage them.'

This is an interesting area. Experts talk about how brands must stand together and resist downward price pressure and promotions, but legally, companies cannot discuss strategies with each other in case they are accused of price-fixing.

Research priorities

In toiletries, as in other FMCG categories, price boundaries - the maximum palatable price for a product in that category - is much discussed and researched. 'It's true that price lining is important, so going from £4.99 to £5.09 is a nasty patch,' says Ambler. 'There is an argument that it's better to hold back until you crash through the barrier in some style. But it's a myth that some brands can sell only below a certain price. As long as everything is going up it's all relative,' he adds.

Ormond says: 'We always advise carrying out research on the implications of going over those thresholds - some products are more price-elastic than others. In some cases, going over the thresholds is catastrophic, but in others you will take a hit, but when you look at it on a profit basis, there is an advantage."

As well as variations between categories, some think it's easier for big companies to push through price increases: if you're the owner of a brand that a retailer needs to stock, it's hard to delist it. That said, last year a dispute between Tesco and Premier Foods led the supermarket to delist some Hovis lines when Premier tried to pass on the cost of escalating wheat prices.

'I don't think it's just about big or small brands as much as strong ones. If you are a secondary brand it's tougher (to make a stand against supermarkets),' says Ormond.

If price rises are unpalatable, the other mechanism keeping margins intact is reducing pack sizes. While many view this as a legitimate and effective way of managing price, consumers are alive to such tactics - one has only to look at the rage expressed on online consumer forums when a beloved brand downsizes. Moreover, brands hate admitting to it.

Kraft-owned Cadbury reduced the size of its Dairy Milk bar from 140g to 120g to avoid price increases and would say only 'we have taken this decision because of a number of economic factors including ingredient costs. By reducing the size we can hold the bar at this price'.

Arduous hikes

The issue of pricing has risen to the top of the agenda as a result of the recent, rapid hike in commodity prices. This was identified at Unilever's fourth-quarter 2010 results by chief executive Paul Polman, who said it was the most significant challenge facing the industry. The rise in edible-oil prices has had a particular impact on the FMCG company, which owns the Flora, Bertolli and Hellmann's brands. Palm-oil prices rose more than 60% and sunflower oil by 55% in the past year (to February), according to commodity analysts Mintec. Products experiencing even higher rises include potatoes, coffee and durum wheat.

As raw material costs soar, there is also considerable pressure on consumer spending as austerity measures bite. Polman went on to say: 'We aim to protect our consumers as far as we can from the impact of higher costs but the responsible thing to do is price realistically and to act promptly in making any changes needed. We will not compromise in the face of predatory pricing from our competitors.'

This is the crux of the dilemma for so many manufacturers, and particularly those in the FMCG sector. On the one hand raw material costs are rising, on the other, the supermarkets are competing fiercely on price, both in terms of keeping everyday pricing low and using price promotions.

Wisdom of reduction

Of course, raw material prices can go down as well as up, although macrotrends suggest these costs will remain on an upward curve. The question remains, however, as to what marketers should do if raw material prices dropped.

'Take chocolate - there have been bad harvests and speculators cornering the market so I'm paying more for my chocolate bar,' says Ormond. 'That situation could change and those prices come down, but once you've accustomed the consumer to price going up, do you bring it down?'

He adds: 'Often, when commodity prices go down, it's a chance to invest in promotion rather than taking the everyday shelf price down. It's a very important question for marketers as you have to look at it from a threeto five-year horizon. You need a long-term view.'

While the relationship between brands and retailers might be fraught at times, there is always the unifying factor of wanting to win over the customer and build loyalty. So, good-quality customer research that benefits both the brand owner and the retailer remains one of the most powerful tools marketers have at their disposal.

BRAND PERSPECTIVE - Simon Duffy, chief executive, Bulldog

'The key thing is that you have no opportunity to discuss the retail price of your products with retailers. It's entirely up to them what they charge. The only thing a brand controls is the wholesale price,' says Simon Duffy, chief executive of male toiletries firm Bulldog.

He takes a pragmatic view of the role of price promotions. 'When it comes to planning promotions, we look at the themes of our category - what proportion of the category is sold on promotion and what isn't - and whether we want to be in line with the trend or try to buck it. Our philosophy is that we can't bury our head in the sand. We would love people to always buy our products at full price, but we have to set up a framework and work out what the right promotional strategy is for us. Our aim is to encourage trial of our products.'

RETAILERS' PERSPECTIVE - 'gilt-edged guarantees'

The cost of raw materials may be rising, but the competition between retailers to offer consumers the lowest prices on everyday items has never been more fierce.

Even upmarket supermarket Waitrose has got in on the act. In September last year, it announced it would match Tesco's price on 1000 branded products. It was the first time the upmarket chain had adopted price-matching tactics, as traditionally used by budget retailers such as Tesco and Asda

For its part, Tesco announced at the end of February that it was launching a £200m campaign to lower prices on more than 1000 everyday items, offering customers double the difference if its products weren't cheaper than Asda.

Asda, though, is equally bullish about its price proposition. Marketing director Jon Owen says: 'As commodity prices rise it becomes critically important that retailers are trusted to do everything they can to minimise the impact on struggling household budgets. We think our pricing strategy is right for the current environment and for the long term. The Asda Price Guarantee has gone from strength to strength - 1m people have used it since it launched. Our customers love it, our rivals don't.'