Farnham: Economics for managers

Case for Analysis

Demand Elasticity and Procter & Gamble’s Pricing Strategies
Like many other companies, Procter & Gamble Co. (P&G) had to constantly alter its pricing strategies as it faced declining and
shifting consumer demand for many of its products from 2009 to 2011. Although the recession that began in December 2007
officially ended in June 2009, P&G managers continued to face consumer cutbacks even on basic household staples. Rather than
purchase P&G premium-priced brands, such as Tide detergent and Pampers diapers, consumers chose less- expensive brands,
including Gain detergent and Luvs diapers. The P&G chief executive noted at the time that consumers were trying more private-
label and retailer brands than they would in more normal economic times.
Because the company also faced higher commodity prices and global currency swings, P&G officials raised prices in the first
quarter of 2009, developed new products, and increased advertising to emphasize why their brands offered more value than the
competition. Officials reported that the higher prices hurt sales volume but increased total sales revenues by 7 percent. However,
industry analysts wondered if the deceased sales volume would eventually cause the company to lower prices and increase
promotions.
By spring 2010, P&G had reversed course and was engaged in a market-share war by cutting prices, increasing product launches and
spending more on advertising. The company’s goal was to win back market share lost during the recession to lower-priced rivals even
at the expense of profitability. P&G lowered prices on almost all of its product categories during early 2010.
This strategy continued into the summer of 2010, although there were concerns at that point that the company had missed
industry analyst profit estimates even though it had increased market share. Although the company announced that it intended to
raise prices in the first half of 2011, officials debated whether consumers had become accustomed to the lower prices. Industry
analysts argued that the company needed to sell more products in the lower- priced categories.
The ongoing discounting reduced P&G’s profits, which decreased 12 percent in the second quarter of 2010, because sales
revenue rose less than P&G expected. To offset the negative effects of the lower prices, P&G introduced new products including
Gillette razors that promised a less irritating shave, Crest toothpaste with a “sensitive shield,” and Downy fabric softener that
advertised keeping sheets smelling fresh for a week. The company also began moving into emerging markets such as Brazil,
where its research showed that Brazillians took more showers, used more hair conditioner, and brushed their teeth more often
than residents of any other country. The company planned to enter the Brazillian market in several new product categories at
once, such as Oral B toothpaste and Olay skin cream.
Given continued lower-than-expected revenue and slow sales in early 2011, P&G announced that it would cut costs but would
also try to raise prices on goods to offset the higher costs. P&G announced initiatives to eliminate some manufacturing lines and
sell off smaller brands. However, private-label brands continued to post larger sales gains than brand names.
In April 2011, the company announced a 7 percent increase in prices for its Pampers diapers and a 3 percent increase in the
price of wipes. Surveys indicated that customers were less likely to switch to a cheaper baby product than for items such as
bleach, bottled water, and liquid soap. The company hoped that parents would be willing to pay higher prices for diapers, even if
they cut back elsewhere, in the belief that the higher-priced products were better for their baby’s comfort or development. P&G
also raised the price of its Charmin toilet paper and Bounty paper towels. One industry analyst concluded that brands that had
the highest market share, were purchased infrequently (such as sunscreen or light bulbs), were necessities, had few competitors,
or where it would be difficult to reduce consumption (toilet paper) were most likely to be the products whose prices could be
increased. P&G, with its distinctive items, including beauty products, pet food, and toothpaste, was likely to be better able to
raise prices than Kimberly-Clark and Clorox that operated in highly competitive product categories with large commodity cost
pressures.
By fall 2011, P&G reported solid sales growth and that it had successfully raised prices even though some of its competitors
held back on their price increases. P&G had more ability to raise prices on its premium products because company officials
observed that higher-end consumer spending had held up better than that of lower-income shoppers, who were still affected by
continuing unemployment. P&G lost some market share in North America and Western Europe because its competitors did not
immediately follow its price increases. However, company officials expected that the competitors would soon follow P&G on
its higher prices.
This case illustrates how a company’s pricing policies depend on how consumers respond to price changes. In the first quarter of
2009, P&G raised prices and then reported declining sales volume but increased sales revenues. In subsequent years, the
company lowered prices, which increased sales volume, but did not increase revenue as much as expected so that there was a
negative effect on profits. Because the company was concerned about consumer adjustment to lower prices over time, it also
adopted other strategies to increase profitability, such as developing new products and entering new markets.
Thus, it appears from the above case that consumer responsiveness to a company’s price changes is related to
1. Tastes and preferences for various quality characteristics of a product as compared to the impact of price
2. Consumer incomes and the amount spent on a product in relation to that income
3. The availability of substitute goods and perceptions about what is an adequate substitute
4. The amount of time needed to adjust to change in prices
To examine these issues in more detail, we first define demand elasticity, and we relate this discussion to the variables
influencing demand.