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Pursuing the 5th P of Marketing

| Issue 106 | Part A
August 2006 

Price and Profitability

What your brand needs to know about the price of profitability

What your brand needs to know

Brand survival and profit Fundamentally, a brands continuity depends on its ability to sustain itself over the longer term. This means that the profit it attracts by virtue of building its equity must be utilized in ensuring its sustenance. Therefore, almost all marketing activity centered around the four Ps of marketing (Price, Place, Promotion, Packaging) carefully balances the resultant outcome on the fifth P Profitability. A brands profitability can be influenced by a variety of internal and extraneous factors but it is invariably linked to its pricing. Pricing is central to a brands marketing strategy: it cannot operate in isolation of other marketing activities and it is a primary driver of brand profit. Shoppers: making sense of what they say It is critical to understand how the ultimate arbiters of brand / marketing success, namely consumers and shoppers, view themselves. ACNielsen ShopperTrends, a study conducted across 50 countries, identifies what shoppers seek from retailers and understands their shopping behaviour in conjunction with retailer brand equity. By intersecting what consumers claim they want from retailers, with what actually influences their shopping behaviour, it is easier to pinpoint consumers propensity towards spiralling prices in the midst of an increasingly aggressive and price-focused trade environment. Surprisingly, the difference between the factors that shoppers state are important versus what ShopperTrends has found to be important indicates that low prices, though claimed by shoppers to be a key determinant in driving choice, is relatively less so. Factors such as Easy to find, Well stocked, Wide range and variety and Selection of quality brands and products are just as likely to be true drivers of shopper choice. Low prices, on the other hand, is seen to be a statement that is said, but not meant. This conclusively proves that shoppers see competitive prices as a necessary or hygiene condition amongst retailers and that better prices per se is not necessarily a strong differentiator. This is because

- John Ruskin.
other retail characteristics are also important, and can help a retailer support a price premium versus the hard discounter. Factors such as range, availability, convenience, and quality, too, can have a bearing on a shoppers exercised choice. Additionally, brand owners can use their brands and their marketing investments to help retailers achieve differentiation in these areas. Nevertheless, pricing is an integral part of creating value, sustaining shopper loyalty and ensuring brand profitability. It is for this reason that pricing strategy assumes the importance it commands and must follow a specific and deliberate process before it takes its final form. This process calls for management decisions on product, pricing, distribution, promotion and personal

There is scarcely anything in the world that some man cannot make a little worse, and sell a little more cheaply. The person who buys on price alone is this mans lawful prey

w about the price of profitability

selling, and in some instances, even customer service. This definition implies that pricing is central to profitable brand marketing!

Pricing toolbox
Sowhatshapedopricingstrategiestypicallytake?Typically,three typesofpricingstrategiesarefound.Theseare:
Pricing a brand based on achieving a given margin over and above costs of manufacturing, marketing and distribution. Often associated with sales- or production-led organisations; tends to encourage a mechanistic approach to cost control and pricing. Examples: Cost-Plus:Price = full cost + mark-up (as a % of full cost) Mark-Up:Price = direct cost + mark-up (as a % of direct cost). This technique is preferred to Cost-Plus for products with a relevant percentage of direct costs on total costs. Break-EvenAnalysis: rice = P variable costs + fixed costs/quantity. This formula does not depend on any cost controlling technique (Full Cost or Direct Cost); it provides a useful decisional support for different marketing strategies, taking into account return on investments. with competitive intelligence-led organizations; characterised by an against-someone positioning. PureParity: rice = Price of P a chosen competitor. Typical strategy of price takers who set price equal to one of the price makers and align constantly to it. This can also be a strategy for specific channels, e.g.: vending impulse. DynamicParity: iven a G chosen competitor, the gap with its price is kept constant in time, in order not to change competitive positioning in the consumer perception. This is most common amongst category leaders and the #2 brand, and is usually expressed as an index, i.e.: #2 brand will aim for 90% of the category leaders price. DiscountPricing: rice is P always below the average of competitors, allowing a precise positioning of low perceived price and low perceived benefits. PremiumPricing: rice is P always above the average of competitors, allowing a precise positioning of high perceived price and high perceived benefits.


Pricing based on value of a brand as perceived by the consumer. Value perceived by consumer may have little to do with the cost of manufacturing, marketing or distribution. Often associated with marketing-led organisations, tends to focus organisations on maximising the value creation process. Some common techniques are: ElasticityAnalysis: The price decision results from the calculation of the sensitivity of volumes to price changes. By simulating different price scenarios it is possible to set the optimal price to the one maximizing expected revenues and profits. Buy-ResponseAnalysis:The price decision results from market research estimating the consumers intention to buy at different price levels. The outcome is a quantification of perceived value. C  onjointAnalysis:The consumer quantifies the economic value of the perceived utility for each product attribute, making it possible to determine the ideal pricing of each product configuration.

2. ompetition-based C strategies

Pricing based on the competitive strategy and on attack/defence moves of competitors against a given brand. Often associated

Defininga pricingstrategy andpricingobjectives

Segmentationpricing, nichepricing,EDLP orHi-Lopricing,and otherapproachesare ultimatelyvariationsof thesethreefundamental strategies.

This toolkit of price tactics is the marketers / retailers arsenal for strategizing in the pricing game. Managing price strategy consists of viewing pricing through a variety of perspectives. By looking at the varied elements of marketing, profit, value, pricing objectives and how these interact with the impact on profitability and the competitive dynamics of the market, arriving at a definitive pricing strategy can be a rewarding activity. This includes looking at key elements of the marketing mix. These are:

Thosethatexertadownward pressureonprices:
Consumerdynamics Macro-economic pressure  Sensitivity to price and gaps to key competitors Whether the product is a luxury, necessity or substitute Competitormarketing Pricing, promotions, media, innovation of the competition in the market New entrants Retailerstrategy Role of category and brand Competition between retailers Private Label strategy Balance of power; trade margin negotiations

Thosethatexertanupward pressureonprices:
Yourownbusinessobjectives Profit, turnover, volume, share Ownmarketing Investment in innovation, media, promotions, packaging Costofgoods Increasing supplier and distribution costs Volume-dependent costs

How price relates to other variables in the marketing mix

TheCharteredInstituteofMarketing(UK)definesmarketingasthemanagement processresponsibleforidentifying,anticipatingandsatisfyingcustomer requirementsprofitably.
Combined with the theory that [profit = volume x (price - cost)] and that Perceived Value = Benefits (both emotional and functional) / Price, this helps us arrive at three major postulates of the pricing game. Pricing is central to profitable brand management. The greater the benefits perceived by the consumer, the greater the price a brand can sustain. Reducing investment in perceived benefits reduces value. This also implies, therefore, that pricing strategy cannot be set in isolation and that the three major areas of interaction with price, namely, promotions, volume, and profit must be carefully understood. and hardly change when the brand changes price. 2. High price and low or no promotions (Hi-No) when the sales hardly change as the brand undertakes promotions and even when it changes price. 3. Harvest price for profit when sales change significantly as the brand changes price and promotes, the strategy will depend on the cost structure of both the brand and the promotion. 4. EDLP when sales change significantly as the brand changes price, but are relatively insignificant when it promotes. changes in underlying volume. This is commonly referred to as the brands price elasticity. The elasticity will be negative i.e. as price increases demand will decrease, and it is also seen that this relationship is not linear but depends on the percentage (%) change. This implies that to understand the impact of price on profit one needs to know the impact on profit per unit and on volume sales.

Priceanditsinteraction withprofit
Pricecanbeseenasadriver ofprofit A price increase has traditionally been the best alternative for increasing profitability. The impact of this on profit is especially magnified if a brands current margin is low. However, price increases are more visible to consumers than cost reductions and the reaction of consumers to price increases are the ultimate determinant of its impact on profit margins and profitability. A clear understanding of consumer sensitivity to a brands price and its profit margin helps assess whether price increases will generally be profitable or unprofitable.

Priceanditsinteraction withvolume
Priceasadriverofvolume A brief understanding of economic theory helps us better understand the impact of price on volume. Equilibrium between supply and demand defines a products natural price; when supply is greater than demand, prices fall and when demand is greater than supply, prices increase to maintain equilibrium. Econometric modelling applies this theory to brand pricing and by removing the effects of promotions, media and seasonality, measures the relationship between historical changes in price and

Priceanditsinteraction withpromotions
A brands strategy can be described by observing the way its sales react to changes in price and promotion and the magnitude of their change. These changes can range from minor changes to major alterations in off-take for the brand. Slotting this interaction into four quadrants allows one to arrive at four strategic situations: 1. High price and frequent promotions (Hi-Lo) when the sales change significantly as the brand promotes

For instance, for a brand with a 20% profit margin, a 1% price increase will increase profit per unit to almost 21% equivalent to a 5% margin improvement per unit. In such a scenario, volume sales would need to decline by more than 5% for total profits (profit per unit x # of units) to decline. Therefore, any volume decline less than 5% will mean that the price increase will translate to a total profit increase. In other words, break-even would be achieved with a price elasticity of -5 (a 5% volume change for a 1% price change). Performing this same calculation for a range of profit margins allows us to plot the break-even point where for any given margin, if the brands price elasticity is higher, then a price increase will reduce profit, and if the brands elasticity is lower, then a price increase will increase profit. A majority of brands have a price elasticity of less than three, so in most cases it is a profitable decision to increase price the brand has to already command a very high margin for it to be unprofitable. It follows therefore that price increases within reason increase profit as well. This caveat of increasing prices within reason also reinforces the importance of the current profit margin. Price increases do, however, also decrease volume depending on the brands price elasticity. Therefore total profit will ultimately depend on a combination of a brands profit margin and its price elasticity.

Conversely,pricedecreases within reasongenerallydrivea declineinprofitability. The resultant increase in volume may offset the decline in profit but in this scenario too, the total impact would depend on the brands current profit margin and its price elasticity. Converting this into a scheme for pricing strategy juxtaposes the two essential parameters of price sensitivity and profit margins to form a quadrant that describes four likely pricing scenarios. They are: 1. When the brand profit margin is low and the brand is not sensitive to changes in price, consider a price increase to drive profit as price reductions will reduce profit. 2. When the brand profit margin is low and it is very sensitive to changes in price, review price



increase or decrease for profit growth. When the brand profit margins are high and the brand is not sensitive to price changes, review price increase or decrease for profit growth. When the brand is very sensitive to price changes and has a high brand profit margin, consider a decrease in price to drive profit since a price increase will reduce profit.

InPartBofthisConsumer InsightsissueonPricing In Part B of our Consumer Issue we will focus on a number of case studies that review pricing in the real world, across different geographies, distribution channels, competitive conditions and product portfolios.

Copyright 2006 ACNielsen. All rights reserved. Produced by ACNielsen Communications Department.

segmentation marketing mix assortment promotion pricing

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