OREANDA-NEWS. January 27, 2016. Consumer packaged goods (CPG) companies are looking for growth. But high growth in developing markets is no longer making up for slow growth in developed markets. In such an environment, it’s tempting to consider raising prices.

This is one of the most complicated issues facing brand strategists. On the one hand, managing price is a critically important lever to increase profitability and generate funds for investment. On the other hand, significant price changes in either direction can have unexpected effects on the market. When one important brand lowered its price to compete against generic competitors back in the early 90s, it lost a staggering 26% of its market capitalization because the market read the signal very broadly as indicating a future in which brands would have less pricing power (something that turned out not to be true).

And the very environment that makes manufacturers look to price increases makes them harder to pull off: It’s exceedingly difficult to raise prices successfully when the whole category or sector is weak. Right now, 45% of CPG categories are flat or declining.

Finally, it may be true that the science of price increases – essentially, understanding the point at which the increase in revenue from units sold must exceed the revenue lost from consumers not prepared to pay the higher price – is well-understood.  After all, if you raise the price from X1 to X2, and the volume drops from Y1 to Y2, your revenue will rise (or fall!) from X1Y1 to X2Y2 – so all you have to do is maximize X2Y2- X1Y1. It’s not a complicated question. But there are so many variables that affect Y1 that brand marketers sometimes become overwhelmed by the “black box” analytics that come back from the pricing experts and make.

Pricing is certainly an art as well as a science. This is good, because adhering strictly to the science of pricing could lead to decisions that take too narrow a view of price increases. Often, price increases are reactive – perhaps the competition has raised prices; perhaps their cost of goods sold has gone up. In the first case, they focus too narrowly on a simple calculation of profit expectations. In the second, they do the same thing, except that the focus is now on making up the margin lost to increased costs.

This leaves marketers vulnerable to the law of unintended consequences, which are bound to result if you haven’t considered all the factors that drive whether a price increase will have the desired effect. To avoid common pitfalls, brand strategists need to ask a number of questions about brand, retail and consumer dynamics when considering a price increase.

Brand Dynamics

What is the brand’s role in your portfolio? A product’s role in the corporate portfolio and where it is in its life-stage are two key internal determinants of a price strategy. For example, as a product matures in its lifecycle, the corporate objective will typically shift from volume growth to profit growth, so a price increase might make sense. On the other hand, if a brand is a cash cow, a company will generally be content to accept volume loss, as long as the brand generates a predictable and steady stream of profit and as long as managing the brand does not divert marketing and sales resources from brands that are growing. And if a product is in a battleground space, companies will (or should) be very reluctant to increase price in almost any situation. In short, this strategic lens should frame all risks.

How strong is your brand? The answer to this question can make or break a price advance. Strong brands (well-differentiated products with high share and brand equity) lower the risk of a price increase. One way of looking at this is that a weak, highly substitutable brand invites consumers to switch when it attempts a price increase. Unlike strong brands, it has built no kind of “loyalty firewall.” But it’s also true that strong brands are more insulated from risk because, when a strong brand raise its price, the whole category often follows under the protection of the strong brand’s price umbrella. Once this happens, there is less money to be saved by switching. Unless consumers can realistically switch out of the whole category, the price increase is very likely to be accepted by retailers and consumers. Another important question is whether one’s strength is linked more to “own price” or more to “price gap.” If “own price” is the key, then, if we go up a dime, we lose no matter what competition does; but if price gap is key, we are insulated if (but only if) competition matches our dime increase.

Which way is your brand trending? Another indicator of the safety or riskiness of a price increase is whether the brand is getting stronger or weaker at the time of the price increase. If the brand is getting stronger, the risk is lower, and vice versa. A weakening brand will generally accelerate its decline with a price increase because it will encourage significant additional consumer defections. Retailers will then compound the problem because they will question the manufacturer’s commitment to growing the brand (and perhaps give the brand fewer facings or less visible shelf presence, etc.). On the other hand, sometimes brand managers will increase their trade promotion spending on a declining brand. Here the goal is to try to compensate for a weakening brand with short-term fixes. The marketers are trying to convince the trade that there is additional investment behind the brand.

How large is your product margin? A product with lower margins can afford more volume loss before the price advance leads to a significant overall fall in profit, all else being equal. Cost structure also matters — products whose costs are primarily variable are in a better position to raise price than if fixed costs are more important, because you can easily lower your costs by producing less, if necessary. Another cost-structure example is that products whose supply chain is more vertically integrated will typically have more cushion in handling pricing contingencies. When constructing scenarios with regard to competitive response, vertical integration should be considered.

What is the likely consequence of a price increase on the “velocity” of your product? A brand with SKUs in its portfolio that “turn” slowly may lose some distribution points with a price increase. This results in even a greater loss in volume than what modeling would have suggested.

What signal are you sending to retailers? If retailers question your commitment to a product – your commitment to keeping the product relevant – your position in the market will be substantially weakened. Maximizing the importance of your product to retailers means maximizing it to consumers. Refreshing flavors and packaging, making your offerings more contemporary, increasing your innovation rate – and communicating all this enthusiastically to the market – make all the difference in the world.

Retail Dynamics

The question of signaling to retailers raises broader issues of retailer perception. There is a wealth of science and best practice devoted to how consumers respond to price changes, but a real dearth of insight with regard to how retailers respond. There is no researched concept of “price elasticity” as regards retailers rather than consumers. This is simply because this information is much more difficult to obtain. Nevertheless, all manufacturers agree that retailers’ perceptions are critical.

How is the retailer likely to react? This is a very important question in the relationship between manufacturer and retailer. If a retailer believes that a manufacturer is disinvesting in a brand, why wouldn’t the retailer follow (by forcing a price increase themselves, by stocking fewer SKUs, providing less favorable trade support, and so on)? Other signals that a brand is being disinvested is whether there are other marketing or spending cuts. A price increase combined with a decrease in trade spending and lower consumer support creates a kind of “negative synergy” — the whole negative effect is greater than the sum of the negative parts. The retailer must be persuaded that a manufacturer plans to undertake a whole range of brand-supporting actions to carry through a price increase. So price changes must be managed in the context of a brand’s marketing mix. Increasing price at a time when a product’s value is being enhanced in some manner (e.g., improved packaging, increased equity, innovation, etc.) is the most sensible way to avoid a bad retailer reaction.

How important is the product to the retailer? If a product plays a destination or loss-leader role – that is, if the retailer regards the product as something the company can afford to sell at a loss (or at reduced margin), because its presence leads consumers to buy enough other products that more than make up that loss, the retailer will be deeply invested in the product. Here, the retailer has probably invested more energy than usual analyzing the product’s price – so any price change might disrupt the retailer’s broader strategy, putting them in a bind: What are the risks of passing along the price increase? One option is for retailers to absorb some margin loss to keep the price to consumers the same – but it’s not an option they will like!

The key here is communication, so that there are no surprises. Many will be surprised to hear that manufacturers seldom consult with retailers about price advances – but so it is. In part this is because when a product does not play a key role in a retailer’s strategy, price advances will usually simply be passed on to the consumer without much concern. However, the fact that manufacturers do regularly talk to retailers about promotions or decreasing prices suggests that brand managers contemplating price advances may simply be avoiding consulting an interested party who will push back on what they want to do. But the retailer will have to know at some time – so earlier is better!

How important is the timing to the retailer? Retailers are naturally interested in tactical considerations such as seasonality. Raising the price of something seasonal provides a buffer against volume loss: consumers need or are used to buying the product at that time. At the same time, however, there is some risk of consumer backlash: raising the price of your turkeys at Thanksgiving might make consumers feel they are being taking advantage of. By contrast, if a product is in its off season, there is less volume at risk, because less volume is moving anyway. But there is also less to stop consumers from walking away (because there is reduced marketing support in the product’s low-season periods). A related phenomenon has to do with the practice of increasing trade-promotion funds when increasing price, because here also we are concerned with a buffer against volume loss. In this case, the buffer is created by using the increase in trade-promotion funds to increase volume through temporary deals and lower prices to consumers.

Consumer Dynamics

Recent developments in pricing capabilities make it possible for us to measure how important consumer groups will respond to pricing actions. It is crucial to know whether a pricing action might upset a vital part of one’s franchise. These consumer groups could be defined by attitude (brand lovers, healthy seekers, etc.), demographics (Hispanics, those with large families, etc.), purchase tendencies (light or heavy buyers, etc.), or combinations of these characteristics. Bringing in consumer response to pricing actions enables one to be more strategic as well. The last thing a brand manager wants to do is to alienate his or her brand’s franchise.

Just as there are price elasticity multipliers (or coefficients) for a product, there are also such metrics for consumer groups. Suppose an average multiplier for a product is -1.5. This means a 2% price advance is expected to generate about a 3% decline in volume. So too with groups of consumers—if the multiplier is -2.0 for heavy buyers, more volume is at risk than if that multiplier is -1.0. Similarly, if the multiplier is -2.0 for Hispanics and Millennials, and these two groups represent an important part of your brand’s franchise, there is more long-term volume at risk than if the multiplier is -1.0. If Boomers are an important part of your franchise, you might be able to sustain a multiplier of -2.0 if your multiplier is lower for Millennials and Hispanics, and you expect them to become major buyers as they age (without a change in their multiplier).

Raising prices can be a high-risk, high-reward game. The best way to lower the risks is to understand them. Here is a summary guide:

PRICE ADVANCES – KEY IMPERATIVES

  • There are numerous risk factors: always construe risk in the context of the product’s corporate role, life-stage, brand strategies, strength and trends.
  • Implement price changes in the context of the whole marketing mix. Best practice (and the best defense) is to increase price not as a stand-alone event, but when increasing relevance and value to the consumer.
  • Understand the drivers of price sensitivity—own price or price gap vs. competition—and use these to plan accordingly.
  • Manage the retailer perception of the price advance carefully and in accordance with the product’s role; avoid unintended consequences (e.g., a manufacturer disinvesting). Develop a sound communication plan with retailers about pricing strategies and tactics.
  • Make sure key consumers won’t be alienated with a price increase.
  • When all of the above considerations have been assessed, hone your tactics – and proceed.