January 29, 2008
CSD: Identifying More Effective Profit-Building Strategies
By David Bishop, Partner, Willard Bishop
Through a special arrangement, what follows is an excerpt of a current article from Convenience Store Decisions magazine presented here for discussion.
In a business like cigars, where unit volume is growing 10 percent plus year-over-year, emerging strategic thinking in convenience retail suggests that retailers can grow even faster by employing a “price-for-volume” strategy for key products. While this seems fairly intuitive, we learned through our retailer surveys that it’s not the commonly held belief today among retailers. In fact, we discovered that c-stores are twice as likely to believe that increasing – not decreasing – prices will lead to improved profits.
This learning prompted us to ask why convenience retailers would believe and possibly execute a strategy that could inadvertently slow growth potential. While we surveyed retailers, we also learned separately by reviewing previously completed shopper research that cigars – especially packs – were a highly planned purchase. This suggested that price could be a determinant in purchase location, but without specific shopper research it would be hard to understand if this rationale were true. So, we developed a hypothesis that retailers offering better prices on pack cigars would experience stronger growth.
While carrying out the surveys, we also gathered information about pricing strategies for cigar singles and packs as well as category performance. We elected to focus on pack pricing strategies since they represent around two-thirds of the business, and we found that more than 80 percent of the retailers priced cigar packs at price points competitive with the primary competitor’s everyday price. To test our pricing-for-volume hypothesis, we analyzed the category growth rates of surveyed retailers relative to their pricing strategies for cigar packs, and discovered that retailers pricing below the competition by five percent or more experienced dramatically stronger growth rates than the market.
But is it the right strategy simply to embrace an everyday low pricing (EDLP) strategy on all packs? To better understand this question, we mined the item-level results from our 2007 total store profitability study completed with three national convenience retailers for the Convenience SuperStudy.
This analysis revealed a couple of key insights that help answer the question. First, we understood that cigar packs generated much higher penny profits (~3.4x) compared to singles. This information became more valuable after we interpreted it based on what we also knew about the shopper and effective pricing strategies. Specifically, we realized that a retailer could invest some of the penny profit from cigars into lower profits. This would create stronger consumer value in the form of lower per unit costs, driving a higher weighted penny profit for the retailer as the price gaps narrow and enticing the consumer to trade up from a single purchase.
Second, we documented that similar to most categories, a small percentage of the SKUs drove the majority of the business. This indicated that the pricing-for-volume strategy could be confined to the best-selling SKUs, assuming that these are what we’d call the “known-value items” in the category. This meant that retailers could enjoy higher margins on secondary brands that rounded out the assortment but didn’t drive the business. So, in the end we identified that a hybrid-EDLP strategy on packs could help retailers accelerate profit growth. In doing so, retailers will be less likely to sub-optimize the strategy by uniformly applying it to all the products, which is the real value of this approach.
Discussion Questions: What factors determine whether a retailer should use a “price for volume” strategy around a key category? In what circumstances shouldn’t they use one? Why do you think there’s apprehension by some c-stores to employ such a strategy?
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This is traditional Category Management 101. Convenience retailers may assign cigars the role of either a destination or routine category. They should use certain items within cigars as traffic builders or turf protectors (which tend to be less profitable, and typically are the larger sizes because of price sensitivity), and the rest as image enhancers and profit builders. For those consumers who are price sensitive, their needs are being met (lower price per cigar in the larger packs).
Another layer that convenience retailers should consider is the difference in consumers who shop at different locations. By completing Location Intelligence analysis, which links demographic data with store level sales data, profiles for different stores can emerge. Segmenting the consumer into different key consumer groups (instead of trying to do a “one size fits all” strategy through one average target consumer), and merchandising based on the key groups and their needs will ensure different consumer needs are being met, based on these key segments.
Is price important to all demographics who purchase cigars? Probably to some, maybe not to others. By doing some location intelligence analysis, those stores can be more easily identified.
The price elasticity of any item is dependent on the item, the customer and the number, location and pricing by competitors. With all of these variables coming into play the number of solutions for price elasticity becomes too great to roll off the top of one’s head. That is why pricing models are becoming so popular. A good pricing model will allow you to maximize your profit vs. volume mix.
I think Sue is right. Nothing too revolutionary here. It’s even more basic than Category Management 101–it’s Customer Service 101. You have to know who shops your stores, what they want and how elastic their parameters of need are. That’s how you develop effective pricing strategies
Sue nailed this one!
If you believe that consumers plan their cigar purchases then you need to broaden your assortment and provide packs and sizes that cover a broad spectrum of prices. This means having a few “singles” at a reasonable price to drive trial. You then need a few “multi-packs” to trade the consumers up to the high-ticket and high-margin items.
Each category needs a spectrum of Traffic Builders and Profit Generators.
Convenience stores are “high cost producers,” versus large format stores like supermarkets and warehouse clubs. Generally, high cost producers can’t afford margin cuts. Additionally, I wonder about location pricing versus brand value. Would it annoy significant numbers of convenience store customers if locations within the same market, sharing the same brand name, had inconsistent prices? How many folks would notice?
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This is traditional Category Management 101. Convenience retailers may assign cigars the role of either a destination or routine category. They should use certain items within cigars as traffic builders or turf protectors (which tend to be less profitable, and typically are the larger sizes because of price sensitivity), and the rest as image enhancers and profit builders. For those consumers who are price sensitive, their needs are being met (lower price per cigar in the larger packs).
Another layer that convenience retailers should consider is the difference in consumers who shop at different locations. By completing Location Intelligence analysis, which links demographic data with store level sales data, profiles for different stores can emerge. Segmenting the consumer into different key consumer groups (instead of trying to do a “one size fits all” strategy through one average target consumer), and merchandising based on the key groups and their needs will ensure different consumer needs are being met, based on these key segments.
Is price important to all demographics who purchase cigars? Probably to some, maybe not to others. By doing some location intelligence analysis, those stores can be more easily identified.
The price elasticity of any item is dependent on the item, the customer and the number, location and pricing by competitors. With all of these variables coming into play the number of solutions for price elasticity becomes too great to roll off the top of one’s head. That is why pricing models are becoming so popular. A good pricing model will allow you to maximize your profit vs. volume mix.
I think Sue is right. Nothing too revolutionary here. It’s even more basic than Category Management 101–it’s Customer Service 101. You have to know who shops your stores, what they want and how elastic their parameters of need are. That’s how you develop effective pricing strategies
Sue nailed this one!
If you believe that consumers plan their cigar purchases then you need to broaden your assortment and provide packs and sizes that cover a broad spectrum of prices. This means having a few “singles” at a reasonable price to drive trial. You then need a few “multi-packs” to trade the consumers up to the high-ticket and high-margin items.
Each category needs a spectrum of Traffic Builders and Profit Generators.
Convenience stores are “high cost producers,” versus large format stores like supermarkets and warehouse clubs. Generally, high cost producers can’t afford margin cuts. Additionally, I wonder about location pricing versus brand value. Would it annoy significant numbers of convenience store customers if locations within the same market, sharing the same brand name, had inconsistent prices? How many folks would notice?