7 “Pricing” Questions

I was contacted by a journalist who needed help in a piece of article she was writing to a magazine. I found the questions she posed stimulating, reason why I am sharing them (with you) along with my answers. Pricing is a very sensitive element in any business. In food & general merchandise retail this is a critical element and responsible for both market share and profits.  Despite the fact that much is said, studied and practiced, there is no “exact” formula to deal with it. The “entrepreneurial” spirit will always play a role in the pricing formulation even if absent in the formula!

 

1)    What is the importance of pricing in retail (small & medium supermarkets)?
One element of the value proposition of any retail business is price. Its importance varies depending on the emphasis given to the other elements of this proposition. The other elements may be: assortment (product offering); service (customer care, checkout speed, readiness in the production-processing areas such as butchery and bakery); food safety or convenience (location-availability).
Current trend is that of strengthening the smaller retail formats. This format may be of a neighborhood store or a convenience store (heavy traffic point of passage). In a neighborhood store the price factor will have more weigh as the relationship with the customer is one of continuity (repetition) in which the competition is another retailer (“big box” or another neighborhood store). In the other store (the point of passage one) the price factor is of lesser importance, as the relationship is not a recurring one and more based on convenience.

 

2)    How to define a pricing policy? What to take into account?
There are two aspects to be considered when defining a pricing policy:
1)    The price formulation per se, what may be, cost plus objective margin or market-competition price minus discount (differentiation with the competition-market);
2)    And the products categories, or even, isolated products, over which each type of pricing will be applied. The definition of products in which each “pricing formula” will be applied will depend on the answers to three questions: (i) what is important – in terms or products categories or isolated products – to my customer? (ii) how do I want to be perceived differently from my competition and in which products categories this is reinforced? And (iii) in which (categories or isolated) products I really can be competitive?
This exercise is comprised of observation, analysis, choices, bets and experimentation. This being the reason why most of the “big box” chains they do have a “pricing” area.

 

3)    How an ill-defined pricing policy may hurt a company? In which forms?
An ill-defined pricing policy is, above all, a symptom that company’s management does not understand its customers and/or its own positioning. And is not only an ill-defined pricing policy but also a static and non-revised one may represent sales loss or lack of stimuli to acquire new customers; build an image of “expensive”; and to the limit, generate losses  for not attaining the necessary gross profit to cover for the business expenses (SG&A).

 

4)    Does the pricing be in accordance with the concept of the product or with the perception of the customers? Why?
The product value, in the case of branded products, is in a large extent established by the manufacturer or importer. Unilever, to give a practical example, establishes the retail price of OMO. The retailer may adopt two postures, the first is to be, always, the cheapest when comes to OMO (even if only by cents) or define that in this category, where OMO is, it will always offer cheaper products than the competition (even observing the retail price defined to OMO by Unilever). And this is a category of high margins, which even by practicing a “discount” over the market price, the contribution to the overall margin mix will be highly positive.
There are other products in which pricing is simpler, either for them having a low price level and /or for having a low (or infrequent) consumption (i.e..: matches and wood stick), in such a case the recommendable is to apply the formula: cost plus objective margin.
Customers’ perception is always important, nevertheless, it should not be taken isolated. There are two other aspects or elements in this equation: in which aspects or elements (reinforced by products or categories) the company wants to be competitive (and recognized) for; and in what can the company be really competitive (and recognized) for.

 

5)    What is the difference between value and price?
This is a tricky question of not an easy answer. Theoretically, price results from quality, that in turn is related to cost and value addition. Nevertheless, in the context of this question we may answer that Value is a relation between price, brand and quality, while price is solely one element of this value formula. The element “brand” is built by the relationship developed with the customer during a longer period of time (repetition) and reinforced by quality. And this is the element which allows a determined manufacturer charge a “premium” for its product.

 

6)    How to calculate the gross profit margin? Which elements must be considered?
The price formula is, theoretically, simple, resulting from: cost plus taxes plus profit.
There is, yet, confusion between the definition of “markup” and “gross profit margin”. Markup is the percentage to be applied over the cost price in order to define the selling price (i.e..: if the cost of the product é R$10,00 and the markup is 50%, the selling price is R$15,00). Gross profit margin, though, results from the division of the gross profit by the selling price multiplied by 100 (i.e.: assuming in the previous example that there are no taxes, just to make the calculation easier, the gross profit is R$ 5,00 (R$ 15,00, selling price – R$ 10,00, cost) which divided by the selling price of R$ 15,00 results in a gross profit margin of 33,33%!
The cost of the product in retail is that of placing the product at the store, available for the customer. Thus, there are costs which simply are not indicated in the sales invoice issued by the supplier. Therefore, the first important aspect to obtain the correct gross profit margin is a well calculated cost of the goods. The second aspect is to have taxes over purchase and over sales well calculated which in Brazil is not simple. Important is to have the taxes (rates, rules)  parameterized in a system managed by only one professional (or group of specialized professionals) and having that, periodically, revised by professionals (accounting or tax areas). The last aspect is the objective margin which is going to be applied to the product. It is referred as objective margin since is the margin to be attained. The difference between the objective and real margins are mainly promotions promoted either by the retailer or the supplier or discounts at the till. This objective margin is defined according to the following aspects: product turnover (demand; what is important to the customer) and differentiation (in what – products and categories - I want to and I can be competitive).

 

7)    Give 5 tips to avoid errors in the pricing process.
1)    Try understand what is important to your customer (when in doubt, visit the competition in order to identify categories and products that are top sellers; confirm your findings with the suppliers’ sales rep);
2)    Find or choose the product or category that you may differentiate your company from the competition (and promote it; communicate it!);
3)    Find out the total cost of the product (purchasing price, storage and logistics etc);
4)    Have a report per product, periodically updated, at least once per quarter, that contains the selling price, objective margin and sold volumes. This is a very important tool to measure and  identify new opportunities in pricing, and, above all,
5)    Do not take for granted that pricing is static, what is far from true. It is an exercise that involves analysis, choices, bets, measurement and correction!