Profitability and the Four P's: Part II

By Caroline J. Beck
January 03, 2011

In a recent issue of Pressing Times, we published Part I of a two-part feature on how to achieve the best profitability for your business by conducting a classic marketing review of the four “P”s – product, placement, pricing and promotion. In Part I, we reviewed product and placement issues. In Part II, we now explore pricing and promotion strategies than can positively impact your success. This segment looks at ways to effectively determine “price floors”, “price ceilings” and everything in between, including competitive positioning and the new consumer mindset about premium luxury brands like extra virgin olive oil.

THE IMPORTANCE OF CREATING VALUE

It is no surprise that awareness and sales of extra virgin olive oil in the U.S. have exploded in the past decade. Along with a growing interest in a food-directed healthy diet and organic products, extra virgin olive oil fits the new food profile perfectly. The positive outcome of this greater awareness is that olive oil sales have expanded not only among higher-income customers but across the board. And the venues for olive oil sales have moved well beyond specialty stores and into “big box” superstores and grocery chains.

The challenge, however, is that purchasing habits of this target consumer has probably changed more over the past three years than in the past three decades. The hardest hit retail category is the upscale, higher-priced premium products, and extra virgin olive oil sits squarely at the center of that category. Recent research shows that about 20% of consumers have switched to lower-priced products and found that they actually like them. And, unlike other recessionary periods in the past, this research also shows it is not likely that all consumers will go back to their “pre-downturn” spending habits. If consumers see no legitimate reason to stick with higher-priced specialty brand olive oils, sales will slowly erode and profit margins will shrink until category competition is determined mainly by price and controlled by only the biggest players who can survive on slim margins from large volume or those who engage in “dumping” (artificially lowering prices and flooding the market) to make a quick grab for market share.

So, now more than ever, what becomes most important in this marketplace dynamic is value. The consumer perception of value is, quite simply, driven by the pricing and promotion of your product. In today’s tough environment, you can best protect your brand’s premium position by making sure the consumer understands the reason for its premium price.

PRICING

The pricing exercise starts with a review of your cost of goods (COG) and cost of sales (COS) from our previous segment, then factoring in two new considerations: a break-even analysis and a reasonable profit margin (~10%). Ultimately, the goal is to establish a price floor (the minimum amount that will cover your total costs) and a price ceiling (the highest amount that will match customer-perceived value and return the greatest profit). The price floor is completely dependent on your expenses. Determining the price ceiling, however, requires more research into market factors that affect what you can charge. It’s important to have a good understanding of your target consumer and the competition, so that you can position your own product in a way that optimizes the trade-off between price and benefits (i.e. value) on one hand, and margins and volumes (i.e. sustainability) on the other.

Most companies find that it is best to start by defining the highest reasonable price – one based on your unique product story. Launching a product by charging too little is far more dangerous than charging too much as it fixes the product’s market value at a low level. Research has demonstrated that once prices hit the market, it is difficult if not impossible to raise them. In 80-90% of the cases, all poorly chosen prices are too low. Bottom line, charging just 1% less than the optimal price for a product can mean forfeiting about 8% of its potential operating profit.

However, if your olive oil replicates what already exists on the store shelf (me-too), it will be difficult to establish a higher price/value ratio that consumers will buy into, especially when they are in the mood to get more for less.

Next, it’s important to study cost-plus pricing (the price floor) to understand your pricing options. In this exercise, make sure to account for all of the costs that ought to be allocated to the product – many producers have a tendency to forget R&D, goodwill linked with acquisitions, costs to service distribution, among other factors. An accurate analysis of costs per unit, plus a margin representing a minimally acceptable return on investment, reveals a new product’s lowest reasonable price level.

Most grocery-store brands use the following strategies:

  • Competitive pricing (>50%), matching the competition to gain market share

  • Cost-based pricing (>25%), ensuring profit, but not volume

  • Demand-based pricing (>15%), capitalizing on popularity, but risky

Most retail stores establish their price by “keystoning”, which means the retail price is double the wholesale price. While this is industry standard, bear in mind that producers don’t have control over what the store charges. And if you use alternate distribution methods, like the internet or farmers’ markets, you can’t undercut the retailer by selling for less without fear of reprisal (dropping your brand).

Finally, a word about sales projections. It’s ok to be optimistically cautious, but if a product’s viability relies on cost savings generated by economies of scale, then a false estimate of the size of the market or a customer segment will be disastrous. If the market can’t bear it, rethink your plan and take the time to fully explore all your pricing options. Your own strategy should be based on careful consideration for both current sustainability and future growth.

PROMOTION

Many really good products fail because of poor marketing and promotional plans. Conversely, many “average” products become blockbuster brands because of how they are presented to consumers – both in image and price. Aggressive distribution programs can fill the pipeline, but bottom line, nice labeling and a good marketing plan can easily double the perceived value of your product.

It might not be surprising to learn that 40% of consumers hold off deciding which brand to choose until they are in a store. In fact, up to 40% change their minds because of something they see, learn or do at this point. So, merchandising and packaging are very important factors. But most grocery store consumers only spend 12 seconds shopping in a particular product area and inspect only 1.2 brands on average, so the right combination of informative and attractive packaging, favorable positioning, and on-shelf messaging is critical.

But if in-store messaging can impact 40% of your potential sales, what about the other 60%? The fact is that most customers are predisposed to brand selection before they ever buy the product.

Marketing has always had one goal: to reach consumers at the moments that most influence their purchase decisions, aka “touch points”. From the above research findings, waiting until they are in-store is a very risky approach. On its own, the old program of pushing marketing messages through one-way communication won’t work anymore. While it is still important to get your brand message out through local press, niche magazines, grocery circulars and direct marketing, this won’t be enough. The most important change in consumer behavior is that they won’t wait for you to reach them. They are doing their own homework – and much of it is done online and through word-of-mouth recommendations. Even internet social networks like Facebook and Twitter are becoming surprisingly powerful mediums to deliver product messages.

This new pattern suggests that your best sales force may very well be your current customers, those who are devoted to your brand and willing to tell others about it. Keep them involved through newsletters, special offers, loyalty programs and product updates. And remember that post-purchase connections are just as important as those leading up to a sale. Send coupon offers direct to their mobile phone or create an easy link with QR (quick response) codes on product labeling or advertising. In one report, 60% of buyers go online AFTER the sale to do more research about the product. Make this target a priority. It costs far less to keep a satisfied customer than to find a new one.

Another important target is the “influencer” that can have the “Oprah” effect on your sales. In other words, if they like it, others will to. Public relations “sampling” programs to introduce your product to this target might bear as much fruit as your latest harvest.

Finally, a word about multi-channel retailing. Beyond classic distribution through specialty stores and upscale grocery chains, there are a number of other avenues to explore. Online sales continue to gain huge momentum; farmers’ markets provide grass-roots opportunities to reach local buyers and offer an inexpensive and easy way to conduct market research; the gift trade industry can bundle your product with other better-known brands and move large volumes in a short timeframe.

With the right mixture of classic marketing techniques and “outside the box” thinking, you can establish a strong brand position for your product despite the onslaught of competition. Do your homework, establish pricing that ensures a profit and provides a value, and build a marketing plan that hits all those “touch points”. Most of all, remember that pricing and marketing are not one-time, static exercises. If you are not getting the results you projected, make changes and continue to keep your finger on the pulse on your program.

Sources:

McKinsey Quarterly

North Carolina Cooperative Extension