Photo: RetailWire
Are ‘price frictions’ undercutting product sales?
A new university study finds some retailers may be slower to reduce prices to stimulate sales due to “price frictions,” for example, reluctance to move away from prices that end in 99 cents.
The research from professors at IESE Business School in Barcelona and the Massachusetts Institute of Technology focused on two situations when retailers face initial demand uncertainty: new stores and new products. The uncertainty increased the likelihood that price adjustments may be advantageous or necessary after observing initial sales.
The study identified three reasons why retailers may be reluctant to adjust new product prices:
- There may be no price changes on related product;
- State-level pricing laws require price stickers on each package;
- The initial prices end in 99 cents.
In many cases, retailers were found to discontinue their sales of underperforming new products altogether rather than lower prices.
“Intuitively, retailers like to retain 99-cent price endings,” said Diego Aparicio, a marketing professor from IESE Business School, in a statement. “And if a new product has low initial sales, retailers prefer not to touch a 99-cent price instead of triggering a promotion, and as a result, the product is more likely to be discontinued in the short-term. This is a novel side effect of price endings that managers and scholars might want to input in their models.”
A Deloitte study from last year identified three “blind spots” that prevent companies from efficiently adapting pricing strategies to evolving consumer behaviors:
- Over reliance on internal data: Overly relying on internal data (or a narrow set of external factors) when analyzing consumers leads brands to miss key trends and opportunities developing elsewhere.
- Outdated assumptions around consumer willingness to pay: Pricing-related actions are often based on assumptions that “treat consumers as broad, homogeneous segments” and not reflective of nuanced changes in consumer preferences, a product’s position relative to competitors and “the true level of differentiation established in the market.”
- Pricing and promoting with uniformity: Many consumer-focused companies continue to set prices and promotional offers at a national level, limiting their ability to capitalize on localized or individualized growth opportunities.
Discussion Questions
DISCUSSION QUESTIONS: Are the pricing frictions cited in the article a major impediment to price optimization? What other habits, rituals or barriers often make retailers reluctant or slow to adjust prices?
Poll
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If the sales of a new product are so low as to require a price reduction then discontinuing that product may be the best solution. If it cannot sell initially at the price set then there is little chance that it will be able to do so in the future. Local pricing is always a difficult one for national retailers. Consumers do not like having different prices from the same retailer when they shop in another one of their stores. It is too easy to say that retailers are leaving profit opportunities om the table.
Retailers incentivize buyers on margin and lowering prices affects their compensation, so I understand the reluctance to change price until absolutely necessary. I don’t understand the study’s finding on pricing on a national level as every retailer I know leverages regional/zone pricing. Some retailers use the 99 cent price point to indicate a sale item so they may be reluctant to modify legacy applications to accommodate the change.
I also wonder if the study accounted for changes in merchandising approaches. Moving a product higher or lower on a shelf or featuring it on an end cap can make a significant difference in sales without changing the price. And why would internal data ever be a bad thing? It’s not over reliance, it’s probably missing opportunities to use the data in addition to wider market signals. Long story short, pricing is a powerful driver of shopper decisions, so studies are important. More important: retailers should leverage every type of data available to them to improve conversions and overall performance.
I agree about what impact changing merchandising can have. I remember the studies provided by snack and other suppliers about what were referred to as weekenders, i.e. temporary displays on endcaps had without any price reductions. Initially didn’t believe it until we tried them and found them to be very effective at increasing sales.
Pricing might be the least understood and most poorly utilized tool in the marketing and retailing toolbox. Myths abound and very few manufacturers or retailers want to test the implications of different prices; I believe manufacturers should be much more proactive here. In our research, we’ve often found that shoppers are less price sensitive than expected, especially for brands with good equity. Indeed, some marketing experts measure brand equity as the ability to withstand higher prices. Be flexible, be willing to experiment.
Price optimization is a loaded concept, especially from the consumer’s point of view. If by “optimization,” we mean the ability to change prices quickly to take advantage of increased demand (or limited availability as the case may be), consumers, as well as local governments, I suspect, are going to take a dim view, it will quickly be positioned as “gouging.” If we’re talking about managing margins across markets where local expense considerations are different, we’re fine. In my experience, the most significant barrier to price changes in-store is execution. Ensuring that team members can find all the items, their tags, the shelf labels, and everywhere else the price is displayed can be a problem, and an expensive one at that when advertised prices are not aligned with store prices. Electronic shelf labels were supposed to solve this, but adoption has been mixed, given their cost and how bad they tend to look on the shelf edge.
Regarding the .99 cent endings history lesson, before there were ERP systems and item systems with robust attributes, price endings were one of the few ways retailers could group items to track performance. .99 for regular, .98 for promotions, .97 for clearance, etc. I’m suddenly feeling very old.
Forgive my ignorance, but is the purported psychology of ending a price in .99 still a thing? With the proliferation of product choices — and competing prices — being so dominant, do consumers still respond to these tactics of yesteryear? I’m guessing people have evolved beyond that type of friction, and instead simply respond to the combination of timing, need and availability that suits their needs for each journey.
New products are a major challenge for many reasons. And, having spent my career with them, it’s never a good thing to have to reduce price soon as that steals value from the new product.
Sadly, most stores don’t do what new products really need — drive sales at higher prices with advertising.
Long ago, and I do mean long ago, pricing was pretty straightforward. Regular prices ended in .00, or sometimes .50. Markdowns and sale prices ended in .99. Simple. But as discounting and promotions became more common (now every day), retailers began using .99 for everyday value pricing. The .99 ending was supposed to immediately telegraph value. $19.99 is some how supposed to be a better deal than $20. It’s not about the penny, it’s about the perception. If it’s $20, I should wait for at least the first markdown.
My perception is that of a Boomer who has been in the business for a while. I need to take a lesson from a customer a couple of decades younger to get a better feel for how the market views these pricing mechanisms these days.
National research and national pricing strategies are at odds with reliance on local store-centered consumer data. The data needs to be analyzed and interpreted separately and in combination to identify trends and local preferences. Pricing friction, optimization, and variation are always challenging when trying to evaluate product sales. It is often difficult to delay making a decision without fully analyzing all the relevant data.
New product pricing has always offered some unique challenges for retailers as it is usually is accompanied by data scarcity and the unknown. Adjusting pricing, however, remains the most impactful and fastest lever a retailer can pull to adjust to demand and drive the results they need. All of Deloitte’s findings remain true today — a robust pricing practice requires a higher level of sophistication than just a .99 cent ending and a one-size-fits-all price for all consumers. The good news is that the most advanced pricing platforms coupled with best practices are helping a lot of top retailers solve this exact problem effectively and allowing them to find the right price for the right consumers through all channels.
Inflation has shone a spotlight on pricing strategy. I wonder how much certain numbers resonate now, given that shoppers just want to know they’re getting the best price they can and the best value possible. I think those are the most important variables.
“In many cases, retailers were found to discontinue their sales of underperforming new products altogether rather than lower prices.” Really? How about retailers discontinue their sales of underperforming products — full stop? I don’t see pricing frictions as a major impediment to price optimization compared to, say, high/low pricing models, perpetual “sales”, faux loyalty programs, poor data analytics, and generally being out of touch with what consumers want and what they are willing to pay for it.
Pricing decisions are not made lightly by retailers. Therefore, decisions to change prices (outside of routine promotion) are also not made lightly. New items, in particular, need to find their stride. Consumers have no established price expectations on new items such that discounting too early could diminish brand equity. Further, retail category management sets performance targets for each item. Lowering prices for an extended period of time affects productivity and profitability. If another item can perform better at regular price, then it would be considered over an item that must be discounted to drive sales. These are not habits are rituals. These are often essential strategies in managing toward fiduciary responsibility in category management.
Often the biggest barriers to price optimisation that you see, fall into 2 areas. Firstly change management as it relates to how the merchandising teams feel about trusting the optimisation and data science behind the recommendation. Secondly the time lag between a recommendation being made at head office by the merchandising team and it being executed in store — often this can be at least 48 hours. Contrast this with an online retailer who can execute instantly — Amazon has been seen to change prices for some products multiple times with in single day.
The price friction is real! Previously, retailers relied on establishing stores in prime physical locations to secure a larger customer base, but with the newer era of the digital revolution, focusing solely on retail location is no longer an option. As a result, retailers’ pricing has become difficult.
Additionally, formulating and analyzing a pricing strategy, positioning, and focusing on value creation for customers is not easy. Moreover, with multiple related and substitute products available for a product, modern pricing has become even more intricate. Therefore, I believe, instead of playing with the “price” retailers should focus on “demand creation”. If a product fails to meet the required demand levels, discontinuing the product appears to be the right solution.
Of course underperforming products are candidates for discontinuation. This has always been true, but the forms of “pricing friction” as described here have relatively little bearing on those decisions.
Retailers are extremely thoughtful about how they implement price changes because of the message that sends to shoppers, a.k.a., “price image.” Too-frequent or illogical price changes engender mistrust. Think of a store brand product priced higher than its branded equivalent. Or various sizes of the same sweater priced differently.
For this reason, price optimization decisions are often constrained by rules programmed into their pricing tools. At one extreme end of the equation are state pricing laws, such as for tobacco products. Another example might be relative prices between economy, mainstream, and premium items within the same category. And yes, some retailers maintain rules for price-endings. Once the rules are obeyed, there can sometimes be relatively little room for demand-driven price optimization.
Absent from the research cited here are the “interaction effects” that occur when retailers use price to shift demand from one item to another. When a store runs a hot price on steak, its ground beef sales may decline that week – a so-called “cannibalization.” At the same time sales of steak sauce might rise a a bit — a so-called “halo effect.”
The well-documented concept of “price sensitivity” describes how price changes on some items may have less or greater influence on sales volume. This leads to a margin calculation that can guide some pricing decisions. Of course, some shoppers are more price sensitive than others, too.
Retailers with loyalty programs are turning more toward “personalized pricing” as a means of delivering attractive deals to valued shoppers without altering posted every-day prices. The offers are often delivered within the digital circular or shopping app.