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Determining the right pricing strategy
The right price should: cover your costs, make you profit, portray the value of your product, and continuously attract more customers. The first step to maintaining this balance amidst the uncertainty of inflation and other contributing factors to cost changes is to develop a dynamic pricing strategy.
Successful FMCG product pricing strategies start and end with one key concept: price elasticity.
Price elasticity measures how a change of price will affect the purchase of your product. The more elastic your product is, the more likely customers will jump ship and find alternatives when prices rise. The more inelastic a product, the less likely shoppers are to purchase alternatives when prices rise.
To measure price elasticity, you need to have two price points, the corresponding volumes sold and the period of time in between.
The formula for determining price elasticity can be applied to many data levels: category, brand, product, or SKU.
The result from this specific example tells us that this particular product has high elasticity, and that for each 1 point of price increase, a loss of 2 percent of volume will likely occur; and the reverse is true; thus bringing the understanding of your products’ price elasticity amongst the first things to consider when re-visiting your pricing
The equation:
(% of change in volume/quantity demanded) : (% of change in price) = elasticity ratio
An example:
(80 – 60) : (10 – 20) = 20:-10 = -2 elasticity
With the right data partner, you can take your strategy to the next level with your brand’s “elasticity split.”
The elasticity split describes the two potential outcomes of the loss in volume indicated in the ration above:
- ‘Own’ elasticity scenario – which is depends on your level of brand loyalty. When a certain SKU increases in price, customers will still want to buy within the same brand but will switch to another SKU. In other words, internal competition.
- External elasticity scenario – when prices on your product rise, customers would look at a competing brand
It is very important to keep in mind a product’s seasonality, and any promotions, when measuring elasticity – your results can be misguided without accounting for these factors. The best practice is to measure your elasticity over the course of a full year to account for all abnormalities – meanwhile noting the impact of “regular shelf pricing” versus “promotional pricing” and any possible impacts from competitive actions.
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What are your greatest challenges right now? What is your go-to solution when faced with a financial crunch in your P&L? Do you consider altering package sizes, increasing prices, consulting data, or simply trusting your instincts?
Review your pricing strategy with these key points in check
The umbrella pricing approach will lose customers
The concept of elasticity applies to each individual product and SKU.
This means that if costs of raw materials increase, and you need to make up for it, applying the same percentage increase across your product line could be the reason previously loyal customers don’t come back anymore.
Instead, apply increases individually and only where necessary. This gives customers a chance to respond within the “own elasticity” scenario.
Prepare for all competitor reactions
There is a total of five ways that a competitor can react in a price-increase scenario:
Scenario
1
They increase their prices first
This is the ideal situation, as it gives you and your team a chance to evaluate.
- Should you follow suit?
- If yes, should you match the price or go lower (more on this in the next point)?
- Should you wait to see consumer reactions to their price increases and then level up?
Scenario
2
They wait you out
This is less ideal because they are willing to take a loss and check the first consumer reaction to your pricing before making a move. You won’t be going blind, though, considering you have the right information about your product and category elasticity.
Scenario
3
They follow suit with price increases
This is another ideal scenario, where all brands within the category level up almost at the same time, on the same level, keeping the competitive grounds the same. It will be up to the customer to continue with buying in the same volume or not, regardless of brand pricing. This could also serve as another opportunity to innovate.
Scenario
4
They follow, but only halfway
This is where you will need to play up either your promotions, availability or review your portfolio to possibly include a new SKU.
Scenario
5
They price even lower
This is a strategy that only a few can afford to do, and the purpose is clear – to gain your market share, and then increase their prices.
Find opportunities to innovate
In this study NIQ found that shoppers will always look for functionality first when deciding on a product. What that means changes per market and per product, so discover what it means for you.
Brand loyalty is at an all-time low, and shoppers will go the extra mile to find the product that works best for them. Here lies an opportunity to have a new look at what your portfolio and individual products can offer more — in short, a chance to innovate.
When to choose which measure to go with
In the scenario that your product’s elasticity allows for a higher increase than your competition, consider carefully opting to go for your product’s maximum. If matching your competitor’s pricing affects your revenue stream enough to cover rising costs in time, that would be the favorable approach.
If the competitor has increased their price points beyond your product’s elasticity measure, always stick to your product’s scoring. In this case, you give your competitor’s customers a new advantage in choosing your product (see external elasticity in earlier section), and you avoid losing the market share you worked hard to gain.
When yours is the new product on the block…
If you’re the new guy on the block, and need to know your elasticity, first understand your category elasticity. Then, if you have not changed the price of your product and don’t have that data, you could measure a close competitor’s elasticity. Otherwise, determining elasticity and optimal pricing is a process of trial and error.
Next…find the right pricing strategy (or strategies) for you here.
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