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Commodity Price Increases — Playing This “Forced” Hand

August 3rd, 2011 | Posted by Guru Raj in Retail

Wide-spread commodity price increases are being reported with greater frequency.  Companies are now not just increasing prices, but doing so in a very public way (e.g. Clorox, Dunkin Donuts) in order to allay investor fears that their profits will be wiped by the squeeze between  commodity prices and consumer prices (e.g. Newell)

If we were economists, we could debate the root cause (e.g. monetary expansion) of this problem, but we have more practical and urgent problems to solve.  Let us also ignore the investment related tools (e.g. “buy forward”) for dealing with commodity prices for the moment and agree that ultimately, increases in commodity prices will force changes in consumer prices.

So, the question du jour is … What’s the optimal way to pass commodity prices onto consumers?  Are there tactics that will be more effective than others?

At first, it seems as though there are only a few ways that increased commodity prices can be passed through:

  • Price increases of goods being sold
  • Decreases in package size or unit count
  • Decreased trade-spend and promotional support
  • Changes to formula or materials

But thinking a little deeper,  it’s clear that there are actually a multitude of possible tactics:

  • Price increases of goods being sold
    • Increased differential pricing by product characteristics
    • Increased differential pricing by store or market characteristics
  • Decreases in package size or unit count
    • Increasing discounts for larger packaged goods, while simultaneously increasing the price of smaller packages
    • Increases in the price, units, and discount offered through bundles (encouraging customers to trade up)
  • Decreased trade-spend and promotional support
    • Re-deployment of marketing spend to most effective levers or those with clear ROI indications
  • Changes to formula or materials
    • Changes to packaing or presentation

In our work with leading retailers, we’ve come to appreciate that successful pricing actions have a few common characteristics

  1. Try something early: In general, the fears about raising prices are unfounded.  We’re not suggesting that you should lead your sector in price increases, but prudent retailers will test the waters early in order to accurately measure how consumers will really react.  Typically, you don’t have to publicize it, and you don’t need many stores or markets.  This information is critically important and more than a few times, early tests revealed that items were underpriced and increases could be passed on without detrimental effect.
  2. Iterative and staged application:  Rising commodity prices are nothing new and are never so urgent that they have to be dealt with immediately.  Smart retailers stage the way that their pricing initiatives roll out (some stores get it first and some stores are held out of the initial change) so that each increase can be accurately measured against doing nothing.  In this way, retailers rapidly build up a repository of which tactics are effective, with which products, in which parts of the year, etc.  This is a more complex than “raise prices everywhere by 3% all at once” and is the true silver bullet that allows the best retailers to navigate the murky, and hugely important, pricing decisions.
  3. A differentiated approach: We’ve often observed that no initiative is uniformly successful or unsuccessful.  This is particularly true for pricing related decisions.  Goods vary greatly in perception, need, interchangeability, etc.  Similar variance exists at the store and market level.  In the retail business, there’s a strong argument for KISS, but uniform pricing decisions are almost always sub-optimal.

As you may have guessed, our advice for pricing is nuanced, but, with a bit of planning, is not much  more complex than what most retailers are already planning.  You can read whitepapers about how to put these ideas into action on our website.

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