Pricing Elasticities: CPGs Renewed Focus on Pricing
Despite the availability of voluminous shopper data and advanced analytics, many consumer packaged goods (CPG) companies leave revenue on the table by failing to optimize the link between product pricing, product development and marketing. Marketers rely primarily on elasticity as the primary factor when setting pricing, and think less about how to move the curve by altering the value shoppers perceive. Understanding the myths that exist around price elasticity and charting a new path forward will unlock new revenue potential for manufacturers and retailers alike.
Last year, nine of the 10 largest CPG manufacturers announced price increases, citing inflation and margin pressure. Many of these increases reflect pent-up trends dating back to the last recession, when ingredient prices rose, but manufacturers were reluctant to raise prices, concerned about losing significant market share.
However, raising prices is just one piece of a larger pricing strategy pie. Revisiting pricing best practices includes being mindful of elasticities, since pricing increases alone are unable to fully offset margin losses related to rises in underlying costs. Without a doubt, CPG companies leverage the data and analytics available today to understand price elasticities and how to use elasticity coefficients in decision making. They will look to elasticities to identify where price increases are possible and by how much.
Unfortunately, using elasticities in this way leads to suboptimal results. Elasticities by definition are a valuable supplement to the decision-making process, but are not a substitute for actual pricing strategy. They only serve as a starting point to sophisticated pricing. In an optimal scenario, marketers should set pricing based on financial, branding, positioning and competitive considerations, and then apply elasticities to determine if the strategy is feasible. If the strategy is feasible, then marketers can proceed with confidence. If not, the process then refocuses on answering a series of questions, the two most prominent of which are:
- What does the elasticity have to be to create a more acceptable tradeoff in volume?
- How do I change it?
The first question is relatively simple to answer by adjusting the branding, positioning and other variables listed above. The second question is the harder nut.
A real-world example is helpful here. A home healthcare premium product manufacturer had a small but loyal customer base for one of its products, but the vast majority of shoppers were turned off by the product's high price. Marketers traced this significant price elasticity among non-triers to the lack of appropriate claims on the packaging. It contained no points of differentiation or the key benefits that the loyal customers mentioned when surveyed. Fixing this situation transformed the product to become wildly successful. New messaging drove a willingness to pay nearly three times the original cost and greatly reduced the product’s overpriced reputation. As a result, sales grew 35 percent within the first few months of the campaign.
The opportunities to move the elasticity curve may seem endless, but turning to five key areas of behavioral economics can give marketers guidance:
- Attribute Priming: Identify and focus on the top features for which shoppers are willing to pay.
- Dominated Alternatives: Determine where a new product offering can make other product attributes appear more valuable.
- Irrational Value Perception/Anchor Effect: Anchor shoppers to a specific quantity or price point to increase stocking and lift.
- Mix Simplification/Assortment Curation: Cut back on unnecessary variety to improve consumer confidence and avoid purchase hesitancy.
- The Power of Free/Deal Effect: Raise price and bundle offerings, advertise new components as “free” or “extra value.”
Elasticities aren't going anywhere and remain a valuable part of pricing decisions, but they shouldn't fully drive pricing decisions. Price increases shouldn't be automatic, but rather one discussion that takes place when marketers continually revisit a product for factors such as marketing messages, benefit tweaks, packaging updates and more. Evolving opinions on the role of elasticities will unlock new opportunities to increase revenues, market share and customer loyalty in today’s unsettled CPG environment.
Ray Florio is a growth consulting partner at Chicago-based IRI, a leading provider of big data, predictive analytics and forward-looking insights that help CPG, OTC healthcare organizations, retailers and media companies to grow their businesses.
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