Why better understanding of price vital to drive profits – column

Food manufacturers operating across Europe, faced with differences in how sensitive different markets are to price, need to develop innovative pricing and promotional strategies to win, Dr Anthony Graham, IRI’s executive vice president of international solutions and innovations, argues.

Pricing is the simplest and most effective lever to pull to optimise margins – but manufacturers need to know when and how far they can heave.

A 1% increase in price can lead to overall profit increases of 10-20%, depending on the EBITDA margin of the manufacturer. However, getting pricing wrong can have a negative impact on the brand and even lead to delisting by the retailer. Knowing which prices to increase, which to reduce, which items to promote more aggressively, and how that should vary from country to country, is critical to driving profitability for manufacturers.
 
The relationship between price and volumes is well-established in economics theory. It is classically measured by looking at how sensitive demand is to price change. Products highly sensitive to changes in price are considered to be ‘elastic’, whereas those where price has a limited impact on volumes are considered to be ‘inelastic’.
 
It is not just products that can be considered to be elastic or inelastic – customers are too and, ultimately, so are countries. Last year, IRI conducted research in Greece looking at price elasticity in a number of countries in the EMEA and APAC regions.
 
The research revealed there is a distinct difference to how sensitive are markets in northern and southern Europe. Countries such as Italy and Greece are much more price sensitive than their northern European counterparts, including France, the UK and the Nordic markets. Perhaps unsurprisingly, out of all regions, northern Europe, the most developed, stands out as the least price sensitive.
 
Given the difficult economic situation over the past few years in many southern European countries, and particularly in Greece, it is no surprise shoppers there have become price sensitive rather than brand loyal, willing to try new products if they are cheaper.
 
To put the situation in Greece into context – it is a relatively small economy, with GDP that accounts for less than 0.25% of world output. But it has suffered more than most, with unemployment at 20% for the last six years and on the edge of deflation. Real output has fallen by 25% since 2008, around the start of the recession, which is significant as, across most countries, there is a correlation between GDP per capita and price sensitivity.
 
So how can food manufacturers make the right decisions over their pricing and promotional strategies in these different markets?
 
If we take pricing, manufacturers can make strategic pricing decisions by better understanding the relative price of their product and its elasticity. Let’s look at a couple of examples.
 
A product – let us call it A – is priced below the market and is price inelastic. This means that price can be increased, without impacting sales volumes: a win-win for both the manufacturer and retailer alike.
 
Product B, however, is priced below the market and is highly elastic. These products are often the battleground for retailers and could form part of their Key Value Item (KVI) strategy. In this case, retailers will be keen to look at Every Day Low Pricing and/or volume-based deals to be particularly competitive. However, not all items in this category will be KVIs and it is important to know where your product stands to reduce the risk of de-listing.
 
Manufacturers need to know how ‘transferable’ a product can be. In other words, if a product was delisted by a retailer, would the sales for this item switch to another product on the shelf, or would the customer just not purchase anything else? Armed with this sort of information, the manufacturer can determine how critical their product is to driving incremental sales for the retailer.
 
The prospect of range rationalisation is a serious consideration for manufacturers, given many major retailers have streamlined – and continue to do so – their offer of brands. Manufacturers will need to collaborate more with retailers on pricing and promotional strategies to help ensure their products are differentiated and kept on the shelf at the right price for the right market.
 
Manufacturers need to understand the impact of pricing, promotions and product transferability on their sales performance. This means creating the right price point for a product in the first place but also looking at how changes in pricing might impact demand for that product within a particular country.
 
The savvy supplier runs ongoing modelling across all their categories to ensure they continue to make the right pricing decisions, keeping their fingers on ever-changing markets.