Inflation related price rises are being felt throughout the supply chain. This eventually finishes with the consumer, who is seeing a rapid rise in the cost of living and more significant pressures on their income. For businesses, price is at the top of the c-suite agenda if it isn’t already. It will touch every facet of the company, so leaders must be armed with the tools and answers to bring to the table as we see the impact on shoppers, channels, sales, products and marketing.
As outlined in our first article of the series, will see several significant changes in how the price will impact consumer behaviour. Expect consumers to start downtrading because of the rising price table, i.e. all products in the market increasing in price from the lowest price tier up. Shoppers will scrutinise the value delivered by products and services, and they will be forced to make choices as the dollars in their pocket decrease in purchasing power. The “good”, “better”, and “best” strategies may see a move to “good enough” in many categories as shoppers decide where they can better bang for their buck. The impact of this is that pricing will be driving category dynamics for at least the next three years, leading to massive volatility in prices and buying behaviour.
Looking beyond historical data
Those companies only using existing econometric pricing models to try and plot their way out of this are likely to find the going tough. Most companies last had to think about long-term price volatility driven by multiple factors for a very long time. That’s why the models they are looking at based upon relatively small historical price changes and outcomes in a stable environment will provide little insight. Consumer goods manufacturers have been reasonably controlled in price increases, relying on promotional elasticities to drive volume. The change is that there is a real need to understand price elasticity and profitability more than ever, and that understanding will only be found outside historical data.
Experimenting with pricing models
Companies need to deploy models that allow them to examine price points and elasticities that are moving way beyond the regimented increases of the past. This means exploring more experimental pricing models that can incorporate forward-looking pricing dynamics. The best way is to utilise a combination of econometric and choice modelling approaches. Choice modelling approaches are a sophisticated way of replicating market behaviour in a scenario environment and allow for simulating complicated pricing scenarios and understanding the econometric constraints within which these decisions occur. Government-regulated categories, such as tobacco, alcohol and fuel, have been dealing with markets with rising price tables for some time and have utilised similar models effectively to predict consumer response. By taking similar approaches, companies can set themselves up for success.
More on the pricing mix
These pricing models allow us to stretch the price continuum beyond the usual parameters and build in the market constraints of distribution, channel mix and marketing. This leads to accurate predictions of the impact of pricing changes, but more importantly, to understand this within the dynamics of the competitive market. Pricing strategy isn’t an isolated exercise, but one where companies will have to react quickly to changing market and competitive pressures. Models dealing with this complexity will give a more significant advantage to those who employ them. Knowing the price elasticity of your products is helpful; knowing your cross-price elasticities with your competitors is essential. Models that allow for scenario planning, i.e. if Competitor X moves brands Y and Z to this price point, we should go to these prices, will be core to winning in this environment. This is where tactical pricing and promotional mechanics come into play, but this must be integrated into the larger long-term strategic price model.
Tactical promotional pricing
Additionally, the effectiveness of promotional price points is intertwined with the shelf price and relative competitor price in which they compete. Companies can maximise efficiency and payoff by combining tactical and strategic pricing models. Consumers can quickly learn to game the system if we reach promotional price points too frequently, buying only when products are at these lower price points. Still, if this needs to be offset by increased purchase volume per household over time or an increase in consumers, it can severely affect profitability and margins. Short-term volume gains from tactical promotional price points can also impact moving to longer-term sustainable prices as consumers learn to see promotional price points as the “real” price.
Some choice modelling approaches can allow us to incorporate promotional mechanics and provide strategic and tactical pricing in a competitive environment but can be even more effective if combined with econometric modelling. This allows for scenario building supplemented with real-world factors. For instance, choice modelling approaches assume that market volume remains constant over time and that price redistributes that volume. By building in econometric modelling that determines impacts on the market volume as the average price for the total market increases and distributing that volume within the model, we can obtain a more accurate view of pricing effects in inflationary markets.
The ability of companies to rely on these types of forward-looking, dynamic pricing tools will be the most critical business success factor over the next few years. Companies that change will benefit, while those that don’t will see increasing competitive pressure exacting a financial impact.
Written by, Todd Eldridge
Director of Advanced Analytics