How to manage product cannibalization in retail to turn it from a negative outcome to a strategic driver of shopper behavior.
Defining product cannibalization
Product cannibalization, also known as demand substitution, happens when similar products compete against each other for the same sales. People most often think of cannibalization in the context of a new product being introduced and taking sales away from an older item in the same portfolio. However, this isn’t the only case. Product cannibalization in retail can occur from other events, including promotions and discounts. Let’s consider this example scenario.
Say you have signed up to run a 10K, and you need to start training. However, your running shoes are worn out, and you need to break in a new pair before the race. As a typical shopper, you will follow the usual buyers journey – Start the decision process by looking at options online or visiting a sporting goods store. Then explore the various brands and styles, comparing prices and looking for those within your price range. Next, you’ll continue to narrow the search based on styles and colors that work for you.
Now having a more select group to choose from, the decision to choose “the” shoe will be heavily influenced by what triggers the retailers provide. What is the difference in price across the various brands you like? Is there a promotion on your preferred style? A discount may make you more inclined to purchase, even if you were willing to pay full price. On the other hand, if a premium style is discounted, you could feel like you’re getting a better deal, and may be willing to spend more to get the higher value product. This is an example of demand substitution or product cannibalization.
Factors that drive product cannibalization in retail
As you would expect, some products are more susceptible to product substitution than others. While there are many factors that come into play, some outside of the retailer’s control, these are a few of the main ones below.
- Features and functionality of the product: Products with a lot of features tend to have lower cannibalization, as it makes the item more unique and harder to substitute.
- Brand loyalty and brand preference: Brand with high loyalty will have low product cannibalization in retail. This is also typically true of stronger brands where consumers are willing to pay a premium. However, it can vary significantly by category.
- Price point: Higher price point items tend to have lower substitution, as consumers expect to pay a premium and are less likely to comparison shop
- Consumption patterns: For example, we have observed that cat food has a lower cannibalization than dog food
What to do about cannibalization
Typically, product cannibalization in retail is considered a negative outcome. And you can see why; if one product merely takes all the sales of another, you now have more inventory but the same amount of sales and revenue.
However, not all cannibalization is bad. While there will always be risks involved, sometimes situations with demand substitution are necessary to help accomplish strategic business goals. If you are too focused on avoiding product cannibalization all together, you could miss out on these opportunities. One of the most common scenarios would be introducing a new item that helps you appeal to a different target or extend your brand. For example, in the last several years, many luxury designer brands have introduced lower-priced product lines. This likely cannibalized their high-end sales some, however they can now tap into a different market that couldn’t previously afford their price tags. The key here is capturing enough new market that your overall sales, revenue and customer base increase.
Product cannibalization can even be used as an analysis tool. If you are looking to optimize a product portfolio, controlled product cannibalization can be helpful for identifying which items in the assortment should be replaced, removed or better promoted to achieve greater results.
Managing product cannibalization
Pricing is the best way manage the impact of demand substitution. If a retailer understands the variations in shopper behaviors across their product assortment, then they can promote the right product at the right discount. This provides a trade-up incentive to the shoppers, i.e., a better value story so the shopper spends more. If the selling price for a category or brand does not decrease as much as the promotional discount, the shopper is trading up and spending more per unit during the promotional period. This is the behavior you want to try and drive as a retailer.
On the other hand, if the category or brand selling price decreases about the same as the promotional discount, the consumer has incentive to take the promotional discount on items for which they were willing to pay a higher price. As a retailer, you want to stop this shopping behavior, as it transfers demand to the promoted items. That results in shoppers taking the discount on the promoted item, when they would have been willing to pay a higher price for non-promoted items.
Again, let’s put this into a real-world example. Take a look at the chart below. It shows us that baby wipes have a higher substitution than baby foods. This tells us that shoppers do not substitute the purchase of “other” types of baby food, even if they are on sale. However, if the wipes are on sale, they would purchase whatever the discounted brand is.
Another interesting observation when can learn from is that organic baby food has a higher cannibalization than other baby food. People who buy organic baby food are more likely to switch brands, as long as the cheaper item is also an organic product. These are the kinds of consumer behavior insights you can glean from product cannibalization to help guide your pricing and promotion decisions.
However, understanding the shopper decision matrix is not straight forward. It requires deep understanding of the shopper needs, and the relationships between different brands, styles and products. These insights empower merchants to drive the shopping behaviors that promote trade-ups. Your best bet to analyzing these data points and managing cannibalization is going to be a powerful pricing solution like Revionics.
Leveraging machine learning
Revionics uses machine learning algorithms to determine the demand substitution index within each category. This index, as shown above, provides insights into which category has a higher propensity of demand substitution and how much of the incremental demand cannibalizes sales from other products. This data assists you in making informed pricing decisions based on your customers’ behavior, and helps predict product cannibalization outcomes before you make a pricing change.
Retailers do have some control in determining the substitution behavior within their products by controlling their assortment. With the use of AI and ML techniques, Revionics enables retailers to drive shopper behavior which is a win-win for the shopper and the retailer. Without these insights, retailers end up promoting the wrong items which results in margin leakage and lost revenues.