Redefining the Traditional Thinking Around the High-Low Pricing Strategy
Pricing is the single most important lever a retailer has to pull. Retailers have spent decades defining price and promotional strategies and approaches. However, with the digital explosion, hyper-competitive landscape, and a price-sensitive shopper, many retailers are finding that the traditional approach to pricing strategies no longer apply in today’s newly defined retail environment.
Historically, a high-low pricing strategy meant that retailers would raise prices for high-demand items and then lower them when the items lost popularity. The retailer would then push to clear out the item. This is also referred to as penetration pricing where retailers introduce items at a higher price to recoup costs and then would slowly reduce the price down as the items lost their popularity.
Often the retailer would apply a high-low strategy in a situation where there was limited availability. In this case they would temporarily raise the price in hopes that they can entice shoppers to pay the higher price for popular items low in supply. However, todays shoppers are aggressively challenging historical thinking and retailers are finding it more and more difficult to use a high-low strategy effectively.
For example, let’s take the theory of supply and demand. Retailers used to be able to raise prices when there was limited availability and shoppers were more than willing to pay those higher prices to have the item. However, today’s shoppers defy this logic. In fact, in a recent Forrester study commissioned by Revionics, shoppers were asked what they would do when retailers raise prices on items due to limited availability. Close to 60% of shoppers said they would wait, not purchase the item, or purchase from a different retailer. That’s a lot of lost or delayed sales – and a huge risk of losing a longtime loyal customer.
Today a high-low pricing strategy is typically applied to items where the price is dropped and heavily promoted for a limited time to drive traffic into the store, increase shopping trips and expand baskets. However, today’s shoppers have become incredibly price sensitive, have complete price transparency and have grown to expect discounts. Yet retailers often promote the wrong items and fail miserably when it come to identifying the optimal price and offer type. Adding salt to the wound, they miss the mark significantly when it comes determining proper combination of promotional vehicles (i.e., circular, end caps, mobile, etc.) to reach the shopper.
Sadly, case studies have shown that on average 85% of the profit from promotions are generated off the top 30% of items. 90% of the revenue comes from the top 30% and one-half of the profit and one-third of the revenue is due to demand transference from other items. Overall, 95% of promotions cancel each other out. In the recent Forrester study referenced above, it was shocking to learn that 52% of shoppers stated they received promotions on items for which they would have been content to pay full price. For a very large specialty retailer, it was identified that they could save $60 million in saving simply by stopping some of these misguided promotions.
Retailers continue to miss the mark when it comes to applying the high-low strategy and understanding which items will drive traffic to their stores while also allowing them to protect their margins, grow baskets, and provide overall fair pricing that drives shopper loyalty.
It’s no secret that today’s shoppers are in the driver’s seat. The first step toward a successful high-low pricing strategy is understanding your shopper and their views around pricing and promotions. An earlier Revionics-commissioned Forrester study also highlighted that only 9% buy at full price, 5% buy at the first price they see, only 17% said they would buy at the lowest price and another 17% demand price matching. If it’s not the highest or the lowest price, what do shoppers say they want? Shoppers want a fair non-arbitrary price and according to the study, 78% of shoppers’ trust data science more than the retailer today to give it to them.
The retail industry today has an overabundance of product selection. Shoppers today won’t tolerate prices they view as unfair. They are also very patient. They won’t be forced into paying prices they do not view as fair. In fact, the research highlighted that 56% of shoppers said they would wait up to 6 months and 31% shoppers are willing to wait as long as it takes to receive a fair price. It’s no wonder promotions continue to fall short and retailers struggle to maintain their market share, let alone increase it.
Price remains king in the eyes of today’s shoppers and without a doubt is the primary driver when determining where to shop. This fact is no great surprise for the off-price discounters. However, it was eye-opening to learn in the study that shoppers rated price as the single most important factor when shoppers are deciding where to shop across off-price discounters, grocery, apparel and DIY. It was also surprising to see Quality rated #2 across those verticals including off-price discounters. Shoppers rated Price and Quality far above other factors the study asked about, including variety, service, speed, and convenience.
So, what are retailers who want to practice a high-low strategy to do? First, they must recognize that there is a difference between penetration and everyday high-low strategy. The days of the highest prices being placed on the most popular items are gone and in reality, it may be the other way around. You may need to sacrifice margin for these very popular and well-known items on an everyday basis to maintain a specific price image and competitive position, while you increase prices and pick up your margins on other items within your assortment where shoppers will tolerate price increases and still view your pricing as fair.
Shoppers today are price sensitive, but they are only price sensitive to a handful of items within your assortment. These items are grouped into what are called Key Value Categories (KVC) with individual Key Value Items (KVI) within them. Most retailers fail at accurately determining their KVIs, which is very unfortunate since these are the most critical items. They determine your shoppers’ price perception or image of you. If you get these wrong, you have the greatest risk of alienating and losing your shoppers.
KVIs are often your traffic drivers but also warrant the strongest competitive strategy. Shoppers have a high price sensitivity when it comes to KVIs, meaning the price is very inelastic with no room to raise it. It’s here that you will most likely need to give up the most margin. However, the rest of the assortment is full of items where the shoppers’ price sensitivity is very low and where you have greater price elasticity and ability to raise prices and recover margin. Implementing a well-informed KVI approach ensures your pricing will continue to be viewed as fair by the shopper. This is where price optimization and the machine-learning science inside it can come into play. The science can rapidly measure and monitor shoppers’ prices elasticities across your assortment and recommend price adjustments that shoppers will view as fair, while also achieving your strategic and financial objectives, including protection and growth of your margins.
Advanced -price and promotion optimization has embedded AI (machine learning) science that can determine which items are truly your KVIs and align to a strategy to support them. It understands which items can play the role of margin enhancing, basket driving, traffic driving, and many other strategies and will align your pricing to support those strategies. It understands how shoppers respond to different offer types, promotional vehicles, channels and touchpoints.
Retail today is hyper-competitive, there is an overabundance of options, and shoppers are very price sensitive and well-informed. To shoppers today, a low price doesn’t mean it has to be the lowest anymore. It means that it needs to be a price and offer that shoppers view as fair and non-arbitrary and they are unforgiving when you get this wrong.
At the end of the day, pricing based upon yesterday’s pricing concepts doesn’t apply today. There will always be high-low pricing. Price and Promotion optimization embodies this concept and can help retailers execute it flawlessly, creating a win/win situation for them and their shoppers. Shoppers receive fair price and promotional offers and retailers achieve their strategic and financial objectives.
It’s a new ballgame with new rules. To keep up with the rules of retail today, retailers must trade in their old gear and take advantage of the major advancements that have been made around pricing science and technology to keep them relevant, competitive and in the winner’s circle.