Retail 101: Part six with Mike Mauti
The Packer: This is Tom Karst, editor of The Packer, and I'm here this afternoon with Mike Mauti of Execulytics in Canada. Mike, good to see you.
Mauti: Good to see you, too Tom. Thank you very much for having me.
The Packer: Over many sessions we have been talking about Retail 101 and the many elements of how retailers get the job done. Today I wanted to visit with you about pricing.
Mauti: Sounds good, one of my favorite of the 4 P’s of Merchandising.
The Packer: For starters, what are the basic inputs that retailers use to set their retail prices?
Mauti: There are many variables used by retail merchants when setting a price. The first and probably most basic variable would be the cost of goods. Each product has a cost associated with it. That cost includes the amount paid to the supplier, plus other associated costs like transportation. To be profitable, the retail price will need to cover the cost of goods and include an amount over and above that cost. The differential between the retail price and the cost of goods is called the margin. Collectively, the total margin of all product sales must pay for all other business expenses and hopefully, if the retailer is to be profitable, have some profit remaining. But cost of goods is not the only variable that merchants will consider when setting the retail price. They will also review their competitor’s price position on similar items. It is no secret that there are different kinds of competitors, ones that focus more on price and ones that focus more on services. Depending on where a particular retail company falls on that spectrum, will determine which competitors are reviewed more closely. Now I do not want to give the wrong impression, just because a merchant is reviewing their competitor’s price position does not mean they will automatically match their price, but more times than not, they will use that competitive intelligence as guidance when setting their own retail price. And finally, the consumer also has their say. It is important to know how the customer is going to react to the price a merchant has set. Some products get a strong consumer response to an increase or decrease in price, these products are called price-elastic, while others get a weaker response, these products are known as price-inelastic. Knowing how the consumer will respond, which in turn will impact sales is another variable that merchants consider before setting a price. There are other variables, but these are the most basic.
The Packer: I find it fascinating that retailers keep tabs on the retail prices of produce in their competitor’s stores. How do retailers know what is going on with their competitors? Do they physically go into the store? Do they look at the ads? What does the process involve?
Mauti: Most retail companies will use a combination of sources. They may make their own observations in their competitor’s stores for time sensitive price checks but the majority of their intelligence will come from third party data companies.
The Packer: When you are talking about cost of goods, you have the spot market, plus produce suppliers often offer contracts locking in volume and cost? How do retailers balance both methods? And how valuable is the opportunity to buy produce at a low-cost during a down market versus the stability and assurances of a contract?
Mauti: In my experience it is best to maintain a mix of the two, for exactly the reasons you said. Having contracted volume will give a buyer the comfort level of knowing their cost. There is value to just knowing your cost, even if it is not at the bottom of the market. More importantly though, it gives the buyer the assurance that they will have product, because without product you have no cost to know and therefore no need to set a retail price. But a buyer also wants to participate when the market costs have hit a low point, to do this they leave a certain amount of their requirements available for spot market buys. By having a good mix of the two methods, a buyer can have a good cost and retail price while mitigating the risk of being out of product.
The Packer: This is pretty elementary, but what about pricing per pound versus per unit? Is there a trend in how merchants price produce? Which way is dominant?
Mauti: There are two schools of thought regarding pricing in produce. The one school of thought focuses on the consumer need for convenience which can be satisfied by purchasing products that are easy to pick up with complete knowledge of how much they will be required to pay for their produce. With unit pricing, consumers have that knowledge. In our current COVID-19 environment, for hygiene reasons, people have become more interested in packaged produce which lends itself to unit pricing. We might find that the lasting effect of the pandemic may decide the debate for us.
Nevertheless, the other school of thought focuses on the consumer need for fresh, high quality produce. This need can be satisfied by offering bountiful displays of fresh, loose fruits and vegetables that allow customers to pick the freshest products to satisfy whatever attribute they value. Produce sold in this fashion is more often priced by the pound. You will see more loose displays in the more service-oriented retailers. These stores cater to consumers that want to select their own produce, sometimes these consumers are referred to as foodies. I think it is still an open question on how COVID-19 is going to impact produce sold off loose displays. Will we see consumers gravitate towards more packaged produce, necessitating more unit pricing? Or will some consumers pick up where they left off pre-pandemic and demand loose produce again? This is a question my company will be monitoring closely.
The Packer: You alluded to a big display, does display size signal to the consumer the price of that product and give them an indication of how good that price is?
Mauti: There are plenty of different merchandising tactics that get layered on top of one another. Pricing happens to be one of the elements of the merchandising plan. If a store layers a hot price on top of a large display, which will more than likely be off shelf, maybe even at the front of the store, combined with a promotion in the weekly flyer, they will send a strong message to the customer that this product is prime for the picking. All tactics work together to strengthen that message, but pricing is as important as any of the others.
The Packer: As a customer I see prices on the displays, and I know they change from time to time. When are prices adjusted in the department, is that typically done overnight or is it done on the fly? Once a week or more often than that?
Mauti: Typically, it is done once a week, although emergencies might necessitate an off-schedule price change. And the task is completed either overnight or early in the day if the store does not employ a night crew. Either way it is best to be done when the store is closed or when there are few customers in the store. It can become a problem when the front-end systems are out of sync with the prices on display. With produce being a volatile department with respect to product costing, changing prices can be a bigger job compared to other departments. Although each department will generally change their prices weekly, it is not uncommon to see close to half of all produce items change price in a given week. Whereas, in the other departments, it would be a much smaller percentages of the assortment being changed weekly.
The Packer: What about for online produce purchases? How do retailers handle the online pricing?
Mauti: I’ve seen a few different strategies employed for the online business. For pickup or curbside services, online pricing is often the same as in-store pricing. The rationale for this pricing strategy is the customer is doing the expensive last mile delivery. In a delivery model, I have seen two pricing strategies. One strategy is to price online the same as in-store and charge a higher deliver fee, while the second strategy is to charge a premium for online products while charging a more modest delivery fee. Either way this model aims to recoup the cost of last mile delivery. One strategy uses pricing as a primary tool to recoup the cost, while the other uses pricing to remain competitive and is more transparent with the cost of the service.
The Packer: Is it easy for a retailer to get a premium price for a premium product? Maybe it is a new variety or a brand known to pack superior quality.
Mauti: It is not always easy to do, but as you know, in produce more so than any other department, eye appeal really is buy appeal. If a retailer is offering a brand or variety that is known to be better than anything else available on the market, and they present their best foot forward by maintaining the product’s superior quality, then often times, they can get that premium price. Now stores don't often do this, but if a store were to have a lesser quality product up against a higher quality alternative with a 50% price premium, the high-quality product would outsell the low-quality product almost every time. The produce consuming public is just not interested in low quality fruits and vegetables when higher quality is available. It is just that simple. Asking a customer to pay an extra 50 cents or a dollar for something they will actually use is not a big thing to ask.
The Packer: Pricing on organic produce is also intriguing. Of course, we always expect organic to have a premium. Is the premium changing for organic over time? Is the premium based on a set percentage?
Mauti: I have not seen the organic premium change a whole lot over the last several years across the produce industry. Certain categories may experience a shrinking premium as their popularity along with supplies increase, leading to better yields from the production end. In these categories, pricing will start to get closer in line with their conventional counterparts. But overall, as more product is being brought into the organic arena all the time, the overall basket maintains a similar differential. If I were to guess we will probably see a similar premium persist, at least for the short term.
The Packer: Is there a number out there as the typical premium like 30% . If so, what kind of premium does organic have?
Mauti: We've completed studies that show the premium to be more like 50%. I think if the premium ever dropped to 30%, that would be a big boon for the organic industry. Of course, that premium is made up from a wide range of products, each with their own individual premium. For example, you might see products like strawberries or packaged salads with comparatively low premiums while other products, with less established organic programs are priced double to their conventional alternative.
The Packer: It seems that the North American economies and around the world are going to be under pressure forcing consumers to be on tight budgets. What does that mean in terms of pricing produce? Do you suspect retailers will need to be more competitive, fighting for a shrinking wallet?
Mauti: That reminds me of the he old adage ‘everyone needs to eat’. With produce being such a basic commodity type category, it will likely enjoy strong demand for the foreseeable future and the industry has always proven capable of supplying that demand. The early portion of the pandemic has not deviated from this norm. If we haven't seen a lot of inflation or deflation in the produce category yet, I suspect we won’t in the near future either. If I were to guess, I would say we can expect inflation to be similar to historic averages, roughly 1.5% to 2% annually on the entire department.
The Packer: So even though we have seen prices stretch out a little bit, you don't expect inflation to really be an issue?
Mauti: I don't think so. it's obviously very hard to predict these sorts of things. But from what I've seen, I don't think so.
The Packer: When pricing at the grower level is at a level where they are not making money, is there any role for buyers to help the grower become profitable?
Mauti: In my experience, the laws of supply and demand rule. Every commodity has its price. If price moves up, demand goes down, in most situations. And normally, the reverse is true, if you move down on price, you can expect increased demand. It's basic economics. In that regard, produce is not special, you’ve got to price it to move it. However, produce is special in that if a particular product is not profitable at the price it needs to be at, then growers can more easily move out of that commodity and into another. Other product categories cannot switch gears nearly so easily. Often, you'll see wild cost swings one year to the next, I'm told by my grower friends this happens when some growers move out of unprofitable commodities and into more profitable ones. In this case, last year’s low-cost commodities become more profitable for the growers while the high cost ones become less profitable because of changes in supply in the marketplace. To a degree, this makes profitability self-regulating over the medium or long term.
The Packer: How does the weekly flyer create incremental sales and tonnage for a category?
Mauti: Nice segue Tom, you are previewing our next topic, promotion. Promotions are a key merchandising tactic capable of growing sales, particularly when the right product makes it to the front page of the weekly flyer. Going back to the idea of layering several merchandising tactics together, you may recall promotion is one of the layers. I am sure you have seen many front-page ads on cherries. More likely than not, that ad will feature a hot price and the cherries will be supported in store with large displays, possibly off shelf and in a high traffic area of the department. And if the timing is during peak season, the quality will probably be the best of the year. So, the ad drives feet into the store and once there, customers see a bountiful display of the year’s highest quality cherries at a hot price. Combined, these layered tactics will drive significant volume, particular for a product like cherries that can deliver the largest single week sales performance of the year. The question is, did the promotion create the sales? I think the answer is the promotion is partially responsible, along with the hot price, the high quality and the bountiful display in a high traffic location.
The Packer: Mike, we appreciate your insight on pricing. Any other last thoughts about this topic?
Mauti: Sure Tom, one important element of pricing is that it is more than just a dollar amount that a customer is required to pay. The price can be used to send a message to your customer. After all, price is a message, in fact, it is perhaps the first message that the customer notices when they see a product display, aside from the product itself. Often, the message a merchant is hoping to send by the price is ‘this product is worth whatever amount of money I'm asking you to pay’.
To that end, there are many ways to convey that message. Rounding to the 99 is a pricing tactic that a lot of retailers use. When you think about it intuitively, it is surprising that when presenting a price like $1.99 to a customer, many will think $1 and change. Even though it is clearly almost $2, many will still view it as a buck and a bit. This prompts a purchase because these customers view the product as being worth more than what they are being asked to pay. It is an age-old tactic that has been used for decades, maybe even for centuries. But rounding to the 99 is not the only tactic used by merchants. Many tactics use volume discounts to send a ‘buy more and save message’ to customers. A multiples tactic, for example selling three units of a product for $5 can send that message. This price tactic suggests that a customer will be getting a better deal if they buy more than one. This tactic can even work if there is no further discount for buying multiples. Another example is to set a volume limit on a price such as buy two for $1.99, with a caveat that any quantities over the limit will have a price of $2.99. With this pricing tactic the merchant is conveying that $1.99 is such a hot price, the store cannot afford to sell more than two to any one customer. Sometimes price can be used to send an entirely different message. For example, the price can tell your customer that a product is superior to other equivalent products on the market. Price can be used as the proof of its superiority. You might see this more frequently with luxury items but you also might see it with exotic or premium produce where the value of the product is tied to its price, hence; the higher the price, the higher the value. As you can see, there are many useful marketing messages that the price can convey to a customer. For this reason, price should be viewed as an important part of the 4 P’s of Merchandising. It is not just a means of collecting revenue from your customer.
Thanks again Tom, I look forward to our next discussion on Promotion.
To read more from Mike Mauti, check out these articles:
Retail 101: Part One with Mike Mauti
Retail 101: Part Two with Mike Mauti
Retail 101: Part Three with Mike Mauti
Retail 101: Part Four with Mike Mauti
Retail 101: Part Five with Mike Mauti
Check out this recent video interview with Mike Mauti: