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The Chartered Institute of Marketing (UK) defines marketing as “the management
process responsible for identifying, anticipating and satisfying customer
requirements profitably”
Combined with the theory that [profit
= volume x (price - cost)] and that
Perceived Value = Benefits (both
emotional and functional) / Price,
this helps us arrive at three major
postulates of the pricing game.
• Pricing is central to profitable
brand management.
• The greater the benefits perceived
by the consumer, the greater the
price a brand can sustain.
• Reducing investment in perceived
benefits reduces value.
This also implies, therefore, that
pricing strategy cannot be set in
isolation and that the three major
areas of interaction with price,
namely, promotions, volume,
and profit must be carefully
understood.
Price and its interaction
with promotions
A brand’s strategy can be described
by observing the way its sales react
to changes in price and promotion
and the magnitude of their change.
These changes can range from
minor changes to major alterations
in off-take for the brand. Slotting this
interaction into four quadrants allows
one to arrive at four strategic situations:
1. High price and frequent promotions
(Hi-Lo) – when the sales change
significantly as the brand promotes and hardly change when the
brand changes price.
2. High price and low or no promotions
(Hi-No) – when the sales hardly
change as the brand undertakes
promotions and even when it
changes price.
3. Harvest price for profit – when
sales change significantly as the
brand changes price and promotes,
the strategy will depend on the
cost structure of both the brand
and the promotion.
4. EDLP – when sales change
significantly as the brand
changes price, but are relatively
insignificant when it promotes.
Price and its interaction
with volume
Price as a driver of volume
A brief understanding of economic
theory helps us better understand
the impact of price on volume.
Equilibrium between supply and
demand defines a product’s natural
price; when supply is greater than
demand, prices fall and when
demand is greater than supply,
prices increase to maintain equilibrium.
Econometric modelling applies
this theory to brand pricing
and by removing the effects of
promotions, media and seasonality,
measures the relationship between
historical changes in price andchanges in underlying volume.
This is commonly referred to as the
brand’s price elasticity.
The elasticity will be negative
i.e. as price increases demand
will decrease, and it is also seen
that this relationship is not linear
but depends on the percentage
(%) change. This implies that to
understand the impact of price on
profit one needs to know the
impact on profit per unit and on
volume sales.
Price and its interaction
with profit
Price can be seen as a driver
of profit
A price increase has traditionally
been the best alternative for
increasing profitability. The impact of
this on profit is especially magnified
if a brand’s current margin is low.
However, price increases are
more visible to consumers than
cost reductions and the reaction
of consumers to price increases
are the ultimate determinant of
its impact on profit margins and
profitability.
A clear understanding of consumer
sensitivity to a brand’s price and its
profit margin helps assess whether
price increases will generally be
profitable or unprofitable.
For instance, for a brand with a 20%
profit margin, a 1% price increase
will increase profit per unit to almost
21% – equivalent to a 5% margin
improvement per unit. In such a
scenario, volume sales would need
to decline by more than 5% for total
profits (profit per unit x # of units)
to decline. Therefore, any volume
decline less than 5% will mean that
the price increase will translate to a
total profit increase. In other words,
break-even would be achieved with
a price elasticity of -5 (a 5% volume
change for a 1% price change).
Performing this same calculation for
a range of profit margins allows us
to plot the break-even point where
for any given margin, if the brand’s
price elasticity is higher, then a price
increase will reduce profit, and if the
brand’s elasticity is lower, then a
price increase will increase profit.
A majority of brands have a price
elasticity of less than three, so in
most cases it is a profitable decision
to increase price – the brand has
to already command a very high
margin for it to be unprofitable.
It follows therefore that price
increases within reason increase
profit as well. This caveat of
increasing prices within reason also
reinforces the importance of the
current profit margin. Price increases
do, however, also decrease volume
depending on the brand’s price
elasticity. Therefore total profit will
ultimately depend on a combination
of a brand’s profit margin and its
price elasticity.
Conversely, price decreases
within reason generally drive a
decline in profitability.
The resultant increase in volume
may offset the decline in profit
but in this scenario too, the total
impact would depend on the
brand’s current profit margin and
its price elasticity.
Converting this into a scheme for
pricing strategy juxtaposes the
two essential parameters of price
sensitivity and profit margins to form
a quadrant that describes four likely
pricing scenarios. They are:
1. When the brand profit margin
is low and the brand is not
sensitive to changes in price,
consider a price increase to
drive profit as price reductions
will reduce profit.
2. When the brand profit margin
is low and it is very sensitive to
changes in price, review price increase or decrease for profit
growth.
3. When the brand profit margins
are high and the brand is not
sensitive to price changes, review
price increase or decrease for
profit growth.
4. When the brand is very sensitive
to price changes and has a high
brand profit margin, consider
a decrease in price to drive
profit since a price increase will
reduce profit.
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