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4 October 2014

The Price of Eggs

Tag(s): Marketing
“Cecil Graham: What is a cynic?
Lord Darlington: A man who knows the price of everything and the value of nothing.”
Lady Windermere’s Fan  Oscar Wilde
 
 A gorilla walks into a deli in New York and orders a pastrami on rye with a pickle on the side to go. The guy behind the counter puts the sandwich together and when it’s ready says: “That’ll be twelve dollars”. He realizes though that he’s been staring, and apologises…”Uh, I’m sorry, sir but to be honest with you, I’ve never seen a gorilla in here before.”
“You keep charging twelve bucks for a sandwich,” says the gorilla, “and you never will again”.
 
 Pricing is one of the most important elements of the Marketing mix. It is also one of the most difficult. Get it right and you may make a lot of profit. Get it wrong and you may have a huge failure on your hands. Of particular interest is the subject of price points and this is what I wrote on the subject in my book The 20 Ps of Marketing.

 “Pricing often settles around a Price point. Retailers talk of a magic Price, a Price where customers’ appreciation of value for money comes into balance with the margin requirements of the supply chain. One of the most extreme examples of this in my experience was in Chile where M&M’s distributor imported M&M’s mainly in their snack size, a small package of the famous candies. The exchange rate was then fixed by the Pinochet régime at 39 pesos to the US$, a policy that allowed the régime to successfully squeeze out inflation and force local manufacturers to compete more directly with international manufacturers such as ourselves. This exchange rate allowed the importer to distribute the sachets to be sold in the street at busy road junctions at 10 pesos each. Huge quantities were sold at this magic Price. However, when the exchange rate started to move after being fixed for three years eventually reaching 90 pesos to the US$ in just three months, the magic Price point was gone and the wholesalers who ran the army of street salesmen replaced it with cheaper locally supplied alternatives. The huge volumes disappeared like snow in summer.

 This is an extreme example of elasticity, the concept that demand is elastic to variations in Price. This can be measured quite precisely and in some large industries is a key mechanism of demand management. Some goods are held to be mainly inelastic, e.g. petrol where demand tends to change only slightly even when Prices are increased sharply. Here the calculations are probably a little distorted as the customers are mixed between those whose costs are passed on to employers and whose demand will not vary and those who pay out of their own money and may have to make some adjustment.
 
 The classic magic Price involves the use of 99, i.e. 99p instead of a £1, £9.99 instead of £10, £14,999 instead of £15,000. This is so ubiquitous that Screaming Lord Sutch, leader of the Monster Raving Loony Party and perennial fighter of elections, actually proposed the introduction of a 99p coin to avoid all the exchange of 1p coins, one of his more imaginative if still loony suggestions. Folk wisdom has it that this practice was initiated by canny retailers who wanted to ensure that shop assistants would be forced to open the till and thus register the transaction rather than just pocketing a bank note, but I find this difficult to believe as the equally canny, but dishonest shop assistant would only have to keep a stock of penny coins to frustrate the trap. The real reason is that despite the smallness of the difference mathematically the Price point really does seem much lower in psychological terms. As a practice it is effective and will stay with us for a lot longer yet.
 
 Traditionally Prices were set by manufacturers and suppliers and then followed by retailers. This tradition came under pressure in the UK in the 1960s and some retailers such as Tesco came to national prominence by testing the practice of Resale Price Maintenance. Edward Heath was the minister responsible for taking through Parliament the abolition of Resale Price Maintenance although some Product categories such as books and newspapers remained exempt. Ironically Mr Heath later was nicknamed Grocer Heath by Private Eye even though this single action was eventually to cause the demise of many thousands of grocers as larger retailers could now compete directly on Price and use their buying Power to exact discounts from suppliers and force smaller retailers out of business.

 This action has mixed economic effects. On the one hand it is obviously in the interests of consumers to see Price competition. However, these same consumers have lost a lot of amenity at the community level and Profits are no longer retained in the community but are rather sucked out and centralized at national level by a few players.

 That Pricing has a political context is undeniable. This became extreme in the 1970s when inflation took off, largely stimulated by massive increases in oil Prices set by OPEC. In both the UK and the USA, now seen as two of the countries most committed to free Markets, legislation was introduced to control Prices. In the UK the ministers responsible to manage this process were Shirley Williams succeeded by Roy Hattersley and, perhaps incredibly, in the USA it was one Donald Rumsfeld.

 But after this disastrous aberration which caused massive distortions in Markets, a new regime emerged where Price points became a matter for intense negotiation between manufacturers and retailers. As retailers increased their Power, so every change in Price became an opportunity for them to increase their share of the available margin. In the early 1980s I learned to play this game at Green’s of Brighton, a leading player in a relatively small Market. As our input Prices for key commodities like flour and sugar, Packaging and labour, changed from time to time we needed to seek a Price increase. Whereas in the past this would have simply involved the calculation and publication of a new Price list it now involved extensive negotiation with each of the major supermarkets. We had to justify the increase by first demonstrating the changes in our input Prices and showing that we had done everything we could to control them. The retailers were helped by having their own brand Products in the same category and therefore having separate information that would support or otherwise our arguments. Once it was agreed that a Price had to change it was then a negotiation over establishing the new Price point and dividing the margin.

 In Products selling at Prices below a pound there are several recognisable Price points and some that will simply not work. We have already discussed 99p but before we get there we will consider 49p but not 50p and so on. Thus on a Product previously sold at 47p for which we sought an increase of 5%, we would have to settle for 49p, an increase of just 4.2% or alternatively go all the way up to 52p, the next recognisable Price point, and thus see the Product go up by 10.6% and risk a serious loss of volume.

 In addition the retailers would have a clear sense of which Products were those which were bought so frequently by customers that they knew the Price. As always there is a mnemonic and this one is Known Value Item, or KVI. While politicians usually can’t answer the question, how much is a loaf of bread, the average housewife can. Similarly she will know what she should pay for Heinz Baked Beans, Kellogg’s Cornflakes, PG Tips and Nescafé, but will be much less certain over the general range of Products sold in the store. This applies particularly to fresh goods which, while bought frequently, are known to vary according to the seasons. Consequently the supermarket buyers responsible for setting Prices have much more leeway on those items, the great majority not deemed as KVIs.
 
 If the Product is subject to VAT there is a major distortion because of the establishment of Price points. In the USA Price points are set and sales tax is added afterwards. Thus you may buy a book (in the USA books are subject to sales tax) with a RSP of $16.99 and then find 6% sales tax is added at the checkout thus taking the final Price to $18.01. The rate of sales tax can be varied without affecting the Price point. However, in the UK Value Added Tax is included in the final Price. At the time of writing the rate of VAT is 20%. As I have explained Price points are supreme and so if a future Chancellor reduces the rate of VAT it may create some artificial situations. However, when the rate of VAT is increased, which has usually been the trend, the effect is a hidden tax on the manufacturer and retailer.

 If a Television has a RSP of say £799 when the tax is 20% what has actually happened is the consumer has bought the TV for £665.83 and paid £133.17 in VAT to HMRC. If the tax is increased to 22.5% the retailer is faced with two alternatives.  He can keep the base Price at £665.83 and the final Price increase to £815.64 thus delivering an extra tax of £16.64. However, he is more likely to judge that this is not a viable Price point and so will keep the final Price at £799 and reduce his base receipt to £652.24. The tax will therefore be £146.76 and the increase in tax will not have been paid by the consumer but by the retailer who will then seek to pass it back to the manufacturer. It is thus a hidden tax on Profits.”

This is taken from Chapter 2 of ‘The 20 Ps of Marketing’. If you want to buy the book there is a link to the publisher, Kogan Page, on the home page of this website.

Copyright David C Pearson 2014 All rights reserved



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