It’s common for grocery retailers to dwell on the topic of Pricing. Pricing is of course a massive lever on profitability. But there are some surprising truths about grocery price optimisation. These are often challenging brain-teasers as retailers begin to rethink their approach to pricing. Here are 7 (perhaps) surprising facts about grocery price optimisation:
1. Typically the incremental profit from optimising SKU prices relative to each other within a category is 10x greater than the profit potential of resetting prices overall versus competitors. That’s not to say competitive pricing’s not important, but generally it’s not so far off optimal compared to intra-Category SKU pricing which is typically where the vast majority of untapped profit potential sits.
2. Price elasticity is not actually very useful for helping retailers optimise prices. It’s probably only the 3rd most important metric to optimise profit within a category’s SKU price ladder.
3. Substitutability is the key metric that helps us unlock profit potential to optimise SKU level pricing. Low substitution allows for price decreases (as volume gained for the target SKU is incremental to the category, not cannibalistic of potentially higher margin SKUs. High substitution allows for price increases (as volume lost by the SKU is retained in the category. You gain from the higher margins on the SKUs where you increase price, and if you lose some volume it’s kept in the category anyway).
4. Differences in margin typically also matter more than a measure of price elasticity for price optimisation. Low margin generally makes price cuts hard, as you have increase in volume from a low margin SKU cannibalising high margin SKUs; higher margin generally makes price cuts much easier, in terms of overall category effects. Quite small differences in calculating real margins (eg, including waste or ABCs for stacking shelves) make a big impact on optimal pricing. Similarly quite small reductions in the costs of goods for a SKU can have a big impact on its optimal price and indeed the relative pricing of adjacent SKUs in the ladder.
5. Categories with a wide spread of margin have the greatest SKU re-pricing opportunities, as there tends to be more opportunity to replace demand for low margin SKUs with high margin SKUs by tweaking prices.
6. Price elasticity measures help you optimise the magnitude of price increases and decrease. But whereas Substitutability and Margin vary quite a lot by SKU, cross-price elasticities between SKUs are generally governed by somewhat predictable rules based on relative SKU shares of a category. For example, lower category-share SKUs have a higher price elasticity.
7. Price optimisation can go hand in hand with SKU rationalisation to optimise a price ladder. Even modest targeted SKU reductions can help manipulate volume into higher margin SKUs. There generally is an opportunity to create a cash margin positive impact by de-ranging the worst 10% of SKUs in any category (worst meaning low margin and high cannibalisation). Often, taking out 20% of SKUs will still be cash margin positive. Although we like to optimise SKU mix algebraically, a simple scorecard can spot the worst offenders, columns for example: Sales volume, Sales value, % Margin, % Incrementality (ie, 1 minus Substitution).
In conclusion, there’s lots to think about in Grocery price optimisation... but what really matters is not always what you think it is!
James Walker is a partner at OC&C Strategy Consultants, and Global Head of Analytics. James is London-based but works globally with CPGs and Retailers on questions of Revenue Growth Management, Route to Market/ Channel Strategy, and Category Strategy. James.Walker@occstrategy.com