Anyone engaged in retail understands that in today’s environment, it’s hard to drive traffic without providing your target audience with a sense that you’re offering a terrific deal. But how do you create a sufficiently compelling offer without corrupting your margins? In this article and the next, we’re going to first examine this issue conceptually, and then offer some real world examples of how to put Price Theory into practice in the jewelry retailing environment.
Consumers are driven to make purchases based on Value, which can be represented mathematically by the ratio of Price to Product Content. But we aren’t machines. As human beings, we make decisions based on our perceptions, so the real driver is more accurately represented by Perceived Value. As such, consumption of any product can be measured and understood in terms of a fundamental concept from the field of Microeconomics called the Price Elasticity curve. At high prices, demand for any specific product will be small. As the price falls, demand will increase, until a level is reached where a further reduction in price fails to stimulate additional demand.
As an illustration, let’s consider pricing for two liter bottles of Coke. At $2.99, demand for Coke is going to be pretty soft (unless it’s in a convenience store environment, where convenience and the availability of the product at after-market-hours may play a role in the consumer’s acceptance of the price). At $1.99, two liter bottles of Coke will start to sell in a standard grocery store environment. At 99 cents, two liter bottles of Coke will fly off the shelves, because at that price, the brand name product will only have to compete with similarly priced generic colas. However, the curve flattens out below 99 cents, so that at, say, 89 cents, demand no longer increases, because it’s already at maximum. So the point of maximum profitability comes at a position on the curve where the value of gross profit percentage times sales is greatest. But the scenario changes when the product no longer serves as a profit center, but instead becomes a traffic driver.
In commodity product categories, whoever has the best price typically wins. Consider, for example, a four corners intersection with gas stations at each corner. You will seldom see differences in price here, because everyone in second place is actually tied for last, and you can’t make sales in a commodity item when you’re in last place. It is for this reason that the entire gas station model changed several decades ago, so that it’s now uncommon to see a gas station without a retail convenience store component. Gasoline is no longer a profit center. Instead, it’s become a traffic driver, where the real source of profit is actually the snacks, soft drinks, and candy that’s being bought by gas customers who, once they stop to buy gas, can be persuaded to make additional purchases because of convenience.
Similarly, independent pharmacies once thrived because medicines were historically a source for profits. But when medicines became commoditized, so that large companies began using them as traffic drivers to then sell general merchandise, the independent pharmacy model collapsed.
But there are some commodity products that don’t lend themselves to add-on sales, so merchants in these categories have turned to other pricing models for profits. Take, for example, the airline industry, where the concept of “Yield Curve” pricing was born. In this instance, the same product - a seat on an airplane - can be sold at widely varying prices depending on the needs of various consumers. A family traveling to see grandparents will plan their trip many weeks in advance, in order to buy seats at the lowest price, whereas a sales executive who discovers the day before that a hot prospect may be ready to buy will pay a much higher price for the same seat.
Fluctuations in distribution channels can also impact pricing, especially when middle men who add little or no value can be disintermediated. Continuing with the airline model, it was once customary to use travel agencies to book airline flights. But when increased access to information allowed travelers to do extensive searches for ticketing without needing an agent, the travel agency model collapsed. And today, if you call Southwest’s toll free number, the first thing you’ll hear is the recording “Lower fares may be available at southwest.com,” a prime example of how merchants are even offering multiple prices for the same item based on the manner in which it is purchased. (And, in the context of jewelry appraisals, you will find that the current state of the art is to value jewelry based on the distribution channel through which it has been purchased, a fact which always causes me to wonder whether we need a new model!)
The Internet has recently given birth to a fascinating new pricing strategy known as “Dynamic Pricing”, where the price of certain items can change dozens, or even hundreds, of times per day. Retailing environments like Amazon, as well as websites that allow consumers to instantly check prices on tens of thousands of Internet retailers’ sites, have necessitated the development of extremely sophisticated software applications allowing merchants to instantly react to changing competitors’ pricing. As just one example, Best Buy’s Internet prices on certain high volume items are now known to change as much as 20 percent, and can change dozens of times during any 24 hour period, in response to changes in competitor pricing.
One of the natural defense mechanisms that many retailers - especially luxury retailers - have brought into play has been branding, where consumers have sometimes demonstrated a willingness to pay more for a brand name item that conveys either status, or quality, and where the purchase can only be made at authorized dealers. We certainly saw a move to this strategy in the jewelry industry during the early to mid 2000s, as retailers correctly identified how increasing consumer affluence - driven by a housing market bubble - was creating an ever increasing willingness to pay more for exclusive brands. But then the collapse occurred in 2008, and suddenly the high priced brands became less desirable, and in many cases simply stopped selling.
Retailers who were caught with high inventories - and higher price point items - ultimately reacted by running sales where the traffic driver was often a percentage discount. But as discounting became a life-jacket for some retailers in stormy economic seas, it appears that its persistent use has now changed consumer perceptions, to the point where “50 percent off” no longer captures consumers’ attention. Yet attempts to move to “one price” strategies are demonstrably ineffective. Just take a look at the spectacular fall in JC Penney’s revenues and stock price in the past nine months as they have attempted to shift to a one-price, non-sales driven formula.
Fortunately, the jewelry industry generally offers products that are fairly difficult to commoditize, which explains the prevalence of independents in a space where, in so many other industries, there just aren’t many independent retailers remaining. But it’s also quite clear that without special offers to drive traffic, especially at peak retail periods like Black Friday, Christmas, and Valentine’s Day, independent jewelers are losing sales, market share, and profitability. The key to understanding how to accomplish this lies in understanding how recent psychographic changes in American consumers have changed our perceptions of value, a topic we will consider in next month’s article.