Pricing Best Practices: Lead with Science, Communicate with Art

By Joe Beier, EVP

Tariffs just added 30% to the cost of goods sold of the product your team supports; now what?

While precisely forecasting the impact of current and proposed (and paused) tariffs surely meets the definition of “a fool’s errand,” it seems clear that they will send shockwaves through the economy, forcing many U.S. brands and suppliers to increase prices or risk severe margin erosion.

This is a big deal, likely to shake up even the most stable competitive dynamics. A little scary, yes, but with change also comes opportunity — the opportunity for brands and retailers to grow, gain share, and elevate their competitive positions.

So, what factors determine the winners vs the whiners in this economic melee? Two rise to the top:

• Setting new price points based on consumer insights (vs solely cost-based or “gut-based” pricing).
• Optimal communication of the pricing action to both retailers and end consumers.

Price: Too Important to Leave to Chance

In nearly 25 years in market research, I have seen hundreds of studies examining the factors consumers consider while finalizing their purchase decisions. Price nearly always shows up as a top three factor. Brand names, features and benefits are important, but price is a bedrock. You’ve got to get it right.

At this crossroads, it’s vital to let the “voice of the customer” guide your execution. This is the embodiment of data-based decision making, which is so vital in this moment. Good news! There is a toolkit of well-established market research solutions that can bring this voice to life, ranging from the relatively simple to the more rigorous and robust. Let’s tour some of the most popular approaches.

A/B In-Market testing

Also known as the “let’s try it and see what happens” method, this is simply presenting two distinct price points (or more) in separate segments of a brand’s marketplace (online or physical retail or both) and simply reading the sales rates at each price point to determine the best choice for the brand. Its strength is that it is the most “organic” method, capturing actual consumers’ product choices and spending. It also is a comprehensive look that naturally includes things like the presence of competitive options and other real marketplace dynamics (i.e., seasonality).

But the flipside of this “organic” benefit is that the test environment is not fully controlled, making attribution purely to pricing levels at times, guesswork. Also, A/B identifies the winner only among the prices tested, which may not include the “optimal” price. Sales impact is typically measured only for the subject products and not for the category as a whole, which can be a significant limitation for retailers and category managers charged with maximizing total category sales and profit.

Iterative Forced-Choice Studies

This simple method exposes respondents to a subset of competing products (including the subject item) and asks which single product they would select out of that available choice set. This is repeated several times, with varying prices and products. Price is typically set at a “base” (or current market level) and then increased (or decreased) on subsequent exposures by whatever increments are under consideration, up to a maximum feasible price change. Data are then cross-tabulated to illuminate the effective price sensitivities for the subject item, giving an approximation of how much sales are expected to drop at each higher price point. (This same method can be run for potential price drops as well).

This method relies on simple data collection and basic data analytics (crosstabs vs. complex statistical modeling). As such, it can be one of the most cost-effective and relatively quick options. It is, however, a static snapshot of highly dynamic marketplaces. For example, it does not allow for potential competitive price changes that may result from the subject item changes. Overall category impacts are also typically not measured, which may limit the value of findings for a retailer or category manager. Nonetheless, it can be a useful tool to optimize pricing at the brand level in the right situations.

Discrete Choice Modeling (DCM)

DCM is broadly regarded as the methodology offering the highest level of precision across the testing toolbox. In a DCM study, consumers are presented with a series of choice exercises in which they are asked to select the product they would be most likely to purchase among a subset of product options. Price is one variable, but it is tested holistically, in the context of other product features and competitive offerings at various prices. Advanced statistical analysis is applied to this rich data set, and a sophisticated model of consumer decision making is developed based on trade-offs between different product attributes and prices.

By modeling real-world scenarios and examining how changes in pricing impact consumer choices, demand can be forecasted with high reliability.  Also, impacts for both the subject items and total category are typically modeled.  Another major advantage of DCM is that it supports “what if” scenario queries. Once the demand model is built (via advanced statistical modeling), users can run unlimited “what if” pricing scenarios and examine their sales impacts. This will be particularly valuable in the post-tariff marketplace, where competitor price responses are likely. DCM studies will tend to require a larger resource commitment and take longer to complete than some of the simpler methods.

Virtual Shelf Shopping

This method virtually replicates a physical store shelf and lets the respondent shop the set virtually. Consumers interact with products in a way they naturally would, capturing realistic purchase behaviors. It is possible to quantify even nuanced shopping behaviors, such as a shopper picking up an item but returning it to the shelf upon further inspection. A major strength is that findings are based on shopping behaviors. Also, this realistic data collection can be combined with sophisticated discrete choice modeling of the data on the back end to build a powerfully predictive solution. As with the DCM method, a read of total category sales and profit impact (not just subject brands) is available. This will be an important metric for a category manager to make the case for a price increase to retailer partners. The main challenge with this method is the heavy upfront investment needed to build out the virtual environment. This includes gathering potentially hundreds of package images and agreeing on typical planograms to depict, which sounds simpler than experience suggests it is. The good news is that once the virtual shelf is created, multiple testing waves can be run on the same stimulus, enabling testing of multiple scenarios as market conditions shift.

The Art of Communicating Price Hikes

If determining optimal price points requires a good deal of “science”, determining the optimal communication of price increases to shoppers at retail requires a big dose of “art”.

While every situation is unique, retailers would do well to consider a few core questions when crafting their communication strategy and messaging:

• What is the strategic role of the subject category, and how price-sensitive do we project our shoppers to be?
  • If the category is a destination and highly price sensitive, a rational choice might be to absorb the increase versus passing any of it on to shoppers. For example, various food retailers took very different approaches to the recent spike in egg prices- from full margin preservation to taking the full margin hit and holding steady at retail.

• How big is the cost increase, and how permanent do we project it to be?
  • Minor cost increases (under 10%) might be best passed along without formal communication as they are unlikely to even be noticed by shoppers (barring a situation in which an increase would drive retail price above a key absolute price threshold).
  • Also, are the factors driving your costs structural or transient? This is hard to know if the moment, but the “on-again, off-again” dynamics we are currently seeing around tariffs might be an example of an increase more likely to be transient in which case it may make sense to not jump too quickly to pass along to shoppers but rather “wait and see.”

If the assessment is that the cost increases are going to be large and lasting, passing them onto shoppers may be the only financially viable option.  At this point, our attention turns to how best to communicate the increase to shoppers. Again, there is no magic formula, but some high-level communication principles can increase your odds of keeping the shopper and the sale despite higher prices:

• A simple and honest tone
• Recognition/gratitude for past loyalty
• High transparency in identifying the factors that are driving the need to take a price increase
• A sense of partnership in navigating the challenge with your shoppers and not just passing the whole of your problem on to them.
  • Show that you are sharing/absorbing some of this pain yourself by sharing examples of what you have done to mitigate the shopper impact (i.e., changed sourcing, made the supply chain more efficient, changed assortment to less expensive options, sacrificed some of your margin/profit). The key is to communicate “we are in this together”.
• A reminder of the core value proposition you provide and your commitment to continue providing it going forward.

Applying these guidelines, a model retailer to shopper communication might look something like this:

Thanks for being a regular <Retailer> shopper. We know that keeping prices fair is an important reason you choose us, and we remain 100% committed to that mission.

Unfortunately, sometimes outside interruptions to our supply chain make price increases necessary. Recently imposed tariffs on Mexico have increased the price we need to pay for avocados by 30%. 

Fortunately, by shopping for new suppliers and finding new shipping efficiencies, we have greatly reduced the price increase we need to pass on to you to only 15%. This includes our taking a significant reduction in our profit margin as well. This increase is necessary for us to deliver the highest quality product and shopping experience that you have come to expect at <Retailer>

Thank you for your understanding and continued support as we navigate this challenging economic time together. We look forward to seeing you in our produce department again soon!

-<Retailer CEO>

Conclusion

Tariffs, Schmariffs! You’ve got this! Turn market chaos to your brand’s advantage with a smart approach that cedes the price-point decision to your consumers and by a trust-building communication that leaves them happy and willing to pay a bit more.