Manipulating Consumer Pricing Power

March 1, 2004

"In 2004 specifically, our challenge will be building consistent, profitable sales."--Rick Anicetti, president and CEO, Food Lion

"The biggest threat out there is how retailers adapt to Wal-Mart ... I think facing the pricing message and adapting to the changing environment are important for the industry."--Neil Golub, CEO, Price Chopper

For more than a decade, the grocery industry has tried to wrest pricing power from Wal-Mart. But pricing power is a double-edged sword. Wal-Mart has become a $250 billion company and the nation's No. 1 grocery retailer by driving down total prices 2% to 10% in its market place. The chain then uses its low-cost structure and logistics to create a 20% to 30% cost advantage over supermarkets. This allows Wal-Mart to charge 15% to 20% less on core grocery items like beverages, paper and laundry detergents.

Most retailers have attempted to counter this attack by concentrating on three areas:

• Lowering operating costs, especially labor costs
• Buying products at lower prices
• Limiting discounts on sensitive items to preserve gross margins

It might come as no surprise that none of these tactics alone have worked. More than half of the population now shops weekly for some food needs at mass merchants or value retailers.

For several years, McKinsey & Company has reported on how value retailers are challenging our industry with low prices and high quality. Simply put, our union journeyman workforce no longer provides superior service in perishables, center store and checkout. Yet our industry’s goal of lower operating costs seems doomed if we continue to manage our business with a workforce that resents management and provides service below value-based rivals.

The grocery industry’s labor disputes spreading across the U.S.--with the Southern California strike and lockout being the most contentious--may be about health benefits and reducing costs to fight off non-union rivals. But they are also about management’s inability to provide superior service and value with a well-paid workforce.

Buying products at a lower cost also seems like a fool’s game because the traditional grocery industry has always bought better than the value channel. Reviewing manufacturers’ cost-to-serve reports reveals that our industry’s forward-buying, slotting, diverting, deducting and "free" store labor practices are unmatched by any other channel.

We persist in believing that consolidation, consignment, centralized buying and even auctions will give us the lower costs needed to eliminate value retailers’ competitive edge. Yet if that were true, there would be no value retailers today, and they would not be food manufacturers’ fastest-growing, most profitable accounts.

Could better ads, shelf talkers and category pricing tactics recapture pricing power? We are all too familiar with Kmart’s disastrous experience trying to compete head on with Wal-Mart. No, even beating value players’ prices or using lower private label pricing tactics won’t guarantee consumers’ trust in traditional retailers' low prices. The old in-store basket comparisons among national supermarkets no longer seem relevant to the value shopper who has pricing information available from dozens of sources.

Price comparisons now come from the Internet, consumer share groups and nonprofit magazines. According to the most recent issue of Consumer Checkbook for the Washington, D.C. area, shoppers could save more than $800 per year by choosing the right value retailer. Value retailers were more than 10% below the national chains in price, and club stores such as Sam’s Club or Costco had prices 35% to 40% below traditional food retailers. Costco also rated substantially higher than area food stores in quality of produce and meats.

A new model for pricing is needed. We know from frequent shopper studies that more than 100% of a retailer’s profits usually come from just 20% of regular shoppers because retailers lose money on the bottom 30% of shoppers that only buy sale items. New technologies from companies like DemandTec are taking the guesswork out of knowing what to charge. Sadly, only a handful of companies, such as HEB are using these new consumer-based pricing tools. We could be even more effective by giving pricing power to our best customers and thereby changing the rules for price leadership.

Most retailers are afraid to rewrite old business rules even in the face of value competition and declining sales. But imagine a world in which a store’s best customers name their own specials, where consumer packaged goods manufacturers give the best customers new items for a free trial, where pricing is dynamic--not static--on shelves. The tools and technologies exist today but require a cultural change that most retailers’ gut instincts prevent.

Patrick Kiernan is president of Day/Kiernan & Associates; senior counselor for the Grocery Manufacturers of America; and is affiliated with The Center for Food Marketing at St. Joseph’s University, Philadelphia, Pa., and the Institute for the Future in Menlo Park, Calif. He can be reached by e-mail at KiernanPat@aol.com.