It is said that the difference between an economist and a pit-trader is that the economist lets newspapers pile up on their desk to read over the weekend, while the pit-trader anxiously peruses them daily upon awakening. The same may be said of a pricing strategist versus a pricing neophyte.
Recently, GM announced its summer sales, including an offer of 0% financing for 60 months on select US full-sized pickups. Some concluded from these consumer incentives that GM has lapsed in their transaction price management. Last year I urged GM to maintain vigilance in managing transaction prices. Have they?
Game of Inches
Transaction price management is a game of earning inches when the goal is a hundred yards ahead. The goal is to reduce profit leaks, that is, to reduce the number of off-invoice and on-invoice discounts and incentives provided to dealers and consumers.
In December 2006, GM was the focus of a Wiglaf Journal case study on reducing the reference price while simultaneously reducing on- and off-invoice discounts and incentives. If undertaken properly, the result would rotate the Price Waterfall Vector towards an increased pocket price and profitability. (See Figure 1.)
Executing this twirling dance between the reference and pocket price is difficult enough to understand. For GM’s profitability health however, GM must not only understand it, it must also execute such a dance on the scale of millions of customized transactions.
The recent consumer incentives might indicate that GM has lost its resolve to manage this interplay between reference and pocket prices. For reasons of fact and insight, I argue that GM’s recent summer incentives are far from evidence of poor transaction price management and, in fact, reflect a wise use of all the marketing levers.
(As a matter of record, attempts were made to contact Ford officials in preparation of this article, yet they were unavailable for comment.)
GM Offered Incentives Slowly and Small
Summer incentives and the automotive industry go hand in hand like peanut butter and jelly. Toyota, Ford, Chrysler, Honda, Nissan and others each participate in providing summer incentives just as GM does.
If summer incentives such as low and long term financing must be offered, transaction price discipline would imply that the best a company such as GM can do is to delay the introduction of these profit leaks as much as possible and to ensure that the profit leaks are as small as possible. That is exactly what GM did.
In responding to our exclusive July 31st inquiry about their summer incentives on US full-sized pickups, John M. McDonald of GM Communications stated “They [Toyota] went to 0% for 60 months 6 weeks ago. They also have about $1,000 more cash on the hood than we do. Ford and DCX are also significantly above GM spending.” This fact is one piece of evidence that GM exercised restraint in their summer incentives.
But are summer incentives required? More specifically, must GM respond to competitors in providing summer incentives? And, what are some positive reasons that summer incentives should be part of the annual pricing cycle?
In any given market, customers hold a set of expectations and perceptions regarding competing products in terms of their price and their benefits. When mapping competing products based on perceived price and perceived benefits, the competing products often line up, forming a value equivalence line. Around that value equivalence line there exists a zone of indifference in which a small price change has no effect, partially due to different customers holding different perceptions. (See Figure 2.)
Incentives reduce the perceived price of a good, thus shifting the overall value equivalence line outward. Immediately following a fluctuation in price or incentives, such as a summer financing incentive on US light trucks, the zone of indifference broadens temporarily as different market segments learns the new price relationships at different speeds.
Once customers have been adequately informed of the new price and incentive structure, the value equivalence line will have shifted outward and the zone of indifference will have relaxed to a narrower state. Any industry competitor that has failed to adjust to the new value equivalence line would now be in an uncompetitive position offering too few benefits for too high of a price.
A pricing executive well informed about customer expectations will notice the new position of the value equivalence line and adjust prices accordingly.
For GM, this implies that movements in pricing and incentives should mirror those of its competitors in order to stay competitive; they should lag in time when adjustments would negatively affect the pocket price on a timescale related to the customers learning time of new price relationships; they should lead quickly when adjustments would positively affect the pocket price.
When asked about the price differential between GM and their competitors in relation to the summer sale, John M. McDonald of GM Communications stated “Discounting with incentives during the summer to clear out end of the year models is an industry phenomenon, and we have always said we will remain competitive. … We take price where we can and adjust incentives strategically and tactically as necessary to keep our products competitive.” In other words, competitive behavior within the industry eventually placed GM in a position where summer incentives were prudent.
Narrowly Targeted Incentives
Reducing profit leaks isn’t the same as eliminating incentives and discounts. Incentives and discounts exist for reasons that are positive for profitability. Specifically, they influence customer and distributor behavior.
Summer incentives on automobiles are part of the annual pricing cycle for many reasons. Most authors site the need to clear inventory, yet there is another side to the issue: price discrimination.
In an analogy, couponing in the consumer packaged goods markets is a well known means to segment the market between those who are highly price sensitive and those who are not. Similarly, annual year-end summer clearance incentives enable the price sensitive segment to purchase the GM product while leaving the less price sensitive remainder of the market to purchase at the regular price.
In other words, year end incentives are one of the automotive industry’s methods of practicing price discrimination. As a business strategist, I find that favorable.
Transaction price management is as difficult a task as disentangling reality from news headlines. As the above facts and analysis indicate, it appears that GM is diligently practicing intelligent transaction price management. Again, John M. McDonald of GM Communications: “We have seen average transaction prices for GM vehicles increase at about 3 percent so far this year, which is above the industry average of about 2 percent. We are generating more revenue from our sales while offering the best value for our products and services. You saw that result today with our announcement of record revenues from automotive operations.”
- Michael V. Marn, Eric V. Roegner, Craig C. Zawada, The Price Advantage, (Hoboken, NJ, John Wiley & Sons, Inc., 2004), pp 23-42.
- N.E. Boudette, “GM Is Increasing Prices on About 35% of its 2007 Models”, The Wall Street Journal, November 9, 2006, p. D5.
- Tim Smith, “GM May Be Learning Price Discipline: Growing Margins While Lowering Prices by Tilting the Price Waterfall Vector”, Wiglaf Journal, December 2006. https://wiglafjournal.com/Articles/2006/06-12-PriceWaterfall.htm
- Tim Smith, “Is GM Really Focused on Value or Low Prices? A discussion with John M. McDonald of GM over their Pricing Strategy”, Wiglaf Journal, April 2006, https://wiglafjournal.com/Articles/2007/07-04-GMFocusedValueLowPrices.html
- John D. Stoll, “GM Reverses Tough Stance on Incentives”, The Wall Street Journal, July 31, 2007, p. A2.
- Mike Spector and John D. Stoll, “Weak Sales, Mixed Outlook Cloud Detroit’s Path”, The Wall Street Journal, August 2, 2007, p. A3.
- As a liberal, this author is in favor of price discrimination, but he leaves this issue to a very different forum.