P&G Shifts Pricing Strategy to Meet Post-Recession Market

The Wall Street Journal has reported that Procter & Gamble Co.’s new CEO, Robert McDonald, is “slashing prices” and warns of an impending price war in the branded consumer packaged good (CPG) industry.  Yet, Mr. McDonald states, “In my mind there’s not a price war going on.”  Is the Wall Street Journal guilty of hyperbole or is Mr. McDonald blithe to the profit destruction of price cuts?

In this article, I argue in favor of Mr. McDonald and moreover why he might be prescient in taking a sensible pricing strategy shift to meet the post-recession market demands.

Up the Price-to-Benefits Trajectory

For decades following the 1940s, the US economy was growing, and much of the middle class was enjoying greater wealth and spending power.  With their increased spending power, these middle class consumers sought not only more products, but also better products.

To meet the demand for more and better products in those decades, companies like P&G followed a proven product strategy:  launch new and improved product formulations at higher prices.  Most new product formulation had more features, delivered more benefits, and commanded a premium price in comparison to their predecessors.  By increasing the price and the benefits in tandem, the new products would encourage consumers to make tradeoffs between the benefits they demand and the price they are willing to pay.

The trajectory was not unique to P&G.  Robert Mondavi Winery followed a similar trajectory to escape the challenges posed by E&J Gallo Winery.  (See 1950-2009 P&G Product Strategy exhibit for a conceptual representation.)

The process of moving up the price-to-benefit trajectory worked as long as incomes continued to grow and consumers continued to demand better products to match their new economic gains.

In the 1990’s two forces however put a halt to the value of this strategic trajectory.  First, the introduction of low-cost store brands that Sanford Bernstein research reports as being perceived to be “good or better than those they replaced” in the consumer’s basket of goods.  Second, incomes stopped growing.

Entry at the Bottom

The lower-priced discount and store brands began eating away at branded consumer packaged good’s pricing power early in the 1990’s.  Evidence of their growing strength can be seen through the increased market share of store brands and the growth of store-brand only retailers such as Aldi.  (See 1990-2009 P&G Competitive Landscape exhibit for a conceptual representation.)

To combat this growing threat, branded consumer packaged goods firms relied on couponing, trial offers, and promotional bundles in order to induce customers back into the brand fold.  This approach may have stemmed some market-share erosion, yet discount promotions are a blunt instrument at best.

As customers tried store brands, they began to determine that the difference in benefits between branded goods and store goods didn’t outweigh the difference in price.  As such, the ability of discounts to attract customers that would convert to becoming a profitable and loyal following waned.

While the threat of lower-priced store brands was at best contained through targeted discounting strategies, a second shift to the marketing environment was underway.

Income Growth Arrested

Since 1999, the middle class has seen flat-to-falling incomes in inflation-adjusted dollars.  Their newly found poverty, or at best limited income growth, has driven a purchase behavior towards a more discriminating position. (See exhibit US Median Income Stopped Growing in 1999).

Without a growing income within the core consumer market segment, the strategy of constantly improving and up-selling customers to higher price and benefit points becomes an economic anathema.

To be clear, some customers will continue to be willing to pay more for some items. Splurging does continue, but it is proving to be more selective.  For instance, a middle-class business man may be willing to accept store-brand bathroom paper towel but eschew anything less than an Allen Edmonds’ shoe.  Or, skimping on the dentist may imply a higher willingness to pay for Crest premium dental products.  Yet does the difference in benefits between P&G’s Charmin and Albertson’s Homelife Soft Choice outweigh the differences in price?  They both end up down the toilet.

The flip side of an increased selectivity in customers’ willingness to pay for higher benefits is that that the mass market has moved to lower price / lower benefit demands.  That is, consumers are increasingly looking for “good enough” products rather than “good / better / best.”  To capture the mass market at the “good enough” position, branded consumer packaged goods firms like P&G need to have a product in that market position.

Shift in Pricing Strategy

Mr. McDonald’s pricing patterns can be suspected to be in line with the tectonic shift in the market environments, both the increase in competition at the bottom and the decade-long slow decline in middle class income.

The shift in pricing policy was targeted.  To quote Mr. McDonald:  “It’s basically been about a 10% price reduction on average on about 10% of the business.”

Anecdotal evidence appears to point to a price reduction that has been targeted appropriately to meet the needs of the increased demand for “good enough” products.  If this evidence proves accurate, then the pricing strategy shift appropriately addresses the demand shift within the market. (See exhibit 2010 P&G Product Strategy Adjustment for a conceptual representation).

P&G may be dropping the price on entry-level products while leaving prices on other, more feature enhanced and beneficial products unchanged.  If they are doing so, P&G is avoiding direct price competition with their branded consumer packaged good industry cohorts while targeting an attack on the unbranded discount goods and store brands.

The effect will be one of raising the incremental price for incremental benefits, thus further encouraging customers to make tradeoffs for the value points they desire.  However, this is usually a sound pricing strategy.  Segmenting the more utility-sensitive customers that will pay for added benefits that they seek from the more price-sensitive customers that will only pay for “good enough” products is a proven strategy for improving both profitability and market share.

Early evidence of the success of this strategy has already been revealed.  P&G’s US market share in 8 out of the 13 largest product categories increased in recent months according to Consumer Edge Research, LLC.  Moreover, P&G increased or maintained market share in all regions of the world for the quarter ending June 30.  Yet the evidence is mixed.  P&G also reported profits falling by 12% for the quarter ending June 30, 2010 due to increased advertising expenditures and lower prices.  .

Communicate

The likelihood of an all-out price war can be contained.  To do so, Mr. McDonald has to improve his messaging to investors and consumers (as well as competitors) regarding the focus of the pricing policy shift.  By focusing his price decreases on the lowest-value products within the category, P&G can meet two challenges with one instrument:  the increase in store brands and the lost buying power of their customer base.

Up, Up, and Away into Till the Field

The past progression of improving the benefits and raising the prices matched middle-class income growth of US.   The current and foreseeable future stagnation-to-decline in middle class incomes implies that the past strategy will fail.  A shift in pricing policy that focuses on the needs of the growing price sensitive market segment should prove profitable in the US, Europe, Japan, and rest of the developed world. (P&G’s Brazilian and Emerging Market strategy requires a separate missive).

Mr. McDonald, I suspect you have been prescient in taking a wise strategic shift in pricing policy to meet the post-recession market demands.  But suspicion isn’t proof and I hold insufficient data to confirm my suggestion.  Until either of the gaps are closed, hodně štěstí pane McDonald.

References

• Ellen Byron, “P&G Chief Wages Offensive Against Rivals, Risks Profits,” Wall Street Journal, (19 August 2010), http://online.wsj.com/article/SB10001424052748703292704575393422328833674.html (accessed 24 August 2010)
• Median Income from US Census Bureau http://www.census.gov/hhes/www/income/data/historical/household/index.html (accessed 24 August 2010)
• Tim Smith, PhD, “Profiting with the Post Recession Customer,”  Wiglaf Journal, (October 2009)
• Tim Smith, PhD, “Hip, Hip, Hooray, the Recession Is Over … Long Live the (Weak) Recovery,”  Wiglaf Journal, (October 2009)
• Tim Smith, PhD, “When Will Demand Return? Strategic Preparation for 2010,”  Wiglaf Journal, (December 2009)
• Paul Flatters and Michael Willmott, “Understanding the Post-Recession Consumer,” Harvard Business Review 87, no. 7/8, (July-August 2009):  106-112.