Value-based pricing doesn’t really work in retail and other consumer oriented businesses right? Surely Black Friday and holiday sales in general are incongruent with value-based pricing? And, more to the point, holiday discounts are just another example of executives making bad decisions to chase volume with profit destroying discounts, yes? Well…maybe, maybe not.
Value-based pricing is an approach that aims to price offerings according to the value customers’ associate with the offering in comparison to its alternatives.
Repeatedly, I hear from challenges to the concept of value-based pricing from people working in retail. They point out that in retailer, competition is intense, that customers are able to compare prices easily between stores, and even more through apps and showrooming. In such an environment, surely value-based pricing doesn’t apply. It’s all about the competition in retail pricing, yes?
I hear that. But, perhaps further consideration is necessary. Or even more subversively, perhaps they are trying to do value-based pricing but didn’t know the term covers their actions. As Mark Stiving states, “Value Base Pricing is Only an Attitude.”
Take the central equation that defines the price customers are willing to pay under a value-based pricing approach.
\(P_F \leq P_C + (B_F\ -\ B_C)\)
It states that the best price a firm can capture (PF) is the price of the nearest competing alternative from the customer’s perspective (PC) adjusted for the perceived differential benefits (BF – BC). This price represents the firm’s best estimate of their willingness to pay. And, value-based pricing aims to price offers at the highest price customers are willing to pay.
Value-based Pricing in Retail and Other Highly-Competitive Environments
Retailers often state that they can’t price things above their competitors. Though there are obvious examples of retailers that do price above competitors (convenience stores, premium retailers, and flagship outlets often do), I am willing to grant that many retailers can’t, or at least that they could but it wouldn’t be as profitable as their current practices given their current customer base.
When they don’t price above their competitors, when retailers attempt to match or beat a competitor’s price, what they are saying is that the benefits of shopping at their outlet are not higher than those of shopping at a competitor’s outlet, at least for their target customer.
For these target customers, the benefits differential goes to zero and the retailer’s price must match or beat the competitors to win their business.
In fact, one can legitimately claim that all competitive pricing approaches are just a subset of value-based pricing approaches. It is a special case of value-based pricing wherein the differential benefits are zero (or negative), and the firm is aiming to price at (or below) what the competition charges.
Value-based Pricing and Holiday Sales
As for holiday sales, we have two issues that impact the potential price-capture for many retailers: competitive dynamics and buying occasion.
During the holiday season, competitors are holding sales and therefore the benchmark prices are lowered. In these situations, the only rational approach to attracting target customers for many retailers is to lower prices to a position which maintains the perceived benefit differential, if any, in light of the competitor’s lower prices.
During industry wide discounting periods, retailers must match the relative depth of holiday discounts to maintain their price positioning, stay competitive, and win customers.
That explains why almost all retailers hold holiday sales in unison. It doesn’t explain why they are necessary and perhaps even beneficial for the industry in the first place. To explain the profit enhancing potential of holiday sales, we need to examine the buying occasion.
During the holiday season, people increase their purchases on goods (gifts) for other people. According to the four-funds of expenditures concept (Pricing Strategy, p. 82), people tend to be more price sensitive when spending their money for other people than when spending their money for themselves.
Also, in gift giving situations, the concept of “benefits” shifts when spending money on other people from “how good is this product” to “how much will the recipient like the product, and therefore appreciate me or the effort I went to get it.” In these situations, we can predict that showy things tend to sell better than useful and practical items. The second half of the four-funds of expenditures theory should indicate the types of products that are discounted more than others, but the first half explains why we see holiday sales in the first place.
As for pricing, the fact that a higher proportion of purchases made during the holiday season are made in an increased price sensitivity context implies that retailers overall will have a higher incentive to provide discounts and sales on their merchandise.
Overall, discounting is likely to have a higher impact on sales volumes on retail sales during holiday gift-giving seasons than during other periods.
General Trends Explained, but the Profit Impact of Value Based Pricing Is in the Details
The above arguments demonstrate that retailers can be said to be doing value-based pricing — they just didn’t know it. But that is only part of the reason retailers should be thinking more in terms of value-based pricing.
Scattered throughout this description of value-based pricing applied to retailers and holiday sales in specific are hints at ways that retailers can improve pricing while capturing customers.
First, note that not all retailers have to match or beat a competitor. Some can be higher. A key question is “who is the target customer and why are they buying?” If a retailer is selling something unique and they are buying the item for themselves, they may be willing to pay a premium. Or, if a retailer is targeting the time-pressed customer that doesn’t want to wait in lines but does want, and is willing to pay for service, then that retailer can charge more.
For the retail executive, thinking about the differential benefits delivered to their target customers at their retail outlet reveals their needed price positioning. If location, surroundings, service, environment, selection, or other attributes impact the shopping experience in a positive manner, that retailer may find some pricing power.
Second, note that the impact of the gift giving holiday seasons may not be felt consistently across a categories or even across products within a category. Certain categories will have very few shoppers buying for gift giving reasons (think groceries, spatulas, or homes); other categories will have a much higher proportion of gift-giving shoppers (think dishes, sweaters, and jewelry). And even within certain categories, certain items will have different proportions of gift-giving customers (luxury nighties vs. practical pajamas.)
For the retail executive, thinking about the buying occasion of the target customers and their product selection reveals opportunities for targeted asymmetric price differentials. If a product has high practical value but little gift value, it may retain its pricing power even during the holiday season.
Hence, the real value of value-based pricing for retailers, even during the holiday gift-giving season, is that value-based pricing gives retail a framework for drilling down and identifying where they might have a little pricing power, and therefore can charge a little more for an item, and where they don’t. Just as with location, selection, display and customer service, so it is with pricing: retail is detail.