Strategic Movements August 2022
PepsiCo Decision: 4/5 Spines of Pricing Backbone
PepsiCo Inc. increased revenue by 5.2% last quarter over the same time last year due to an increase in average price captured by 12%. Clearly, some volume was lost yet this is acceptable.
If revenue increased when the price increased, the magnitude of the volume loss was less than that of the price increase. When the magnitude of the volume loss is less than the price increase, the demand is inelastic. No profit-oriented company in a mature industry should accept pricing in the inelastic range.
Therefore, the average price increase at PepsiCo was profit enhancing despite the small volume loss.
Hugh Johnston, CFO of PepsiCo, stated, “Unlike things like cars and houses and durable goods like washing machines, we’re just sort of an affordable treat, even when times are tougher.”
Affordable luxuries do not suffer the same price sensitivity as commodities. Enabling consumers to perceive items like Doritos, Fritos, Quaker Oats, Lay’s Potato Chips, and Pepsi as affordable luxuries is the result of strong branding. (Back in 2019, PepsiCo increased advertising expenditures by 12% resulting in organic growth of 4.3%.) Using that brand perception to manage prices during periods of cost inflation is strong pricing.
To combat the threat of revenue loss as consumers switch to lower-priced alternatives, PepsiCo reports they are carefully examining category entry price points and shifting brands stocked within their product mix. For example, the company is stocking some stores with more low-priced offerings such as Santitas tortilla chips. This may lower the overall price captured (cannibalization) yet increase the market served (expansion) leading to stronger profits. Balancing this tradeoff is a routine and core challenge with all good-better-best versioning product lineups.
PepsiCo’s Pricing Backbone Demonstrated in this Decision: 4 out of 5 Spines.
PEP (PepsiCo Inc.) has increased 5.45% to 180 in the past month. 2021 revenue of $79 billion with a 2022 11.3% margin and a P/E ratio near 27.
Harring, Alex (2022, July 13). Higher Prices Boost Pepsi Sales. Wall Street Journal, B3.
Mom-and-Pop Dry Cleaners Decision: 5/5 Spines of Pricing Backbone
Dry cleaners have had a tough go at it recently. Demand declined as work-from-home casual outfits replaced more formal wear. Input inflation on starch, steam irons, hangers, utilities, labor, and rent drove up operating costs.
What should you do in a declining industry when costs are increasing? Either quit or raise prices.
Thirty percent of U.S. dry cleaners have closed since the pandemic began. Check.
Average prices were up 10.1% in May over the year prior, outstripping the then consumer inflation rate of 8.6%. Check.
Mom-and-Pop Dry Cleaners Pricing Backbone Demonstrated Deciding to Raise Prices: 5 out of 5 Spines.
“Get real or go home” is a mantra many small business owners know too well.
Wolfe, Rachel (2022, July 6). Struggling Dry Cleaners Are Forced to Lift Prices. Wall Street Journal, A9.
ESPN+ Decision: 5/5 Spines of Pricing Backbone
On August 23rd, ESPN+ subscriptions will cost $9.99 a month, up from currently $6.99 a month, impacting current and new subscribers alike.
ESPN+ executives point consumers to the value of their offering in both scale and content. Meanwhile, ESPN+ executives are contending with the increased costs of acquiring live sports programming. ESPN+ lost money last year.
What shall we expect of this price move? To answer this question, we must first ask if ESPN+ is serving a growth or mature industry.
In growth industries, venture capitalists have demonstrated a willingness to restrain price increases to fuel greater subscriber numbers of unit volumes even when operating at a loss. Public companies in growth industries generally temper their willingness to operate at a loss and rather tend to operate with neither profits nor losses as long as unit volumes are increasing.
In mature industries, pricing fundamentals recommend raising prices where possible or required for profits, especially for profit-oriented public companies.
In Q2 2022, ESPN+ had 22.3 million subscribers, up 62% from the 13.8 million subscribers the year prior. With growth rates this high, one might expect this to be a growth industry. As an offering of a public company in a growth industry, we would expect ESPN+ to seek to operate at or near positive profits.
A very rough estimate of the potential market for ESPN+ can be calculated as follows: Start with the 130 million U.S. households. Gallop reports that 60% of Americans claim to be sports fans with upper income and males are more likely to identify as sports fans than other incomes and females; therefore, assume only 60% of households would be interested in the offering and any price. Next, estimate that at most 50% of those interested would actually pay real money due to differences between a desire and a willingness to pay. Then multiply to estimate the market potential of ESPN+ is 39 million subscribers.
With 22.3 million subscribers currently, ESPN+ is near this roughly estimated market saturation potential of 39 million. One might expect that future subscriber growth to slow, if not decline due to post-pandemic declines in binge-watching. In other words, ESPN+ looks like it is near maturity if it hasn’t already reached maturity. Pricing strategy would recommend, at a minimum, raising prices to maintain profitability.
Hence, we suspect that the price increase will improve the profitability of ESPN+ for Disney AND we expect the subscriber numbers to be near flat, if not declining by up to 10%, ignoring the potential impact of a potential recession.
Recall, some live sports can be watched on a pay-for-fee basis on various Disney properties. This potential substitute offering could absorb the non-subscribers and even improve profits greater.
ESPN+ Pricing Backbone Demonstrated in this Decision: 5 out of 5 Spines.
As Disney is a media and entertainment conglomerate, and as Dan Loeb, an activist investor with Third Point, has taken a vocal interest in Disney, we do not expect the price of one of its offerings to significantly impact its valuation. Given this disclaimer, DIS (Walt Disney Co) has increased to 122 from 96 in the month following their announcement.
Jacob, Denny (2022, July 16). Disney Set to Raise Prices for ESPN Streaming Services. Wall Street Journal, B3.
Unilever Decision: 5/5 Spines of Pricing Backbone
Revenue growth of 8.8% was achieved via an 11% price increase and a 2.1% volume decline at Unilever for Q2 2022.
Alan Jope, CEO of Unilever, stated, “We are pricing ahead of the market, and we’re prepared to tolerate low-single-digit volume declines and some compromises on competitiveness for a limited period of time in order to land that price.”
If the magnitude of price increases exceeds that of volume decreases, the company is priced in the inelastic range. No profit-oriented company in a mature industry should price in the inelastic range for it leaves money (profits) on the table. Unilever was in this position; therefore, their price increase was appropriate, despite the small loss of volume.
Notice the quote from Jope. It is direct and honest in setting expectations for the future. He was not overly apologetic about the price increase.
Unilever’s Pricing Backbone Demonstrated in this Decision: 5 out of 5 Spines.
UL (Unilever PLC) was relatively unchanged hovering around 48 in the weeks following this and other announcements. Revenue of $62 billion for 2021 with an 11.5% margin and a current P/E ratio near 20.
Chaudhuri, Saabira (2022, July 27). Unilever Price Rises Cut Both Ways. Wall Street Journal, B7.
Is It Time to Quit Serving Walmart or Amazon?
Walmart Inc. is charging suppliers that use Walmart to transport goods to their warehouses with a new fuel surcharge. Amazon did similarly to suppliers using its fulfillment services.
For suppliers, this would cause manageable challenges if prices of offerings sold to Walmart or through Amazon can be changed, but reportedly some supplier contracts, especially those from Walmart, prohibit or strongly discourage price changes. It would also be a manageable challenge if contracts had not already been signed regarding expected deliveries and volumes, but reportedly they have been. As it stands, some suppliers state they are confronted with a new and unexpected cost with no means to cover or avoid it.
Are Walmart and/or Amazon bad customers? Should producers stop selling to them to reach customers?
An unprofitable customer isn’t a customer. It is a leech sucking the lifeblood, called profits, out of the company.
Pricing Backbone Demonstrated in Walmart’s and Amazon’s Decision to Create New Supplier Fees: 5 out of 5 Spines.
Nassauer, Sarah (2022, July 6). Walmart Sets Fuel Fee for Suppliers. Wall Street Journal, B3.
Kraft Heinz Decision: 2/5 Spines of Pricing Backbone
Organic revenue grew 10.1% in Q2 2022 over the same period year prior. Price increased 12.4% while volume decreased 2.3%.
Miguel Patricio, CEO of Kraft Heinz, stated, “We are mindful of the current inflationary environment and how it affects consumers.”
If the magnitude of price increases exceeds that of volume decreases, the company is priced in the inelastic range. No profit-oriented company in a mature industry should price in the inelastic range for it leaves money (profits) on the table. Kraft Heinz was in this position; therefore, their price increase was appropriate, despite the small loss of volume.
Kraft Heinz executives revealed their strong pricing performance with announcements about increasing promotions.
Should Kraft Heinz increase promotions today?
In support of increased price promotions: Industry volatility, consumer price expectation theory, and price segmentation. Against price promotions: profit impact and alternative investment decisions.
Regarding industry volatility and price promotions:
- During the pandemic, Kraft Heinz, like many of its peers, decreased promotions. This was wise back in 2020 when supply chains were snarled, production plants were short on labor, demand shifted from industrial to grocery channels, and simply offering consumers a familiar and useful product was sufficient to drive sales. (Recall, there was once even a shortage of dried beans.)
- Post pandemic crises period, the industry challenges have changed. Today’s economic environment is one of high inflation and an uncertain economic future. Plus, low-cost competitors are able to reliably supply once again. Today, CPG companies are experiencing increased brand betrayal towards lower-cost store brands.
- As competitive pressure has returned, we should expect a return to promotional activity.
Consumer price expectation theory warrants price promotions during moderately high-inflation periods (1).
- Research into behavioral economics demonstrates that consumers strongly anchor their price expectations based upon the price they last purchased at, not the price currently required to purchase.
- When prices are above consumer expectations, demand decreases. Consumers often respond with thoughts like “I will wait for the price to come back down” or “they are trying to rip me off”.
- Moderately high inflation drives noticeable price increases above that expected by consumers.
- To soften the blow of a large price increase, temporary coupons and promotions can give consumers the feeling that they are “getting a deal” and beating the system while the new list price adjusts the expected price to pay upwards.
- Thus, when taking a large price increase on branded goods, increased promotions may be expected on a transitory basis.
Price promotions can be a good form of price segmentation.
- Pricing fundamentals state that price segmentation can increase profitability.
- Price promotions and couponing activity is a form of price segmentation for not everyone will take the effort to use coupons or change behavior to participate in a price promotion.
- As such, price promotions can increase profitability.
Repeatedly, research has demonstrated most price promotions harm profits.
- At a basic level, promotions lower prices in the hopes of gaining volumes to improve profits. The volume gains are rarely sufficient to overcome the price losses.
- In 1990, Scott Neslin published a model for estimating the impact of promotional activity on profits. This and similar modeling efforts repeatedly reveal that most price promotions harm profits.
Price promotions are not the only choice.
- While a price promotion may drive volume growth temporarily to the cheers of many sales and marketing executives, it is not the only choice. That same budget can be used for branding.
- Across consumer packaged goods, companies find the branding elasticity is around 0.2 on average. Meaning a doubling of the advertising and branding budget should drive a 20% increase in sales volume.
- PepsiCo made the decision to decrease promotions and increase brand advertising with positive outcomes during 2019 and before the pandemic.
- Miguel Patricio, CEO of Kraft Heinz, stated a need to nurture national brands in early 2020 right before the pandemic. Hence, we are aware Patricio and his team is aware of the alternatives.
Weighing the pros and the cons, we are skeptical.
Kraft Heinz Pricing Backbone Demonstrated in the Decision to Increase Prices: 4 out of 5 Spines.
Kraft Heinz Pricing Backbone Demonstrated in the Decision to Increase Promotions: 2 out of 5 Spines.
KHC (Kraft Heinz Co) fell from 38.6 to 35.6 on the day of the announcement and has since recovered. Revenue in 2021 of $26 billion with a 2022 P/E ratio near 37.
Gasparro, Annie (2022, July 28). Kraft Heinz Raises Outlook, Plans Promotional Items. Wall Street Journal, B3.
(1) Inflation of around 10% is only moderately high in my judgment. Given the experiences of currencies across the globe in my professional lifetime, I think of 20% as high and 100% or greater as entering the hyperinflationary territory. Comparing the relatively recent experiences of people in Turkey or Argentina versus Yugoslavia or Zimbabwe, we conclude that the current inflation felt in Europe and North America is painful and unpleasant but should be categorized as merely moderately high.
Diageo Decision: 3/5 Spines of Pricing Backbone
Revenue grew 21.4% driven by price, mix, and volume growth. Volume increases contributed 10.3% of the reported revenue growth. Price and product mix improvements contributed 11.1% of the reported revenue growth.
Regarding price improvements, Diageo stated that they increased prices by mid-single-digits. As for mix improvements, Diageo reported that consumers are purchasing a higher ratio of premium liquor over last year and demand is outstripping supply in some of the aged liquors, such as tequila.
Lavanya Chandrashekar, CFO of Diageo, stated “Our products are really an affordable luxury in the U.S.”
As a business, improving price, mix, and volumes simultaneously is a marketing trifecta.
Yet, the fact that price and volume increased simultaneously implies that Diageo’s products are currently inelastic and, assuming Diageo is a profit-seeking company, further price increases are warranted.
And if we take Diageo’s indications that supply is outstripping demand on premium aged liquors as true, we would further recommend that prices on premium aged products be raised yet more rather than leave money on the table.
Hence, we conclude that Diageo has more pricing improvements to make.
Diageo’s Pricing Backbone Demonstrated in this Decision: 3 out of 5 Spines.
DEO (Diageo PLC) improved strongly on the days surrounding the announcement to 193 from 182. Revenue in 2022 of £15.5 billion with a P/E ratio near 28.
Chaudhuri, Saabira (2022, July 29). Diageo Earnings Helped by Drinker’s Growing Thirst for Expensive Brands. Wall Street Journal, B3.
Nestle Decision: 3/5 Spines of Pricing Backbone
Organic revenue grew 8.1% driven by price and volume growth in the first half of 2022. Volume increased 1.7% and price increased 6.5%. Full-year forward guidance increased for organic revenue growth to 7%–8% from 5%.
The price increases were category sensitive. Some categories had higher price increases than others. See chart.
While higher costs led to a 2.8% drop in gross margins, underlying trading operating profit increased to 7.7 million CHF from 7.3 million CHF.
As a business, improving price and volumes simultaneously is a marketing win. And the specificity indicated in price change by category implies careful thinking regarding price increases.
Yet, the fact that price and volume increased simultaneously implies that Nestle’s products are currently inelastic and, assuming Nestle is a profit-seeking company, further price increases are warranted.
Hence, we conclude that Nestle has more pricing improvements to make.
Nestle’s Pricing Backbone Demonstrated in this Decision: 3 out of 5 Spines.
NSRGY (Nestle SA) has been relatively flat at 122 since the announcement. Revenue for 2021 of 87.1 billion CHF with a 2022 P/E ratio near 28.
Chaudhuri, Saabira (2022, July 29). Nestle’s Profit Margin Narrows. Wall Street Journal, B3.
VinFast Enters U.S. with Attractive Price Structure
VinFast of Vietnam launched electric sports-utility vehicles in the US. The VF 8 starts at $40,700 and VF 9 starts at $55,500. VinFast is executing a direct-to-consumer sales strategy with showrooms enabling customers to order a car for the future. So far, a relatively normal EV business model at a relatively low price.
However, customers of VinFast also must choose a battery subscription plan. Plans range from $35/month to $160/month depending on model and usage.
The price structure is a typical tying arrangement similar to that deployed by Gillette with razor handles and blades or HP with printers and ink. In tying arrangements, relatively low-priced durable offerings are used to entice customers to purchase in the expectation of making profits from higher-priced consumable offerings. Generally, the durable offering relies on the tied consumable offering to be of use to the customer, and the ability of a competitor to provide the tied consumable offering is restricted by patents or intellectual property.
A tying arrangement’s success should be contrasted with the lack of strong success of its alternative. Some of you may be aware that Kodak offers higher-priced printers with significantly lower-cost ink in direct contrast to HP’s pricing model. Some, but few. Kodak’s business model has not enabled them to displace HP as the market leader by a long shot, even though their printers are very good.
VinFast’s Pricing Backbone Demonstrated in this Decision: 5 out of 5 Spines.
McLain, Sean (2022, August 2). Walmart Sets Fuel Fee for Suppliers. Wall Street Journal, B3.
Kellogg Decision: 4/5 Spines of Pricing Backbone
Kellogg Co. increased prices to retailers by 14% in the current quarter. Sales volume dropped by 1.5%.
Steve Cahillane, CEO of Kellogg, stated, “This has been wave after wave of price increases because of how persistent inflation has been. … What you’re seeing in supermarkets is elevated pricing across categories and you’ll continue to see that.”
Kellogg increased profit projections from 1%–2% to 4%–5% for the year.
If the magnitude of price increases exceeds that of volume decreases, the company is priced in the inelastic range. No profit-oriented company in a mature industry should price in the inelastic range for it leaves money (profits) on the table. Kellogg was in this position; therefore, their price increase was appropriate, despite the small loss of volume, and we see the impact on their profit projections.
Notice Cahillane’s statements. They were direct about the impact of inflation (a current global issue) on prices in setting expectations for the future. He was not quoted as overly apologetic about the price increase.
Kellogg’s Pricing Backbone Demonstrated in this Decision: 4 out of 5 Spines.
K (Kellogg Co) rose slightly to 76 from 74 in the weeks following this and other announcements. Revenue for 2021 of $14.2 billion with a 10.5% margin and a P/E ratio of 17.5.
Gasparro, Annie and Hart, Connor (2022, August 5). Kellogg Raises Outlook, as Higher Prices Boost Sales. Wall Street Journal, B3.
Caterpillar Decision: 4/5 Spines of Pricing Backbone
Caterpillar Inc. revealed that higher prices contributed $1.1 billion to an 11% sales growth in Q2 over the same time last year.
Not all regions experienced similar sales growth. A 20% increase in sales in North America occurred amid lower sales in Europe and Asia. Some of the sales decreases in Europe and the Middle East/Africa regions were attributed to unfavorable exchange rate changes.
To quantify the impact of price, volume, mix, and exchange rates on profits and revenue, see Profit bridges that disambiguate impacts of currency fluctuations from other marketing variables.
Demand for Caterpillar offerings is derived demand. It comes from the demand for mining, roads, construction, and other industries rather than that of the pure joy of owning a Caterpillar simply for the sake of owning one. In derived demand industries, industry-wide sales volume is largely independent of industry-average pricing.
Jim Umpleby, CEO of Caterpillar, apparently recognizes this as demonstrated by his choice to raise prices, partly in response to inflation, and the outcome of strong sales.
Caterpillar’s Pricing Backbone Demonstrated in this Decision: 4 out of 5 Spines.
CAT (Caterpillar Inc.) increased from 184 to 195 in the two weeks following reporting. Revenue for 2021 of $51 billion with margins of 13.5 % and a current P/E ratio of 16.
Tita, Bob, and Hart, Connor (2022, August 3). Price Rise Boost Caterpillar. Wall Street Journal, B3.
Tyson Price-Volume-Mix Analysis Shows Consumer Downgrading
Tyson Foods Inc., the largest U.S. meat processor, said the average sales price of beef decreased 1.2% and that of pork decreased 3.9% in Q2. Meanwhile, the average sales price of chicken surged by 20%.
Statements from Tyson indicate that the mix of meats sold, not the pricing of the meat itself, drove the changes in average sales price.
To quantify the impact of mix versus price on profits, conduct a price-volume-mix analysis, aka a profit bridge. See Normative decomposition of the profit bridge into the impact of changes in marketing variables.
Profits at Tyson were flat compared to one year ago as costs for labor, cattle, logistics, and other inputs increased and meat processing plan labor shortages hampered production.
Tyson’s Pricing Backbone Demonstrated in this Decision: ??? out of 5 Spines for no decision is identified in their quarterly statements.
TSN (Tyson) fell sharply on the day of the news from 87 to 79. 2021 revenue of $47 billion with margins of 6.5% and a P/E ratio of 7.4.
Thomas, Patrick (2022, August 9). Tyson Sees Shoppers Trade Down. Wall Street Journal, B1.
Ford F-150 Lightning Decision: 4/5 Spines of Pricing Backbone
Executives decided to raise the price of their all-electric light truck F-150 Lightning product line by 7% to 18% only four months after launch. The entry R-150 Lightning version rose to $46,974, about $7,000 higher than its prior price. The top version is now priced at $96,874.
What went wrong (or right) with pricing?
Executives stated the price “adjustment” is driven by higher material costs. A believable statement due to higher lithium and cobalt costs, required elements for producing electric vehicle (EV) batteries.
Competing GMC executives increased the price of the Hummer electric model by $6,250 in June.
Customer demand for electric vehicles has broadly remained strong, and Ford currently has a waiting list for the F-150 Lightning.
I suspect nothing went wrong with the launch pricing, but rather the facts changed between last year when a launch price was set and this year when the product was launched. Competitive price moves, input cost increases, and strong customer demand all indicate a price increase was the right move, even if the product launched only a few months prior.
Ford’s Pricing Backbone Demonstrated in this Decision: 4 out of 5 Spines.
F (Ford Motor Co.) rose from 15.4 to 16.4 in the week following the news. Revenue for 2021 of $18 billion with margins of 12% and a current P/E ratio near 6.
Eckert, Nora (2022, August 10). Ford Raises Price of New E-Truck. Wall Street Journal, B1.