Strategic Movements October 2022

Darden Pricing Decision Spine:  1 of 5 Vertebrae

Darden Restaurants recently reported a revenue increase of 6.1% was overwhelmed by higher cost increases resulting in a 16% reduction in profits over same period last year in their September earnings call.

Why didn’t Darden raise prices more?

In their recent earnings call, management indicated that price increases have been deliberately set below inflation rates to protect the “value proposition” of its brands and avoid sticker shock.

A year ago, CEO Eugene Lee states the company will be “very cautious” in its pricing decisions.  “We want to make sure this big group of consumers that we service feel as though they can still come to our restaurants and get an extremely great value for what they have to pay. … Because at some point your average consumer could get priced out of casual dining if it costs too much”, said Lee.

Well, we see the predictably poor results of this decision.

(1) If costs increase but prices don’t increase sufficiently, profits measured in either currency or margins will decrease unless the customer volumes grow sufficiently.  Volumes didn’t exceed the calculable volume hurdle.

(2) A strategy that puts a higher priority on customer satisfaction ahead of a healthy price management routinely harms profits.  Maintaining low prices is an inferior strategy for driving customer satisfaction and maintaining a healthy company compared to improving the value-proposition or the perception of value delivered.  For restaurants, this can come from offering superior service, variety, location, branding, and many other sources.

(3) if the category is shrinking due to customer budget constraints, lowering prices to stimulate volumes and recover profits is unlikely to succeed.  The customer has simply left the market, at least for now.

The management teams at Darden have recently been following poor pricing practices.

Darden Pricing Spine:  1 out of 5 vertebrae on their recent decisions.

DRI (Darden Restaurants Inc.) fell sharply on the news from a high of 134 on the day prior to a low of 126 on the day after their earnings call. 2022 revenue of $9.6 billion with a 9.4% margin and P/E ratio near 18.

Seal, Dean (2022, September 23). Darden Profit Falls 16% On Higher Food Costs. Wall Street Journal, B3.

Cracker Barrel Pricing Decision Spine:  1 of 5 Vertebrae

In an attempt to retain their “inflation battered customers amid higher-than-expected gas prices”, Cracker Barrel Old Country Store didn’t raise prices commensurate with costs increases.  Result: profit fell 8% for the recent quarter compared to same period last year.

Sandra Cochran, CEO, stated “We decided to pass on much, but not all, of the cost impact in our pricing.”  Cracker Barrel also indicated further price increases would be coming over the next year but cautioned that management will give priority to keeping “our value-perception scores high.”

The poor results of their managerial decisions were predictable.

(1) If costs increase but prices don’t increase sufficiently, profits measured in either currency or margins will decrease unless the customer volumes grow sufficiently.  They didn’t.

(2) A strategy that puts a higher priority on customer satisfaction, “net-promoter scores”, or other metrics of customer “value-perception” ahead of a healthy price management routinely harms profits.  Maintaining low prices is an inferior strategy for driving customer satisfaction and maintaining a healthy company compared to improving the value-proposition or the perception of value delivered.  For retailers and restaurants, this can come from offering superior service, variety, location, branding, and many other sources.

(3) While the cross elasticity between gas prices and Cracker Barrel dining or shopping is likely non-zero, I strongly suspect it is very low.  Dining and petrol aren’t good substitutes.  While I accept that Cracker Barrel’s customer base may be facing larger budget constraints than normal, lowering prices to stimulate demand when customers are making a categorical decision to decrease consumption is not a proven success.  Managerial claims to keep restaurants prices low because gas prices are high seem like a non-sequitur from a sound pricing-decision-making viewpoint.

The management teams at Cracker Barrel Old Country Store have recently been following poor pricing practices.

Cracker Barrel Pricing Spine:  1 out of 5 vertebrae on their recent decisions.

CBRL (Cracker Barrel Old Country Store Inc.) fell in the days following the news to 95 on October 7 from 99 on September 26^th, the day before their most recent earning’s call.  2022 revenue of $3.2 billion with a 4.0 % margin and P/E ratio near 17.

Feuer, Will (2022, September 28). Lid on Prices Hurt Cracker Barrel. Wall Street Journal, B3.

FedEx Pricing Decision Spine:  3 of 5 Vertebrae

FedEx announced a 6.9% price increase for January 2023.  Why?

For the quarter ending August 31 compared to same period last year, packages handled fell 11%, the third straight quarter of declines.  Increases in rates and fees like fuel surcharges improved revenue.  Overall, however, volume declines and cost increases weighed heavier than price increases on earnings and profits declined.

(A profit bridge would show this.  See Measuring the Impact of Pricing Initiatives | Wiglaf Journal)

While most analysts in their earning call focused on operational costs, I focus on pricing decisions. The FedEx price increase announcement is good but question if the size is too small.

FedEx price increase announcements for the coming year are generally made this time of the year and matched by UPS, their major competitor.  I applaud FedEx for informing customers and investors regarding expected changes to the terms of engagement.  On the calendar, UPS’s earnings call falls one month later and hence we anticipate a parallel announcement to come.

But is the price increase of 6.9% the right size?  This is a large price increase for FedEx but is much lower that the recent headline inflation rate.  Loss of logistics to Amazon challenges price increases but a shrinking market does not always necessitate lower prices. Last year, FedEx announced a 4.9% price increase around this time only to raise prices further by around 5.9%.  This time may see a repeat.

On the clarity of FedEx’s announcement I give kudos but the size of the price increase was reported without any clear reasoning.

FedEx Pricing Spine:  3 out of 5 vertebrae on their recent decisions.

FDX (FedEx Corp.) fluctuated but held relatively steady in the days following the news around 155.  2022 revenue of $93 billion with a 3.8 % margin and P/E ratio near 11.

Fung, Esther (2022, September 23). FedEx to Raise Shipping Rates. Wall Street Journal, B1.

Costco Pricing Decision Spine:  5 of 5 Vertebrae

Shipping and commodity prices have slipped.  Prices at Costco’s 839 stores haven’t.

Deflection comments from Costco: (1) Costco locked in prices it pays to suppliers months ago so, presumably, they can’t pass on savings to customers yet; (2) Costco is facing rising labor costs.

Evidence supporting the validity of deflection comments, respectively:  (1) Example of cost reduction: Container freight spot-rates across the Pacific have fallen nearly tenfold from ~$21,000 in September 2021 to ~$2,300 in September 2022; (2) Example of cost increase: Average hourly wages at Costco exceed $25, and 90% of Costco employees are hourly-wage earners.

Other facts to reduce consumer pressure to raise prices: hot dogs and rotisserie chicken are still $1.50 and $4.99, respectively.

Hard facts that support keeping prices high for now:  Inflation isn’t over.  Customer retention rates at Costco exceed 90%.  Revenue rose if the quarter ending August 2022 over same period last year.

Best practice when facing costs reductions is to hold prices high until competition forces a move.  Right now, Costco isn’t facing competitive pressure to lower prices.  Partly due to the nature of the membership-buying business model (two-part tariff in pricing lingo), and partly due to the similar challenges faced by Costco’s competitors (Sam’s Club and Walmart, Kroger, Albertsons, Safeway, etc.).

The management teams at Costco are currently following pricing best practices.

Costco Pricing Spine:  5 out of 5 vertebrae on this decision.

COST (Costco Wholesale Corp.) fluctuated only slightly in the day following the news around 482. 2022 revenue of $227 billion with a 2.6% margin and P/E ratio near 37.

Williams-Alvarez, Jennifer (2022, October 7). Costco Waits on Price Cuts Even as Freight Rates Slide. Wall Street Journal, B3.

General Mills Pricing Decision Spine:  5 of 5 Vertebrae

General Mills reported organic sales increased by 10% driven by 15% higher prices that overcame lower sales volumes.  Overall, profits increased at General Mills to $820 million from $627 million over same period last year driven by revenue increases that exceeded cost increases.

We have covered General Mills many times.

In April 2022, we expressed hope that General Mills was learning of their pricing power.  In January of 2022, we noted the planned price increases and package size decreases at General Mills. In July 2021, General Mills announced a reduction in discounts and promotions.  In April 2021, we took note of General Mills’ plan to raise prices in response to commodity price inflation.  In October 2019, we applauded the demonstration of Pricing Power at General Mills.  In April 2019, we applauded their prioritization of profits over volume.

The evidence is clear.

General Mills Pricing Spine:  5 out of 5 vertebrae on this decision.

GIS (General Mills.) rose sharply on the news from 75 on the day prior to 79 on the day after their earnings call.  2022 revenue of $19 billion with a 15% margin and P/E ratio near 16.

Ojea, Sabela (2022, September 22). Higher Prices Lift Sales at General Mills. Wall Street Journal, B3.

e.l.f. Pricing Decision Spine:  4 of 5 Vertebrae

e.l.f. (a company named for an acronym for eyes, lips, and face) held prices constant on one-third of their items, typically their cheapest, while raising prices on others and launching new higher-priced items.

While any pricing strategy that demands for unchanging prices is unsound over the long-term, additional information merits exploration prior to tendering a rating.

First, e.l.f. raised prices overall by 10%.  Holding prices constant on some items while raising them on others indicates the practice of good price segmentation, not poor price management.

Second, e.l.f. has chosen to increase spending on advertising rather than on price promotions and discounts.  This is strongly suspected by many to be a superior customer engagement strategy than simply offering more coupons and promotions like many consumer product goods (CPG) peers.

Third, e.l.f. is experiencing a 26% sales increase and is valued for its growth even though it is a little mature considering it was founded in 2004.  As mentioned in my article “In Pricing, What is the Goal?”, profits alone is not the only metric of good pricing.

And fourth, low prices on entry products that drive customers to purchase higher margin items on repeat purchases is a customer acquisition strategy, not necessarily a pricing strategy.  This is a common refrain among pricing professions working with “freemiums” in SaaS business.

Given these caveats, the management team at e.l.f. should be given a tentative positive evaluation.

e.l.f. Pricing Spine:  4 out of 5 vertebrae on this decision.

ELF (elf Beauty Inc.) is fluctuating around 38.  2022 revenue of $392 million expected with a 6% margin.7 and P/E ratio near 74.

Terlep, Sharon (2022, September 21). At $3, a Lipstick Defies Inflation. Wall Street Journal, B1.

Pricing Benchmark:  CPG Promotions

Grocer promotions have receded over the pandemic.  Full disclosure:  this was a recommendation we made to several consumer packaged goods (CPG) corporations.

In Q3 2022, 20% of food and beverage items were sold on promotion according to Information Research Inc.  As a baseline, compare this to pre-pandemic Q3 2019 when 25.7% of items sold were sold on promotion.  By items we mean individual transactions on individual products.

Promotions are generally supported with funds from the CPG manufacturer. According to Inmar Intelligence, a market research firm, CPG corporation typically return 15% to 18% of their revenue to grocers in the form of rebates to fund promotions.

Kang, Jaewon (2022, October 3). Grocer Discounts are Harder to Find. Wall Street Journal, B1.

New Legal Challenge over Bundling:  Agrochemicals

The Federal Trade Commission filed suit against Corteva and Syngenta, two agrochemical giants, alleging their use of rebate programs block competition.

Do these rebate programs reduce competition?  Of course.

Are these rebate programs illegal?  That is the billion-dollar question to which the courts are being asked to decide.

In “Are Rebates and Customer Loyalty Programs Illegal? A Strategic and Legal Case Study of Intel and Eaton”, we looked at similar legal cases. Yes, 2014 was eight years ago, but these cases are infrequent and Lina Khan, FTC chairperson, has been noted to be a bit more aggressive than her predecessors.