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Go Figure – Pricing & Segmentation – Part 3 of 4

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Part 3 of Tim Harford’s article on pricing and segmentation. The 4th and final part will be published next week.

Supermarkets have turned price targeting into an art, developing a vast array of strategies to that end. Above the main concourse of Liverpool Street station, there’s a Marks and Spencer “Simply Food” store, catering for busy commuters on the way in and out of London. Knowing what we do about scarcity value, we shouldn’t be surprised to find that this shop isn’t cheap – even compared with another branch of M&S merely 500 metres or so away, at Moorgate.

I picked up five products at random in the Liverpool Street store and managed to locate four of them in the Moorgate store. Every single one was about 15 per cent cheaper there. Big salads were down from £3.50 to £3.00, sandwiches from £2.20 to £1.90. But even when such discrepancies come to light, few City workers would be willing to stray that distance to save 30p. A bold and effective piece of price-targeting.

Other supermarkets are more circumspect about their pricing policy. Going undercover once again, I made a comparison between the smallish Sainsbury’s supermarket in Tottenham Court Road, and the large store in Dalston, one of east London’s less prosperous neighbourhoods. It was harder to find examples of identical products selling for different prices, although by no means impossible. Does this mean that Sainsbury’s doesn’t price-target as much as M&S? Not at all. They simply go about the whole process with more finesse.

When researching Sainsbury’s, my approach was the same as with M&S: walk into the shop and see what caught my eye. As you probably know, what catches our eye as we walk into the supermarket is no coincidence; it’s the result of careful planning designed to throw attractive but profitable products in the path of customers. What constitutes an attractive product depends on who those customers are. In Tottenham Court Road the obvious goods were all quite expensive: Tropicana orange juice at £1.95 a litre, Tropicana “Smoothies” at £1.99 for 100ml, Vittel mineral water at 80p for 750ml, and so on. It wasn’t that these products were more expensive in Tottenham Court Road than in Dalston (only the Vittel was), it was just that in Dalston cheaper substitutes sprang into view far more readily.

For instance, I couldn’t find inexpensive orange juice in the Tottenham Court Road store, but in Dalston, Sainsbury’s own brand of fresh chilled juice was sitting next to the Tropicana at about half the price, and the concentrated juice was almost six times cheaper than the Tropicana. Brand-name pasta was the same price in both shops, but only in Dalston was it sitting next to Sainsbury’s pasta, which again was almost six times cheaper. The effect was to target the whole Tottenham Court Road store at shoppers who are indifferent to prices, but to aim the Dalston stores at shoppers with a keener eye for a bargain – while of course giving any price- blind Dalston shoppers plenty of opportunity to show their true colours.

Another very common pricing strategy is sale pricing. We’re all so used to seeing a store-wide sale with hundreds of items reduced in price that we don’t pause and ask ourselves why on earth shops do this. When you think hard about it, it becomes quite a puzzling way of setting prices. The effect of a sale is to lower the average price a shop charges. But why knock 30 per cent off many of your prices twice a year, when you could knock 5 per cent off year- round? Varying prices is a lot of hassle for shops because they need to change their labels and their advertising, so why does it make sense for them to go to the trouble of mixing things up?

One explanation is that sales are an effective form of self- targeting. If some customers shop around for a good deal and some customers do not, it’s best for stores to have either high prices to prise cash from the loyal (or lazy) customers, or low prices to win business from the bargain-hunters. Middle-of-the-road prices are no good: not high enough to exploit loyal customers, not low enough to attract the bargain-hunters. But that’s not the end of the story, because if prices were stable then surely even the most price-insensitive customers would learn where to get particular goods cheaply. So rather than stick to either high or low prices, shops jump between the two extremes.

One common situation is for two supermarkets to be competing for the same customers. As we’ve discussed, it’s hard for one to be systematically more expensive than the other without losing a lot of business, so they will charge similar prices on average, but both will also mix up their prices. That way, both can distinguish the bargain hunters from those in need of specific products, such as people shopping to pick up ingredients for a recipe they are making for a dinner party. Bargain-hunters will pick up whatever is on sale and make something of it. The dinner-party shoppers came to the supermarket to buy specific products and will be less sensitive to prices. The price-targeting strategy only works because the supermarkets always vary the patterns of their special offers, and because it is too much trouble to go to both stores. If shoppers could reliably predict what was to be discounted, they could choose recipes ahead of time, and even choose the appropriate supermarket to pick up the ingredients wherever they’re least expensive.

In fact, it is just as accurate, and more illuminating, to turn the “sale” on its head and view prices as premiums on the sale price rather than discounts on the regular price. The random pattern of sales is also a random pattern of price increases – companies find it more profitable to increase prices (above the sale price) by a larger amount on an unpredictable basis than by a small amount in a predictable way. Customers find it troublesome to avoid unpredictable price increases – and may not even notice them for lower-value goods – but easy to avoid predictable ones.

Try to spot other odd mix-ups next time you’re in the supermarket. Have you noticed that supermarkets often charge 10 times as much for fresh chilli peppers in a packet as for loose fresh chillies? That’s because the typical customer buys such small quantities that he doesn’t think to check whether they cost 4p or 40p. Randomly tripling the price of a vegetable is a favourite trick: customers who notice the mark-up just buy a different vegetable that week; customers who don’t have self-targeted a whopping price rise. I once spotted a particularly inspired trick while on a search for crisps. My favourite brand was available on the top shelf in salt and pepper flavour and on the bottom shelf, just a few feet away, in other flavours, all the same size. The top shelf crisps cost 25 per cent more, and customers who reached for the top shelf demonstrated that they hadn’t made a price-comparison between two near-identical products in near-identical locations. They were more interested in snacking.

This entry was posted on Friday, May 25th, 2007 at 9:17 am and is filed under Articles, Branding, Market Research, Pricing Strategy, Segmentation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.