Do price increases reflect value?

An interesting article appeared in Advertising Age this week regarding Restoration Hardware's latest pricing strategy. Hint: It's all in the marketing! Click here.

How will the current retail environment affect green industry sales in the spring?

Quick overview of some of yesterday's December retail data (no real surprises):

Wal-Mart cut fiscal Q4 earnings target about 10%.
Costco posted a 4% drop in December same-store sales.
Family Dollar gained 8%; Same store sales gained 6%.
BJ’s Wholesale had 1.6% sales growth; the lowest in a year.
Sears (the largest U.S. department-store) sales fell 7.3%.
Target same-store sales fell 4.1%.
Macy’s December sales fell 4%.
Gap stores sales fell 14%.
Abercrombie & Fitch fell -24%.
Neiman Marcus reported a 28% drop off.
Limited Brands reported a 10% drop.

Also, a recent DJN press release states:

Food retailers are girding for a "battle" with vendors in the first half of the year as grocers push for lower prices to help shoppers through the recession and food manufacturers resist, Supervalu Inc. (SVU) Chief Executive Jeff Noddle said Wednesday.

With commodity and ingredient costs falling sharply in recent months, supermarket chains have been pushing for lower prices on everything from coffee to soups to help increase sputtering sales. In recent months, both Supervalu and competitor Safeway Inc. (SWY) have switched to a pricing strategy that sells more products at "everyday low prices" rather than relying on coupons or other promotions.

But food manufacturers have been reluctant to roll back their price increases, taken to offset higher input costs, despite some consumer product categories experiencing declines in sales volume of between 3% to 5%, Moody's Investors Service said in a recent report on the sector.

Lastly, from Wednesday's Business Week:

Shoppers are getting used to those 75 percent off sale signs, and that's bad news for merchants who worry they will also have to quickly slash prices on spring goods to attract customers.

Anxieties about how rampant discounts have affected shoppers' psyches and stores' profits are running high...The deep price cuts are making shoppers question the true value of items.

My Commentary:

Obviously, all of the trends above begs the question of whether or not we are "training" consumers to be more price (discount) oriented that they have been in the past. Or, as a friend of mine put it...what is the longer-term psychological impact of the drastic price reductions of the holiday and post-holiday sales periods going to be on the going-forward consumer expectations and purchase behaviors?

Obviously, people are currently spending less than normal; certainly less than justified according to their actual incomes (they are saving more which is good in the long run but bad for the economy in the short run). They are also shopping smarter, focusing on the "value" they derive from each precious dollar spent. So as we have discussed before on this blog, those retailers that have their value proposition clearly delineated will be in a much better competitive position than those who don't.

Without a doubt, several leading lawn & garden retailers are already positioning themselves for price-oriented competition this spring. We have always had a segment of consumers that are price-conscious shoppers and this will obviously bode well for them. Today's economic environment may increase the number of these price-oriented consumers and the real question is by how much.

But the majority of our core lawn & garden consumer base have other things besides price in their value equation. The question is whether or not retail firms have successfully identified what THEIR key customer base truly values and are differentiating themselves accordingly.

Another key point to remember is that even though unemployment is at 7.2% (from today's labor report), we'll still have 93% of the workforce earning a wage. The monies not being spent now will eventually burn a hole in people's pockets (if historical behavior holds true). It will probably take a few more months of spending declines for this hole-burning to take effect, so the economy will likely hit its low point this spring.

The key question then is whether "spring fever" will induce our core customer base to let go of those discretionary dollars burning a hole in their pockets. And, if so, will they be willing to pay the prices we must charge to cover the cost increases we've incurred in the last 2 years? Again, they are much more likely to do so if we appeal to their value equation.

It will also be very interesting to see how President-elect Obama's yet-released-but-being-revamped stimulus plan is eventually structured and even more interesting to see how much of it is actually spent (historically only 20-40% of a stimulus is spent -- the rest is saved or used to pay down debt). But fortunately, many folks will be receiving their tax returns about the time spring season kicks off, which means another influx of funds to burn a hole in their pockets!

Ok, now that we've discussed the retail environment, what does all of this mean for green industry growers? The tougher selling environment at the retail level this spring translates into a need to develop more intensive and collaborative relationships with your customers in meeting the needs of the end consumer – particularly in terms of their value proposition. During the downturn in 2008, those growers that proactively worked with their retailers (and usually these were pay by scan sales) to more closely provide landscape solutions for consumers were the ones who were most successful.

If any of you attended the recent industry webinar entitled, “It’s a Great Time to be in Business” you probably heard lots of great ideas. One of the best quotes that I wrote down during the webinar was “These are the times during which great companies are made.” Bearing that in mind, recall also that there are plenty of companies that have survived the last 50 years, which means they have gone through 11 such recessionary periods. How did they do it? By relentlessly focusing on and emphasizing their value proposition to their key customer base. There's a great lesson there. What is yours?

Discounting can be dangerous!

During tough economic times, companies often rush to reduce prices on their products and services. That seems like common sense: People can’t afford to spend as much, so charge less to keep them buying. But discounting has its perils.

To be sure, discounting is effective when done wisely and strategically. It can get consumers excited about a product, encourage them to buy more, and help your short-term bottom line. However, whether the purchase is a hot dog, a handbag, or a stay at a five-star hotel, customers want good value for their hard-earned money. The price of something is often an important determinant of its perceived value, as Dan Ariely points out in Predictably Irrational. Often, the more consumers pay, the more value they ascribe to a purchase. If you discount prices purely to boost sales, buyers may begin to question that value.

Consider Abercrombie & Fitch, which lowered prices by roughly 15% during the 2000–2002 downturn. When the dust cleared, the company realized that it had sacrificed much of its brand’s cachet and lost significant market share. A&F didn’t recover until 2004—and then only after returning to higher prices. In August 2008, having learned its lesson, the company announced that it was considering another price increase, despite a decline in second-quarter profits. The goal: to enhance what the CEO called the “iconic status” of the brand.

But discounting is so easy that some companies simply can’t resist. Starbucks, which posted its first-ever earnings loss in July, has begun to offer lower-priced options, such as a cup of coffee for $1, with free refills. This strategy may boost sales in the short term, but we suspect that, as with A&F, it will hurt the Starbucks brand in the long term.

Discounting is not always a bad idea, though—there are safe ways to lower prices. Earlier this year, Chrysler discounted something that does not affect its core brand: gasoline. It guaranteed to purchasers of new cars a price of no more than $2.99 per gallon of gas for three years. The idea was to subsidize the fuel that a new car uses, not the car itself. It’s similar to what GM did in 2001 by discounting its financing rather than its cars. Obviously, the auto industry has more problems than brand deterioration. Nonetheless, this is smart marketing during a downturn: It couples the appeal of a discount with an implicit message about the value of the core product.

So if you’re eyeing a simple, traditional discount strategy during the present slowdown, first consider the potential for damage to your brand and then evaluate the brand insurance that a more nuanced approach may offer. If you inadvertently shatter your brand’s mystique, reestablishing the value proposition to consumers may be tougher than you expect.

Jeffrey M. Stibel and Peter Delgrosso in the latest Harvard Business Review.

Pricing in a downturn

From the latest McKinsey Quarterly...

Getting pricing right is always a challenge in an economic downturn, as decreasing demand, excess capacity, and greater price sensitivity all conspire to drive down prices. In most downturns, the cost of raw materials, feedstocks, and other upstream supplies—as well as the cost to serve customers (for delivering goods, for example)—tends to stabilize and even decrease as business activity slows. As a result, decreases in downstream prices are at least partially offset by lower upstream costs. But in the current environment, not only is weaker demand from the end user making it harder to maintain prices, but significantly higher and more volatile input costs mean that companies caught in the middle are getting hit from both sides.

What’s a business to do? In this unusual downturn, companies need to manage the profitability of individual customers and transactions with greater precision, develop richer insights into their customers’ changing needs and price sensitivities, and understand more clearly the microeconomics that shape their own industries and those of their suppliers. We’ve assembled six tactics aimed at maintaining the best balance possible between sales volume and profit margins in the current challenging environment.

Watch for sudden shifts in price structure

Companies should be vigilant in monitoring pricing policies that reduce revenue—such as volume discounts, rebates, and cash discounts—as well as cost-to-serve, including freight and sales support. In the current downturn, rising costs and declining demand can cause these elements to change more dramatically and quickly than they have in the past. Rapidly increasing fuel prices, for example, are putting intense pressure on delivery costs. Declining demand means that some customers may be collecting volume discounts they no longer deserve. Best-practice companies are reviewing much more frequently their pocket margin waterfalls, which show how much revenue companies really keep from each of their transactions, and adjusting their pricing policies accordingly—for example, by adding delivery fuel surcharges to every order. Without the extra attention and quick action, erosion at all points of a transaction can quickly destroy profits in times like these.

Monitor customer-level profitability

Companies should use transaction-level data to measure precisely the profitability of each customer. By doing so, companies can detect if the cost to serve particular customers or declining order volumes are nudging those customers below target profitability levels. In this downturn, for example, many customer groups are becoming simultaneously smaller and more costly to serve. One industrial company found that more than 20 percent of its customers had fallen below breakeven profitability, forcing it to raise prices selectively and, where possible, lower cost-to-serve by decreasing delivery frequency, reducing sales support, or fulfilling orders through alternate channels.

Adjust to changing customer needs

Downturns always prompt changes in customer needs and in the benefits they value when choosing a supplier. The dynamics of the current downturn mean that such swings can occur even more rapidly. In this environment, the best companies are constantly assessing—through market research and direct contact—how economics are changing for their customers. Even more important, they are reacting quickly by retooling their price and benefit offerings accordingly. For example, one plastic resins supplier that had developed a fast-curing resin (to enhance capacity of injection molders when the economy was strong) has now developed a less costly resin that doesn’t cure as quickly. The new resin helps the supplier’s customers decrease costs, because molders are not running at full capacity during the downturn. With other supplies raising their prices, many molders see the slow-curing resin as an attractive alternative. As a result, the supplier can maintain its profit margins even while selling the alternative resin at a lower price. The combination of lower demand and higher input costs in the current downturn makes it critical to get these kinds of adjustments to the cost/benefit balance correct.

Update price sensitivity research

Dramatic increases in energy and food prices have made consumers much more sensitive to prices across a wide range of product categories. Each price increase for necessities such as food and fuel has cut a little more from discretionary budgets, sharply increasing price sensitivity. Market price tests become obsolete after just a few months. To get price points right, pricing sensitivity research and market price tests should be rerun immediately to track these changes.

Monitor your industry’s microeconomics

Radical shifts in costs and demand have thrown previously predictable market pricing mechanisms into chaos. Responding correctly requires a keen understanding of the microeconomic forces at play at the industry level. In one example, a building materials company found itself in a precarious position as the downturn deepened: a precipitous decline in US housing starts meant diminishing demand, while the costs for raw materials, energy, and transportation were increasing rapidly. In response, the company reassessed the industry’s microeconomics, looking in particular at the latest supply, demand, and cost dynamics. With this new information, managers cut capacity at a plant in an area where the decreased supply would not cause a local shortage. The capacity reduction, which would have had little if any effect on market prices a year earlier, brought about a better balance between supply and demand and kept market prices an estimated 10 percent higher than they would have been without the change.

Study your suppliers

The extreme volatility in this downturn demands that companies reexamine not only the microeconomics of their own industries but also the microeconomics of their suppliers’ industries. Recently, a specialty chemicals company invested in modeling the current industry supply, demand, and cost dynamics for one of its primary raw materials. By doing so, the company predicted an industry-wide, 15 percent price increase for that raw material three months before it happened—a feat of some significance because there hadn’t been an annual price increase of more than 5 percent for that material within the past six years. Suspecting an imminent and unusually large price increase, the chemicals company began adding clauses covering raw-material price increases to its customer contracts, a move that would have met extreme resistance if made after the price increases were announced. Instead, the move established an industry precedent for passing cost increases through to customers.

About the Authors

Cheri Eyink is a consultant and Mike Marn is a principal in McKinsey’s Cleveland office; Stephen Moss is an associate principal in the Stamford office.

Solving the cost-price squeeze

According to Table 10 in today's BEA report, real disposable personal income increased in July by 1.2% compared to July last year, following a 3.4% annual increase in June and 6.3% increase in May. Both growth rates (May and June) were above the 2.6% average growth in real disposable income since 2001, following 7 months (October 2007 to April 2008) of below-average growth.

Although real disposable income growth showed weakness in the last quarter of 2007 (0.6%) and the first quarter of 2008 (-0.7%), the above-average, year-to-year growth rates of 6.3% (May) and 3.4% (June) contributed to an 11.4% increase in real disposable income during the second quarter 2008 (see Table 6), one of the biggest quarterly increases in history, largely due to the Economic Stimulus Act of 2008.

Couple this increase in real disposable income with the core inflation rate holding relatively steady (see 8/15/08 post) and this means that [a sizable portion of] our end consumer in the green industry has the means with which to purchase our products and services, but do they have the desire -- particularly at the prices we must charge in order to cover our current cost-price squeeze?

My friend, Lloyd Traven of Peace Tree Farm, just reiterated to me of how tough it is for growers right now given the "20% increases in pots, film, chemicals, and 30+% for fertilizers, soil, etc---and don't forget to add energy, labor, etc. BTW, medical just went up again, and let's not forget tuition." The recent news of Hines Nursery's bankruptcy (and the rumors of others pending) also reminds us that no one is immune from the effects of this cost-price squeeze.

But the key question is what to do about it? Logic would tell us there are only two options -- either (1) employ the supply side strategy of continuing to shave costs out of the value chain internally or (2) opt for the demand side strategy of increasing price. Anyone who has been reading Making Cents for a while will readily know that I have been pushing for growers to embrace both strategies, but particularly option #2 (click on the differentiation tab on the right hand side of the page to view relevant posts).

On the flip side, however, never underestimate the value of a regimen of lean flow analyses on your value chain activities. Several growers at the Seeley Conference related some impressive cost savings testimonials to the rest of the group. You might want to give Gary Hudson a call if you're interested in finding out more about lean flow. Also check out recent issues of Greenhouse Grower and GMPro for lean-related articles.

Stay tuned on more on the cost-price squeeze topic later...

Real versus perceived value

Marvin Miller's latest musings in the August 18 America in Bloom newsletter is a must read. Click here to view his comments. Pay particular attention to his "perceived" value comments.

Signaling perceived value is a key point in any successful differentiation strategy. The questions you must answer about these signals include:

1. What mix of quality, price, service, convenience, and selection signals can influence perceived value?
   
2. What signals work for your customers?
   
3. Are multiple signals necessary?
   
4. Does it depend on purchasing behavior, customer segment, or outlet(s) chosen, or all or the above?
   

Why does it matter? The greater the perceived value that higher the willingness to pay. Period.

America in Bloom is designed to increase perceived value by promoting nationwide community beautification programs through the use of flowers, plants, trees, and other environmental and lifestyle enhancements. AIB does this by providing educational programs, resources, and the challenge of a friendly competition between participating communities across the country.

The end result? Only a few things like improved quality of life, enjoyable end results, greater community involvement, recognition for volunteer efforts, inspired imaginations, beautified spaces, educational opportunities, shared ideas, and new friendships. Sounds like a good way to increase perceived value of our products and services to me.

Gas prices actually do influence driving behavior

The chart below shows the annual vehicle traffic volume, measured in billions of miles traveled in the U.S., on a moving 12-month basis through February 2008 from the Federal Highway Administration. The flat trend in traffic volume over the last year or more, along with the declines in each of the last four months through February 2008, appears to be the most significant adjustment to traffic volume in any comparable period during the last 25 years. High gas prices appear to be having an effect on driving habits.


Other behavior changes:
More bicycles are being sold.
More folks are taking mass transit.
More small cars are being sold.

Your taste buds are in your wallet

My good friend, Stan Pohmer, emailed today with a blurb from the April 28 issue of BusinessWeek (see below). He then asked "Do you think the same mindset applies to floral products?" An interesting notion for sure. Let's take a quick look at the short article (below) and then I'll comment on Stan's question.

Your Taste Buds Are In Your Wallet
Is that Rubicon Estate cabernet worth the $80 you may have paid? The answer lies within the folds of your medial prefrontal cortex. A recent study conducted by researchers at Stanford Graduate School of Business and the California Institute of Technology concludes that when people know a wine is expensive, the pleasure they get from it is enhanced in the area of the brain where such sensations are processed. In the study, published online earlier this year in the Proceedings of the National Academy of Sciences, students were placed in an MRI machine and given sips of red wine--including the same one presented twice, with two different price tags: $5 (the actual bottle price) and $45 (a fiction). The subjects all said they liked the "expensive" wine better--a preference mirrored by increased activity in their prefrontal cortexes. The lesson, says Baba Shiv, an associate professor of marketing at Stanford: "There's a temptation among marketers to keep reducing prices. We're saying be careful before you embark on that strategy." -Steve Hamm

Now bear in mind, Stan, that I am no medical doctor but even the neophyte knows the medial prefrontal cortex region of the brain has been implicated in planning complex cognitive behaviors, personality expression, and moderating correct social behavior. The most typical neurological term for functions carried out by the prefrontal cortex area is executive function. Executive function relates to abilities to differentiate among conflicting thoughts, determine good and bad, better and best, same and different, etc.

In the marketing literature, it is a commonplace observation that in many markets where consumers are not fully informed about product quality (e.g. safety, durability, probability of being satisfied) prior to purchase, goods sold at relatively high prices tend to be associated with high quality. In other words, price acts as a quality signal -- in both directions.

It seems to me that the wine example fits this model perfectly since the novice wine drinker knows very little about what constitutes "quality." They merely associate a higher price with a higher quality wine -- at least until they take a wine tasting class. In the same way, the average buyer of floral products knows very little [in my humble opinion] about what constitutes a "quality" flower and in the absence of grades and standards to tell them what is quality and what is not, they will naturally gravitate to the same price signaling measure of quality as the novice wine buyer.

If this is indeed the case, much money is being left on the table.

Reasons for rising food prices

Ok, I realize that this post might seem peculiar at first given that this is a green industry oriented blog. But remember that the supply chain for our products is quite similar to that of perishable foods. Therefore, logically, any supply chain dynamics affecting one industry must also affect the other. Given that premise, let's proceed.

Much attention has been placed in the media on the fact that market prices for major food commodities such as grains and vegetable oils have risen sharply to historic highs of more than 60 percent above levels just 2 years ago. Many factors have contributed to the runup in food commodity prices. Some factors reflect trends of slower growth in production and more rapid growth in demand, which have contributed to a tightening of world balances of grains and oilseeds over the last decade.

Recent factors that have further tightened world markets include increased global demand for biofuels feedstocks and adverse weather conditions in 2006 and 2007 in some major grain and oilseed producing areas.

Other factors that have added to global food commodity price inflation include the declining value of the U.S. dollar, rising energy prices, increasing agricultural costs of production, growing foreign exchange holdings by major food importing countries, and policies adopted recently by some exporting and importing countries to mitigate their own food price inflation.

In assessing prospects for the future, there are a number of uncertainties and concerns:

Global economic growth: If rapid growth continues, particularly in developing countries, it will continue to put upward pressure on food commodity prices through increases in food demand.

Energy prices: If petroleum prices continue to rise, costs of agricultural production will rise, as will the cost of processing, and the cost of transporting products to markets both within a country and exporting to other countries. Continued high petroleum prices will also sustain the global incentives to produce more biofuels.

Biofuels production: In USDA’s 10-year agricultural projections, global growth in biofuels production begins to slow in the next several years and production from grains and oilseeds flattens out in the next half decade. World food commodity prices are not projected to retreat to past levels. However, several years into the future, the underlying long-term trend in rapidly increasing global demand is expected once again to be the primary contributor to future upward pressure on food commodity
prices.

Supply response capacity of the global agricultural production system:
• Cost of inputs: Continued increases in production costs, especially in energy-related costs, will restrain the world’s production response. Higher costs for fertilizer, fuel, and seeds could cause farmers without access to credit to plant less than they otherwise would have, or to shift to crops requiring fewer inputs.

• Additional cropland (quantity and quality): What will be the long-run impact of higher world food commodity prices on the amount of land used to produce the crops? What is the productivity of the land that will be used to increase production?

• Water shortages: How quickly will constraints on the amount of water available for agricultural production become more widespread?

• New seed varieties and use of biotechnology: Will higher food prices encourage some countries to adopt the use of biotechnology, especially genetically modified seed for crops? Will future research focus more on yield-enhancing varieties rather than cost-reducing innovations?

• Biophysical response to climate change: How will climate change affect agricultural production? How will it change temperatures, precipitation, the length of growing seasons, and variability of yields? How, and under what circumstances, will climate change increase and/or reduce production? In affected regions, how difficult will it be for producers to shift to different crops, to adopt new cropping patterns, and to adjust production practices to the new environment?

With such low world stocks of food commodities, food prices are vulnerable to a production shortfall in one or more major production areas. If a significant shortfall occurs this year due to weather or disease, food prices might continue to rise sharply from the current high level.

Although trade flows can mitigate some of these effects, new or existing trade restrictions or barriers can exacerbate price impacts. However, if good crop production conditions exist in the Northern Hemisphere during the next 6 months, food commodity prices could retreat significantly from their current highs.

Exploring the psychological "rules" of pricing

Even wonder why retailers price goods at $4.99 rather than $5.00? There may be a good reason - establishing the increment of comparison around the price anchor. In the April 2008 issue of Scientific America, an article by Wray Herbert explores this issue.

One of Alfred Hitchcock’s most enduring bits of cinematic comedy is the auction scene in the espionage thriller North by Northwest. Cary Grant plays Roger Thornhill, a businessman who has been mistaken for a CIA agent by the ruthless Phillip Vandamm. At a critical juncture, Thornhill is cornered by his enemies inside a Chicago auction house, and the only way he can escape is by drawing attention to himself. When the bidding on an antique reaches $2,250, Thornhill yells out, “Fifteen hundred!” When the auctioneer gently chides him, he loudly changes his bid: “Twelve hundred!” When the bidding on a Louis XIV chaise longue reaches $1,200, Thornhill blurts outs, “Thirteen dollars!” The genteel crowd is outraged, but Thornhill gets precisely what he wants: the auctioneer summons the police, who “escort” him past Vandamm’s henchmen to safety.

Clever thinking and good comedy. It is funny for a lot of reasons, and one is that Thornhill violates every psychological “rule” for how we negotiate price and value with one another. So much of life involves “auctions,” whether it is buying a used car or making health care choices or even choosing a mate. But, unlike Roger Thornhill, most of us are motivated by the desire for a fair deal, and we employ some sophisticated cognitive tools to weigh offers, fashion responses, and so forth—all the to-and-fro in getting to an agreement.

But how does life’s dickering play out in the brain? And is it a trustworthy tool for getting what we want? Psychologists have been studying cognitive bartering for some time, and several basics are well established. For example, an opening “bid” of any sort is usually perceived as a mental anchor, a starting point for the psychological jockeying to follow. If we perceive an opening bid as fundamentally inaccurate or unfair, we reject it by countering with something in another ballpark altogether. But what about less dramatic counter offers? What makes us settle on a response?

University of Florida marketing professors Chris Janiszewski and Dan Uy suspected that something fundamental might be going on, that some characteristic of the opening bid itself might influence the way the brain thinks about value and shapes bidding behavior. In particular, they wanted to see if the degree of precision of the opening bid might be important to how the brain acts at an auction. Or, to put it in more familiar terms: Are we really fooled when storekeepers price something at $19.95 instead of a round 20 bucks?

Janiszewski and Uy ran a series of tests to explore this idea. The experiments used hypothetical scenarios, in which participants were required to make a variety of “educated guesses.” For example, they had subjects think about a scenario in which they were buying a high-definition plasma TV and asked them to guesstimate the wholesale cost. The participants were told the retail price, plus the fact that the retailer had a reputation for pricing TVs competitively.

There were three scenarios involving different retail prices: one group of buyers was given a price of $5,000, another was given a price of $4,988, and the third was told $5,012. When all the buyers were asked to estimate the wholesale price, those with the $5,000 price tag in their head guessed much lower than those contemplating the more precise retail prices. That is, they moved farther away from the mental anchor. What is more, those who started with the round number as their mental anchor were much more likely to guess a wholesale price that was also in round numbers. The scientists ran this experiment again and again with different scenarios and always got the same result.

Why would this happen? As Janiszewski and Uy explain in the February issue of Psychological Science, people appear to create mental measuring sticks that run in increments away from any opening bid, and the size of the increments depends on the opening bid. That is, if we see a $20 toaster, we might wonder whether it is worth $19 or $18 or $21; we are thinking in round numbers. But if the starting point is $19.95, the mental measuring stick would look different. We might still think it is wrongly priced, but in our minds we are thinking about nickels and dimes instead of dollars, so a fair comeback might be $19.75 or $19.50.

The psychologists decided to check these lab findings in the real world. They looked at five years of real estate sales in Alachua County, Florida, comparing list prices and actual sale prices of homes. They found that sellers who listed their homes more precisely—say $494,500 as opposed to $500,000—consistently got closer to their asking price. Put another way, buyers were less likely to negotiate the price down as far when they encountered a precise asking price. Furthermore, houses listed in round numbers lost more value if they sat on the market for a couple of months. So, bottom line: one way to deal with a buyer’s market may be to pick an exact list price to begin with.

More on pricing...

In the most recent OFA Bulletin (Jan/Feb 2008), Behe and Dudek presented an article that reinforced the negative impacts of retailers discounting prices needlessly. Using prices collected from Michigan garden centers, the authors demonstrate the WIDE variation in pricing for similarly-sized products in the same trade area. The analysis showed that significant dollars can be left “on the table” from under pricing -- using price as the single mechanism used to attract customers (see Table 1 – click on the table to view in larger format).

However, the same data can be used to demonstrate a significant reverse corollary. Recall that in an earlier post, I talked of the inelasticity of demand and that if firms successfully differentiate themselves from competitors in their local trade area, they are able to raise prices and though they may sell fewer units, total revenue for the firm actually increases.

Using Table 1 data, assume that the current price is $3.99 per unit (which requires sales of 162 units to break even and generates sales revenue of $1,995). If price per unit is increased to $4.49 (a 10% increase), only 144 units are needed to break even and profit rises to $2,245. In similar fashion, an additional 10% increase in price translates into even fewer units to break even and another increase in sales revenue.

Ceteris parabis, holding all other things constant, profit rises as well. So what are you waiting for?

An Economic Justification to Raising Your Prices

In the January issue of GrowerTalks, Chris Beytes provided us with some excellent case studies of firms that have recently raised their prices (great job Chris!). I think it merits repeating that the only way in which this makes sense economically is if the company successfully differentiates itself in the mind of the customer in terms of the types of products or services offered and the segment(s) of customers that are being targeted. It is a well-proven fact that customers use five different attributes in making a decision about what products/services to buy and from whom to buy them from – quality, value, service, convenience, and selection.

We economists characterize demand by a concept called the price elasticity of demand which measures the nature and degree of the relationship between changes in the quantity demanded of a good/service and changes in its price. An important relationship to understand is the one between elasticity and total revenue. The demand for a good/service is considered relatively inelastic when the quantity demanded does not change much with the price change. So when the price is raised, the total revenue of the firm increases, and vice versa. What this effectively means is that green industry firms can actually raise their price, and though they might sell fewer units of the product they are selling or the service they are offering, total revenue for the firm still goes up. So, the obvious question is this…how does one go about making their local demand more inelastic? The answer…by making the firm unique and different somehow in terms of quality, value, service, convenience, and selection! That’s why your marketing efforts are so important. They are the key to successful differentiation.

In summary, if your company is successful in differentiating itself from competitors, you are essentially making your firm-level demand more inelastic within your respective trade area and you can subsequently raise your prices and [even though you may sell fewer units] total firm revenue will still increase.

Now I can already hear the objections: “If I raise my price, my customers are going to defect and buy from my competitors.” Let me provide my own testimonial regarding this common objection to raising price. Over the last few years, all (100%) of the green industry firms that I have convinced [after much prompting and counseling] to actually try this have experienced an increase in total firm revenue. Not many, not most…ALL. Interestingly, some even found that per-unit sales actually increased when they increased their prices, which tells me they were pricing their products way too low to begin with. Low prices tend to result in a low quality perception in the mind of the customer and when you raise your prices, sometimes you can influence the price-quality connotation positively.

To bring this to a close, lean manufacturing and shaving costs out the value chain is important as the industry matures, but if we [as an industry] are to make any meaningful increase in our margins and increase profitability, it has to come from the demand side of the equation, whcih means we must obtain higher prices for the products and services we offer!

Economics of Bidding and Estimating

Landscape service firms must do 2 things if they are to make money in today's competitive Green Industry environment -- (1) develop an accurate estimate of hourly field-labor costs and (2) develop a system to fully recover overhead expenses. Once this is accomplished, generating realistic (and profitable) bids and estimates becomes a much more straightforward task. Benchmarking the firm's performance relative to similarly-sized businesses is also a mandatory managerial task for those who desire to see their business grow and prosper. More detailed information can be found in a presentation delivered at the recent education seminar held by the Southeast Texas Nursery Growers Association. Click here to view this presentation.

How can they sell it at that price?

Let’s face it. Business in the Green Industry is competitive and sometimes cut-throat. In recent years, I have had many growers ask me the question: What do I do when another grower is selling product in my market at a price that is below my break-even cost? While there is no perfect answer to this question, I have included several tried and true suggestions below.

• Sharpen your sales skills. For example, educate buyers regarding your unique selling proposition in terms of your quality, value, service, convenience, and selection relative to the competitor(s). Also emphasize the historic “win-win” relationship you have shared with the buyer – assuming you have one of course. Some examples might include: a) that you have been there when they needed you, b) that you did not gouge them with extraordinary price increases when availability of a certain product in the market was low, c) that the low prices obtained from the undercutting grower are simply not possible at the quality level you typically provide.
  


• Go and buy as much of the competitor’s product you can and use it as part of your own inventory – assuming it is of comparable quality or could be within a short period of time.
  Match the price in the short run. A marginal pricing strategy (where selling price is greater than your variable costs but less than total costs) can be used in the short run, but remember that it is not sustainable in the long run. With this strategy, you are attempting to “wait out” the competition until theoretically they go out of business or can no longer afford to compete in your market. This is considered to be more reactive in nature, whereas the first two options are more proactive. You must emphasize to the buyer that this is a one-time phenomena; that you are only doing this because you value their business.
  


• Consider the nature of the product they are selling in your market. If the product they are selling in competition to yours has become “commodicized” – that it has become a commodity item that many are starting to grow and carry – then you have the option to quit growing it, or grow a different size, form, cultivar, or variety. In other words, tweak the commodity so that it becomes a differentiated product.
  
  
• Examine your production system and the associated costs of production for that product. It may be that you are using a system that increases your relative costs of production. To do this, you may have to visit other growers, attend educational conferences and workshops, or participate in field tours.