The Economist - UK (2022-03-26)

The Economist March 26th 2022 Business 63

Pricingpower(1)

Artificial prices

F

ewamericanbusinesstacticsareas peculiar in a freewheeling capitalist societyasthemanufacturer’ssuggestedre tailprice.P.H.Hanes,founderofthetextile millthatwouldeventuallybecomeHanes Brands,cameupwithitinthe1920s.That allowedhimtouseadvertsinpublications acrossAmericatodeterdistributorsfrom gouging buyers of his knitted under garments. Even today many American shopkeepershewto manufacturers’ rec ommendedprices,asmuchastheywould lovetoraisethemtooffsettheinflationary pressuresontheirothercosts.Agrowing number,though,resorttomoresophisti cated pricing techniques. A seminal study from 2010 by McKin sey, a consultancy, estimated that raising prices by 1% without losing sales can boost operating profits by 8.7%, on average. Get ting this right can be tricky. Set prices too high and you risk losing customers; set them too low and you leave money on the table. Retailers have historically used rules of thumb, such as adding a fixed margin on top of costs or matching what competitors charge. As energy, labour and other inputs go through the roof, they can no longer af ford to treat pricing as an afterthought. To gain an edge, shopkeepers have been turning to priceoptimisation systems. These predict how customers will respond to different pricing scenarios, and recom mend those that maximise sales or profits. At their core are mathematical models that use oodles of transaction data to estimate price elasticities—how much demand in creases as the price falls and vice versa— for thousands of products. Pricesensitive items can then be discounted and pricein sensitive ones marked up. Merchants can finetune the algorithms to prevent unde sirable outcomes, such as doubledigit price surges or larger packages costing more by unit of weight than smaller ones. These systems are becoming cleverer thanks to advances in artificial intelli gence (ai). Whereas older models used his torical sales data to estimate price elastic ities for individual items, the latest crop of aipowered ones can spot patterns and re lationships between multiple items. Mak ers of pricing software are incorporating new data sources into their models, from customers’ tweets to online product re views, says Doug Fuehne of Pricefx, one such firm. The cloudbased platform de veloped by Eversight, another provider, al

lowsretailerstotesthow slight increases or decreases in the price of, say, Heinz ketchup at different stores affect sales not just of that specific condiment but across the category. It is used by big manufactur ers such as CocaCola and Johnson & John son, as well as some supermarkets (Ra ley’s) and clothessellers (JCPenney). All this makes pricing systems “much more threedimensional”, observes Chad Yoes, a former executive at Walmart who oversaw pricing at the retail behemoth. Re tail bosses are keen to promote this sophis tication to investors, who value firms’ pric ing power at a time of high inflation. In February Starbucks, a chain of coffee shops, boasted about its use of analytics and ai to model pricing “on an ongoing basis”. us Foods, a food distributor, has touted its pricing system’s ability to use “over a dozen different inputs” to boost sales and profits. Priceoptimisation may make prices more volatile. “Retailers are pricing faster today than they ever have before,” says Matt Pavich of Revionics, another pricing software firm. That is especially true in the fastmoving world of ecommerce. But even Walmart reviews the prices of many items in its stores 24 times a year, says Mr Yoes, up from once or twice a few years ago. What pricing systems do not do is lead inexorably to higher prices. Mr Pavich calls this misconception “one of the biggest myths” about products like his. Sysco, a big food distributor which rolled out new pric ing software last year, is a case in point. The firm says the system allows it to lower prices on “key value items”—as pricesen sitive bestsellers are known in the trade— and raise them on other products. It can thus increase profits by expandingsales while maintaining margins. That keeps investors content and shoppers sweet. n

How companies price their products is turning from art into science

Priced to measure

Pricingpower(2)

Foodfight

T

he market for packaged foodsis a competitiveone,wherepricerisesby onefirmriskpushingshoppersintothe armsofrivals.Companiesintheindustry dealwithsoaringcostsbyhedgingagainst spikesincommoditymarketsusingfor wardcontracts,reformulatingproductsso theycontainlessofthepricierfoodstuffs or, failing that, surreptitiously making packagesa bitsmallerwhilekeepingthe ticketpricethesame. Amid pandemicrelated supplychain bottlenecks, labour shortages and crop failures,foodfirmshaverepeatedlydone allthat.Evenso,theyhave hadtoraise prices,oftenlessjudiciouslythanisideal (see previous article). The invasion of Ukraine,known asEurope’sbreadbasket thanks to its rich soil, by Russia, the world’stopexporterofwheat,isforcing theirhandonceagain.Togetherthetwo countriesaccountfor29%ofinternational wheatsalesandnearly80%ofsalesofsun flower oil. Disruptionsto those critical suppliesarepushingupfoodcompanies’ costsjustasenergycostsarealsoskyhigh asa resultofthewar. It willbeharderforEuropeanfoodcom panies topass pricerises to consumers thanforAmericanfirms.Supermarketsin Europe are more concentrated than in America,anddrivea harderbargainwith suppliers. Walmart, America’s biggest, controls17%ofthedomesticmarket.Its British and German opposite numbers, TescoandEdeka,respectively,havenearly 30% oftheirs. Moreover, costconscious Europeansshopmoreatdiscounterssuch asAldiorLidl.Theyarealsolessfussythan Americans about brandedproducts and

B ERLIN Producersofpackagedfoodsare makingyourlunchmoreexpensive

Cannons and fodder Share prices, February 22nd 2022=100, $ terms

Source:RefinitivDatastream

110

105

100

95

90

85

80 February March

Foshan Haitian

General Mills

Danone

Kraft Heinz

The Economist - UK (2022-03-26)

Get our desktop app

Company

Features

Documentation

Resources