Who Controls Price?
May/12/2011 01:31 PM
This is an interesting question and topic that can stir a heated debate. Is it the retailer, the manufacturer or the consumer? Well, there are three legs to this stool and all of them keep the stool standing. Retailers, manufacturers and consumers all influence the final price for goods purchased. Price may actually be influenced by other forces including our government and foreign governments. Farm subsidies and foreign government control over currency exchange rates, for example can influence cost of goods and ultimately price consumers pay at the register.
In pricing, there are many simultaneous forces at work including supply/demand, commodity prices, competition, and the presence of monopolist or oligopoly power in the market. Retailers set the initial retail price, which usually falls within margin expectations for the category. Manufacturers can influence the retail price based on their wholesale prices, trade incentives or discounts offered directly to the consumer. An example of this is a coupon or manufacturer rebate. In the real world the initial price may not stick and over time as market forces establish an equilibrium price or pricing norm. As soon as the price is dangled in front of the consumer, a series of interactions occurs. Some customers will buy at that price point, others will not. Competitive retailers may react by matching that price or lowering theirs. Competitive manufacturers may also lower or match pricing to close any retail price gaps. Manufacturers will offer retailers what’s called price “buy down” allowances to manage price gaps. To maintain parity pricing at the shelf, manufacturers offer retailers a penny for penny allowance on what’s sold through the register. In this first round, everyone takes a wait and see approach.`If volume is up but profit is down, retailers may inch prices back up. Retailers will often use computer programs to set prices based on elasticity modeling and other data inputs. Computer software recommends a price and buyers can set rules to automatically change prices or override what the recommendations says.
Game theory is often factored into pricing decisions. In the classic “prisoner’s dilemma”, if both retailers lower price, they both lose. If they both raise price they both win and if one goes up while the other stays flat, there is winner and a loser. Computer models and people cannot predict what the competition will do. But there is price signaling that goes on and yes this is perfectly legal. The prices of key items or what’s commonly referred to as KVI’s or Key Value Items is closely monitored by the trade. Competitors all know prices will fluctuate up and down and there is some tacit collusion. If everyone agrees not to set suicidal pricing, everyone wins. Suicidal pricing is when a retailer tries to make a pricing statement and that sets off a price war. It forces everyone in the market to lower prices to reduce the price gap. Most retailers are smart enough not to be the first mover. In a price war nobody wins except the consumer. Profitability is reduced and since retailers are graded on same store sales and accountable to shareholders there is heat to maintain current sales levels.
Consumers determine if a price being charged is fair or not. They vote with their pocketbook by either purchasing the item, buying a substitute, or nothing at all. Retailers set prices using wholesale price as the starting point and expected margins for products in the category. Manufacturer’s set wholesale price based on an internal hurdle rate, usually a well kept secret. Market mechanisms keep prices in balance. If demand is low, prices may drop to stimulate sales. If demand is brisk, prices will stay high. Competitive activity including price matching or price decreases may trigger a price change and there may be several rounds of price changes until an equilibrium price is set by the market. This plays out differently in each market geography. Labor costs, transportation costs and rent get factored into price. The strength of discounters such as warehouse club store and mass merchandisers will also influence prices locally. That’s why a bottle of Hidden Valley Ranch salad dressing may cost $4.79 in San Francisco, $4.29 in Los Angeles and $3.89 in Denver.
So let’s circle back to our original question of who controls price. In CPG and everyday consumer goods, consumers, manufacturers, and retailers influence price but no one entity controls it. Government can also influence prices consumers pay indirectly through taxes, trade quotas and subsidies. In CPG we see examples of this with cigarettes-taxes, dairy products/grains- farm subsidy, and imported products made from chocolate, dairy, cotton, and yes even olives, anchovies and tuna.
In non-CPG categories, manufacturers have more control over price. This is particularly true for exclusive or luxury brands. Exclusive brands like Apple and Herman Miller, and luxury brands like Gucci, Prada and Mercedes-Benz have more control over distribution channels and therefore price. Bargain shoppers will have a hard time finding an Aeron chair, iPad, Gucci bag or SL500 at discounted prices. The brand is vertically integrated through company stores or through very strict retailer agreements than span merchandising, customer experience and price. Now wouldn’t CPG be more interesting if this was possible?
In pricing, there are many simultaneous forces at work including supply/demand, commodity prices, competition, and the presence of monopolist or oligopoly power in the market. Retailers set the initial retail price, which usually falls within margin expectations for the category. Manufacturers can influence the retail price based on their wholesale prices, trade incentives or discounts offered directly to the consumer. An example of this is a coupon or manufacturer rebate. In the real world the initial price may not stick and over time as market forces establish an equilibrium price or pricing norm. As soon as the price is dangled in front of the consumer, a series of interactions occurs. Some customers will buy at that price point, others will not. Competitive retailers may react by matching that price or lowering theirs. Competitive manufacturers may also lower or match pricing to close any retail price gaps. Manufacturers will offer retailers what’s called price “buy down” allowances to manage price gaps. To maintain parity pricing at the shelf, manufacturers offer retailers a penny for penny allowance on what’s sold through the register. In this first round, everyone takes a wait and see approach.`If volume is up but profit is down, retailers may inch prices back up. Retailers will often use computer programs to set prices based on elasticity modeling and other data inputs. Computer software recommends a price and buyers can set rules to automatically change prices or override what the recommendations says.
Game theory is often factored into pricing decisions. In the classic “prisoner’s dilemma”, if both retailers lower price, they both lose. If they both raise price they both win and if one goes up while the other stays flat, there is winner and a loser. Computer models and people cannot predict what the competition will do. But there is price signaling that goes on and yes this is perfectly legal. The prices of key items or what’s commonly referred to as KVI’s or Key Value Items is closely monitored by the trade. Competitors all know prices will fluctuate up and down and there is some tacit collusion. If everyone agrees not to set suicidal pricing, everyone wins. Suicidal pricing is when a retailer tries to make a pricing statement and that sets off a price war. It forces everyone in the market to lower prices to reduce the price gap. Most retailers are smart enough not to be the first mover. In a price war nobody wins except the consumer. Profitability is reduced and since retailers are graded on same store sales and accountable to shareholders there is heat to maintain current sales levels.
Consumers determine if a price being charged is fair or not. They vote with their pocketbook by either purchasing the item, buying a substitute, or nothing at all. Retailers set prices using wholesale price as the starting point and expected margins for products in the category. Manufacturer’s set wholesale price based on an internal hurdle rate, usually a well kept secret. Market mechanisms keep prices in balance. If demand is low, prices may drop to stimulate sales. If demand is brisk, prices will stay high. Competitive activity including price matching or price decreases may trigger a price change and there may be several rounds of price changes until an equilibrium price is set by the market. This plays out differently in each market geography. Labor costs, transportation costs and rent get factored into price. The strength of discounters such as warehouse club store and mass merchandisers will also influence prices locally. That’s why a bottle of Hidden Valley Ranch salad dressing may cost $4.79 in San Francisco, $4.29 in Los Angeles and $3.89 in Denver.
So let’s circle back to our original question of who controls price. In CPG and everyday consumer goods, consumers, manufacturers, and retailers influence price but no one entity controls it. Government can also influence prices consumers pay indirectly through taxes, trade quotas and subsidies. In CPG we see examples of this with cigarettes-taxes, dairy products/grains- farm subsidy, and imported products made from chocolate, dairy, cotton, and yes even olives, anchovies and tuna.
In non-CPG categories, manufacturers have more control over price. This is particularly true for exclusive or luxury brands. Exclusive brands like Apple and Herman Miller, and luxury brands like Gucci, Prada and Mercedes-Benz have more control over distribution channels and therefore price. Bargain shoppers will have a hard time finding an Aeron chair, iPad, Gucci bag or SL500 at discounted prices. The brand is vertically integrated through company stores or through very strict retailer agreements than span merchandising, customer experience and price. Now wouldn’t CPG be more interesting if this was possible?