Yesterday, Hedgeye Restaurants Sector Head Howard Penney hosted a conference call with Leslie Kerr, founder and CEO of Intellaprice. Leslie built the pricing structure for Dunkin’ Donuts and has held brand management and strategic positions at Baskin-Robbins, PepsiCo Restaurant Services Group, and Disney Consumer Products. After working in Coopers & Lybrand’s compensation consulting practice, Leslie founded Intellaprice, a recognized leader in pricing strategies, finance, brand management consulting.
Leslie presented a “Pricing 101” seminar for subscribers. Investors almost never think about how a restaurant chain arrives at prices for its menu offerings. Worse, many restaurant companies don’t think strategically about pricing. Intellaprice focuses company managements to focus on pricing the same way they focus on areas such as inventory management, operations, or purchasing.
A pricing strategy reflects relationships within the company. Who makles pricing decisions? What is the company’s brand image and objective, and how does pricing work to achieve that objective? Who is the actual customer of the company’s pricing strategy? (It’s often the franchisee, not the customer.) How does a company derive pricing information, and who uses that data?
Companies should view pricing in the context of brand identification. What does a brand stand for? What is the objective of pricing? It’s not enough to say “we sell a premium product, so we charge more.” A shop owner who says “I’m a discounter, so I’ll charge 25% less than the store across the street” has a pricing strategy. Many major companies don’t even have something that basic.
Kerr says it is surprising how many major companies do not understand their own pricing data, and where no one is clearly responsible for pricing policy. Despite tremendous quantities of price data flowing through a company, many companies do not compile this data into usable information to make available to operators. Kerr says most point-of-sale (POS) systems are not set up to track pricing patterns, and many companies do not communicate a pricing strategy to their managers or franchisees, making it impossible for operators to make effective pricing decisions.
The goal of a pricing policy is to support franchisees and managers by laying out strategic reasons for corporate pricing decisions, and to make pricing a basic and ongoing part of business discussions.
Kerr says her research at Intellaprice shows that the return on investment to establish a pricing strategy can be over four times the cost of establishing that strategy, and she says her clients experience sales increases of up to 3% as a result of using her recommendations.
The “Five D’s of Pricing”:
DEBUNKING – managers believe antitrust laws make it illegal to discuss pricing. It is illegal to price-fix, but it is perfectly legal to have a corporate pricing strategy.
Companies let pricing decisions default to other functions: finance on the basis of profitability, marketing on the basis of sales volume. But, says Kerr, successful companies see pricing as a component of brand definition.
Companies believe that the market dictates prices, or that technological solutions – expensive software packages – should make pricing determinations.
Kerr says all of these approaches lead to inefficient pricing. Pricing must be part of a rigorous management decision-making process.
DEFINING – a price strategy is more than just saying “we’re a premium brand,” or “we’re a discounter.” Management needs to identify business objectives and the role pricing plays in brand and company identity, what Kerr calls a “Pricing Philosophy.”
DIRECTION – pricing needs to be a defined and repeatable process that includes data collection and analysis, testing, and the development of optimal pricing. This must be communicated clearly across the company. The loop closes with performance analysis, which becomes the data collection stage for the next iteration of the process.
Kerr gave examples using four approaches to synthesizing information:
Competitive – compare with prices of comparable or substitute goods
Consumer – public perception of products and price sensitivity
Store – demographics and sales mix
Economic – cost, profitability and economic trends
She then laid out four pricing methods, citing pros and cons of each:
The Market-Based approach provides good price data on price behavior, but lacks predictive ability.
Consumer-Based measures price sensitivity and purchasing decisions, but is too costly to be used exclusively.
Price Optimization allows a company to leverage its own sales data but does not allow any non-price factors into the decision-making process.
Cost-Plus is the simplest to apply, but it ignores the customer’s willingness to pay for the product.
DATA – a company chooses among sources of information (its own POS data, competitors’ prices, customer sensitivity). A number of services also offer statistical tools for various retail settings.
The database must be appropriate for the company and its industry. Brand performance, customer traffic and comments and complaints are among the most useful sources of information.
DECISIONS – what makes a successful pricing decision? It must be integrated into the company’s overall decision making. It is grounded in reality. It emerges from a continuous process linked to company objectives. The most successful pricing processes are built around pricing committees that work across functional areas of a company, communicating within the organization and harmonizing objectives. The group responsible for pricing must also stay in communication with franchisees, brand managers, and other decision makers in the field. Effective pricing managers have ongoing dialogue that also provides valuable information as an input to the pricing decision-making process.
Pricing has been a neglected component of corporate strategy. Investors should ask: does this company have an established pricing process? Who is responsible for pricing decisions – Where in the corporate structure does pricing “live”? How robust is the pricing process? What resources are committed to it? Are senior executives involved in the pricing process? What pricing data is used for decisions, and what other inputs does the process rely on?
Kerr’s analysis shows that companies have realized profits in excess of 400% of every dollar committed to developing a pricing strategy. Yet this is an area that remains largely unexplored, even by some major firms. In mature industries, such as restaurants, marginal differences in profitability can sometimes drive significant gains in stock price. Investors who learn to ask hard questions about a company’s pricing strategy – or lack thereof – stand to be rewarded.