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Aldi and Lidl are growing; is price-matching the right approach?

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In recent days the trade press has been full of stories about Lidl’s plans to enter the US market and bring their ultra-low prices to new parts of the US. A recent article about Aldi referenced an ad from Aldi that stated “we don’t match our competitors’ prices because that would mean increasing our prices”.  Walmart’s CEO very publicly stated that they were going on offense with price.  With all this focus on low prices, should retailers simply price-match their competition to ensure they don’t lose customers?

In the first article in this series we discussed why pricing is a hot topic these days and provided a framework for thinking about pricing.  We also discussed three over-arching approaches to pricing: cost-driven pricing, market-driven pricing and customer-driven pricing.  In the second article we discussed cost-driven pricing in some detail.  In this third article we’ll discuss market-driven pricing and the pros and cons of matching competitor’s prices.

Isn’t market-driven pricing a sure-fire bet to beat the competition?  Market-driven pricing uses the competition as a guide to setting prices. The belief with this approach is that no consumer will ever willingly pay a higher price for exactly the same item when they can purchase it for a lower price at another store.

In general, there is much to be said of this belief and there are two important components which lend credibility to this approach: there are some items that will mainly be purchased on price or value and, as a result, customers will be very aware of any price differences between local competitors on this specific set of items; being priced higher on directly comparable items within a local trading area could have a meaningful negative impact on consumers’ overall price perception of a retailer.  These two components will sometimes lead retailers to take an approach that they perceive to be the lowest risk in this regard: they will proactively price-match a large number of items against the competition.Some shoppers will proactively price-match a large number of items against the competition.

But there are some challenges with this approach. Firstly, this approach assumes that the customers shopping with one retailer are very similar to the customers shopping at a competitor and have exactly the same needs, which is not always the case. Secondly, this approach assumes that the competitor knows how to make intelligent pricing decisions and retailers could fall into the trap of "the blind leading the blind".  In effect, taking this approach can lead a retailer to outsource a portion of their pricing strategy to their competitors, which doesn’t appear to be a good way to out-compete the competition.

That said, an attractive aspect of market-driven pricing is that it has the appearance of being simple to execute from an operational perspective. You gather your competitors' prices and then you simply match them.  But appearances can be deceptive.

Is localization essential for market-driven pricing?  If competitive price matching is to be truly effective it should be executed at the local level; what’s the point of matching a competitor when their closest store is 15 or more miles from one of the retailer’s stores? This in turn leads to other considerations about how a retailer should determine which competitors they compete against in each local trade area:

  • Do they always compete against the same national or regional competitors in every local trade area or does their competitive set change by location?
  • Should they compete against the lowest priced competitor in each market, even if the lowest priced retailer has a very different value proposition?
  • Should the retailer compete on the basis of an average or a weighted index of a group of competitors?

This approach to pricing is starting to sound complicated, but there’s still more to it…

Is market-driven pricing the right approach for all items?  Competitive price matching also requires a retailer to determine on which items they are going to match the competition. Should they match against all items or just a subset of items (if a subset, how should this subset of items be identified), should they only match against national brands, should they attempt to identify comparable private label products against which to match, etc.?

According to an article in Business Insider by Ashely Lutz, one of the keys to success for Aldi is that they stock mainly private label products.  How does a competitor decide to compete on products that they themselves do not carry?  They could undertake a process of identifying “comparable” products to Aldi’s private label products, but how do you determine if the quality is “comparable” in order to ensure your matching prices on an apples-to-apples basis?  In addition, Aldi typically carries around 2,000 items compared to a mainstream grocer who typically carries 40,000 items.  Should they compete on all 2,000 items?  And what should they do about the other 38,000 items?

How should retailers choose to price with a market-driven pricing approach? Finally, this approach requires the retailer to determine how exactly they would like to compete on the basis of price against the competition. Should they match exact price points or average prices or on a weighted index basis?  How much above or below the competition should they be?  Should they match regular shelf prices, promotional prices, average price or most common price, etc.?  All of these questions need to be addressed before embarking on a price-matching approach.

Is it possible for retailers to truly operationalize market-driven pricing?  All of the previous points raise some important operational considerations but there's another factor upon which all the others rest: a competitor price matching approach is only as good as the availability and quality of competitive price data. Effectively executing this approach could require a retailer to gather competitor prices at a local level on a frequent basis for a variety of different competitors for a large number of items.  Of course there are short cuts that can alleviate some of these challenges:

  • A retailer may decide to match only a small subset of competitors
  • They may choose to match at one price point across all stores in their chain
  • They may choose to only match on a small subset of items
  • They may choose to only update their competitor price data once per quarter or per year

But all of these short cuts come with a price (please excuse the pun!):

  • Despite all of their efforts a retailer may not end up matching an important local competitor's prices and consumers may perceive them as a higher priced retailer in that trade area
  • The retailer may lower a price in a store where no competitive retailer is located and give away margin
  • By price matching a small subset of items they may miss an important item on which it is imperative for them to match a competitor’s price
  • They may be matching a competitor price that is out-of-date and they may end up either higher or lower than they should be.

To overcome these challenges retailers sometimes undertake price checks using their own resources, they sometimes use third party auditors and they sometimes use independent companies who's sole purpose is to provide competitive price data.  Whatever approach the retailer uses, they have to ensure they receive timely, high-quality competitor price data and that it is used in the right way.

How important is market-driven pricing for shoppers?  This approach raises the question of how shoppers identify competing prices, on which items they focus and how much of a price difference matters. Do shoppers really have the time to go into a number of competing retailers to assess competitive prices and then go back to the store for the lowest price for each item, even if that means visiting 3 or 4 stores to obtain competitive prices and then going back to 3 or 4 stores to purchase a subset of items from each store depending on which store has the lowest price for each item?  It’s possible there are shoppers in some locations that would undertake this effort but it raises the question as to whether the savings will offset the time and expense of driving to multiple stores on multiple occasions each week.

When it comes to the items about which shoppers mainly purchase based on price or value, we have to take into account the fact that a typical grocery retailer carries about 40,000 items in a single store. No individual customer ever purchases all of these items.  A typical weekly stock-up shopping trip can involve 50 or so items; does an individual shopper know the price point for all 50 items?  In all the research I’ve seen from intercept interviews (as shoppers leave the store with their groceries) the average percent of items in their basket that a shopper will know the exact price of is in the 10%-15% range.  There will be shoppers that will know a higher percent of the prices and others that will know less but this still leaves a lot of items that are being purchased mainly on some criteria other than price or value.There are a significant number of items where customers are purchasing for reasons other than low price

There's also the question of how big a difference in price matters to consumers.  Do shoppers require a retailer to match exactly the competitor price?  Do they need the price to be below a competitor?  Or do consumers not really care if an item is a penny or two above the competition?  The answer is that it will matter more on some items than others and it will matter more to some shoppers than others. It all comes back to understanding your customers and their needs.

Is there a risk to market-driven pricing?  There is a financial risk to competing mainly or solely based upon matching competitor prices. If you have the lowest cost position in the market due to scale or lower service-levels (e.g. fewer staff in stores, lower operational or maintenance costs, etc.) then you have a cost structure in place that will allow you to compete on the basis of having the lowest prices in the market.  But if you don’t have the lowest costs and you try to holistically price-match a competitor who does have the lowest costs then it becomes challenging to operate your business in a financially sustainable manner.

This reminds of a situation I found when working with a mainstream retailer who was looking to competing aggressively against a low-priced leader who had a very low cost structure.  The mainstream retailer decided that they had to have price leadership on a specific item and implemented a pricing rule that determined the item's price to be 2% below their low-priced competitor.  Interestingly the low-priced leader responded by lowering their price to be 2% below the mainstream retailer.  A death spiral then ensued with each retailer continually responding by lowering their price to be 2% below the competition.

When we analyzed their sales, basket, customer and market share data we found that there was absolutely no change in any of these metrics.  But when we looked at the retailer's profit data they had significantly damaged their profits.  We suggested that the mainstream retailer probably didn't need to be 2% lower then the competitor on this specific item as customers didn't respond to ever-lower prices by buying and consuming greater quantities of the item.  The retailer implemented the pricing recommendation and profits returned to acceptable levels (while sales, baskets, number of customers and market share were all maintained).

This story brings me to what I believe to be the greatest risk with taking a mainly market-driven pricing approach: by matching competitor prices on a large portion of items a retailer may be aligning their prices with the needs of shoppers that shop primarily at a competitor rather than aligning their prices with the customers who shop in their own stores. There is most likely a subset of items for each retailer where they absolutely need to be seen to be competitive on price, but there are a significant number of items where customers are purchasing for reasons other than low price and getting this balance right is essential for a successful pricing approach. 

Market-driven pricing has its place in the pricing strategy of a retailer but it has to be deployed in the right way or it can undermine the ability of a retailer to satisfy the needs of their customers and compete effectively while building a financially sustainable business.

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