Pricing Strategies: Is Competing on (Low) Price A Sustainable Strategy?

Low-Price-Strategy-Costco

The following statement is part of “Pricing Strategies 1 on 1”: positioning your brand as the lowest priced competitor is a risky strategy. And in most cases it is, at least in theory.

The economic reality is different. With little to no meaningful differentiation between products,  operating on skinny margins is a common strategy. The low price pressure is experienced by everyone in the supply chain: manufacturers, distributors, agents, and service providers.

The “Extreme” Consumer

As a society, we’ve come to expect excellent products at rock-bottom prices, and flawless customer service. Consumers have become polarised in their spending habits: the same person can spend a lot of money on things and experiences that convey a certain status, and close to nothing on other life necessities that are not as “flashy”.

There are many reasons behind this trend:

-the job market is more precarious than ever, especially for millennials. Full time jobs that pay well, are relatively stable and offer good benefits that have been enjoyed by the baby boomers are quickly disappearing. The new jobs are often short term, part-time, and offer hardly any perks, hence the need to spend wisely.

-the gap between the rich and the poor is widening globally. More people live frugally, either by choice or necessity.

-millennials are less obsessed with owning “things” put more value on “experiences” . “Owning” has been replaced with “sharing”.

-the same person can illustrate the spending extremes, indulging in luxury purchases that convey a particular status, while rationalising drastically in non-essential categories.

The “Stuck In the Middle” Danger

The above trends illustrate a new reality brands have to face in search for identity: the mid-market segment is slowly disappearing. Being “stuck in the middle” is a serious threat for many brands.

Nowhere is this trend more noticeable than in retail. In North America, 2017 has been a brutal year for retail. Many well-established brands, that have been a staple for many generations, have either filed from bankruptcy or announced massive store closings: Sears, Toys ‘R’ Us,  Gymboree, Payless ShoeSource, RadioShack, just to name a few.

As players is the medium price point are struggling to find their value proposition, brands at the 2 extremes are prospering.

Given this reality, brands will have to make a choice to move either up or down, and re-invent themselves. Many will find it easier to move down, as turning a generic brand into a luxury one is an almost impossible task.

Is the Low-Price Strategy Viable?

As we’ve seen above many brands are forced to consider becoming a low-priced competitors, which begs the question: can you make the low-price strategy work?

The short answer is yes, if executed properly. Many businesses claim to offer “best-value” to their customers, but for most the promise is just a meaningless slogan.

When it comes to executing the “best value for money” strategy to almost to perfection, I can’t think of a better example than American retail giant Costco.

For those of you not familiar with the brand, Costco is the second largest retailer in the world after Walmart, and  the largest retailer in the world in certain categories such as wine, organic beef and rotisserie chicken.

While most  retailers struggle to attract customers via expensive marketing campaigns promoting aggressive price cuts, Costco customers have to pay an upfront annual fee for the privilege of shopping there.

Enjoying a yearly membership renewal rate around 90%, Costco plans to open another 28 locations in 2018. Costco has also built a reputation of looking after their employees, who enjoy good benefits and work conditions.

How does Costco manage to prosper, at a skinny margin (said to be between 8%-10%) in an environment where most competitors are forced to close stores or file for bankruptcy? A closer look at its business model will give us the answer.  Here is how Costco does it:

Narrow product assortment- traditional business wisdom dictates that the more products in the assortment, the higher the sales. Line extensions are the preferred growth strategy, to the point where consumers are overwhelmed by the number of choices in every category.

Costco assortment consists of 1 or 2 choices in each category, which translate into high inventory turnover, low acquisition costs, and maximised store space. Costco shoppers deal with less uncertainty as to what product to buy, the limited options forcing them to make a decision.

Smart packaging: every product manager knows that packaging costs can really add up. For some brands packaging is part of their DNA (Apple for example). For Costco, packaging has a strictly functional value. As a result most products are backed bulk, directly on pallets, with no fancy signage. In its quest for cost efficiencies, the retailer pays attention to the smallest detail, such as how the shape of the packaging influences the number of products that can be stored on a pallet.

Excellent buyers-Given the narrow product selection, Costco buyers are tasked with the major responsibility of selecting the 1 or 2 items that will make it to the store shelves. They have the understanding of the market, product knowledge, negotiating skills, and decision-making capabilities to always deliver on the brand promise: the best value for money. Costco’s success is due in part to its buyers being the best in the business.

Minimal (but great) service: A low price always comes with trade-offs, and Costco is no different. The retailer does not offer many of the services offered by traditional retail (in exchange for a between price), while over-delivering on the essential ones.

Costco does not employ sales clerks, merchandisers or store designers. Costco stores are basically giant warehouses. However, Costco is famous for its excellent service: best exchange/return policy of any retailer (including membership refund in case you are not satisfied), no risk purchases, cashback rewards, speed of service and the overall customer service.

High quality products (including a reputable private label). We often associate low price with low-quality products. This is not the case at Costco, which has built a reputation for high quality products. The retailer assortment consists of brands consumers are familiar with, eliminating the need for expensive advertising and educating the consumer. The retailer also managed to build and one of the most trusted private label brands in retail, Kirkland, which generates a quarter of its total sales.

In a nutshell, Costco turned the traditional retail model on its head, by doing the exact opposite: narrowing the assortment, rationalising packaging, investing in employees, eliminating non-essential expenses, and offering high-quality products.

Your brand might have to adopt the same bold strategy in order to succeed. That being said, simply copying the strategy above will not be enough, as many brands have already discovered. What sets the winners apart is the discipline and consistency in execution.

Photo Credit: Mike Mozart on Flickr

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