Identifying More Effective Profit-Building Strategies

“In a business like cigars, where unit volume is growing 10% plus year-over-year, emerging strategic thinking in convenience retail suggests that retailers can grow even faster by employing a “price-for-volume” strategy for key products.” David Bishop, partner, Willard Bishop

This summer, we examined how convenience retailers could manage the cigar category differently to realize above-market growth rates. This was an interesting assignment to start with as cigars have experienced strong industry growth over the last few years. So, we started by getting a better understanding of the business from the retailer perspective and then identifying more effective merchandising strategies connected with generating above-average growth rates.

To accomplish this, we leveraged our experience in retail planning, conducted extensive surveys with retailers on the topic, and mined information from our recently completed total-store profitability study that documented the performance and profitability of products sold in convenience stores, entitled the “Convenience SuperStudy.”

The lessons learned from this overall approach reinforce the value of viewing the business from another perspective while still applying commonly used methods, but just in a different way. This is part of a strategic, soon-to-be published merchandising guide for convenience retailers that lays out the evidence supporting alternative strategies to accelerate profit growth. Here’s a brief overview of what we learned.

Would You Jump Off the Bridge?
In a business like cigars, where unit volume is growing 10% plus year-over-year, emerging strategic thinking in convenience retail suggests that retailers can grow even faster by employing a “price-for-volume” strategy for key products.

While this seems fairly intuitive, we learned through our retailer surveys that it’s not the commonly held belief today among retailers. In fact, we discovered that retailers are twice as likely to believe that increasing–not decreasing–prices will lead to improved profits.

This learning prompted us to ask why convenience retailers would believe and possibly execute a strategy that could inadvertently slow growth potential. In a way, it’s analogous to the age-old argument we’d sometimes use with kids about judgment or the lack thereof.

Do You Know What I Know?
While we surveyed retailers, we also learned separately by reviewing previously completed shopper research that cigars—especially packs—were a highly planned purchase. This suggested that price could be a determinant in purchase location, but without specific shopper research it would be hard to understand if this rationale were true. So, we developed a hypothesis that retailers offering better prices on pack cigars would experience stronger growth.

However, based on what we were finding from the retailer surveys relative to the pricing tactics that could produce stronger profit growth, we questioned how widely these types of shopper insights were known at retail.

At minimum, the current retailer beliefs indicated that either they didn’t know this information or they didn’t believe it was relevant to pricing decisions. In either case, we wanted to test our hypothesis to determine its validity.

Is There a Connection?
While carrying out the survey, we also gathered information about pricing strategies for cigar singles and packs as well as category performance. We elected to focus on pack pricing strategies since they represent around two-thirds of the business, and we found that more than 80% of the retailers priced cigar packs at price points competitive with the primary competitor’s everyday price. This finding simply helped us understand that the vast majority of retailers were competitively pricing cigars.

To test our pricing-for-volume hypothesis, we analyzed the category growth rates of surveyed retailers relative to their pricing strategies for cigar packs, and discovered that retailers pricing below the competition by 5% or more experienced dramatically stronger growth rates than the market. This approach provided evidence validating that retailers who pursue a price-for-volume strategy on cigar packs do benefit with significantly stronger growth results.

What Should You Do?
We learned that price-for-volume is a valid pricing strategy in cigars that isn’t employed by many retailers currently, but is it the right strategy simply to embrace an every day low pricing (EDLP) strategy on all packs? To better understand this question, we mined the item-level results from our 2007 total store profitability study completed with three national convenience retailers for the Convenience SuperStudy.

This analysis revealed a couple of key insights that help answer the question. First, we understood that cigar packs generated much higher penny profits (~3.4x) compared to singles. This information became more valuable after we interpreted it based on what we also knew about the shopper and effective pricing strategies. Specifically, we realized that a retailer could invest some of the penny profit from cigars into lower profits. This would create stronger consumer value in the form of lower per unit costs, driving a higher weighted penny profit for the retailer as the price gaps narrow and enticing the consumer to trade up from a single purchase.

Second, we documented that similar to most categories, a small percentage of the SKUs drove the majority of the business. This indicated that the pricing-for-volume strategy could be confined to the best-selling SKUs, assuming that these are what we’d call the “known-value items” in the category. This meant that retailers could enjoy higher margins on secondary brands that rounded out the assortment but didn’t drive the business. So, in the end we identified that a hybrid-EDLP strategy on packs could help retailers accelerate profit growth. In doing so, retailers will be less likely to sub-optimize the strategy by uniformly applying it to all the products, which is the real value of this approach.

What Does This Mean?
Looking at the business differently can help companies uncover new information, generating fresh insights and more effective strategies, and the more you know about the business, the better you’ll be at developing solutions to grow it. It’s also important to question commonly held beliefs to ensure they’re the right approach for you. Lastly, companies that act counter to the rest of the market can enjoy the advantages of being the first mover.

Retailers should reflect on how merchandising strategies are developed with a focus upstream on the generation of new testable hypothesis. A vital part of this should involve collaboration with valued supplier partners as they’ll be able to bring other insights to the table. Part of this will involve knowing the what, when, and how to accomplish this within the overall planning process. Suppliers should understand what our mantra proclaims, which is, “information is not insight. Facts, figures and findings only form the foundation. Knowledge without know-how is not enough. You need to know what to do with what you know.” Therefore, suppliers should find ways to move more quickly to provide retailers with input into the next testable hypothesis. This will require looking at new data sources and gaining a better understanding of the business from the retailer’s perspective.

For information on the Convenience SuperStudy, visit www.willardbishop.com.

  • Jonathan Przybyl

    One of the best ways to gain ideas on how to change problematic areas across your brand is to gain a usable data set of what is going on. If you can gain a data set that the majority of your managers will be intrigued by, it can spark some vital brainstorming on your next steps towards differentiation.

    Jonathan Przybyl
    Eagle Eye Retail Intelligence
    http://www.eagleeyeshops.com

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