Should You Move To EDLP?
Adding facts and nuance to your pricing strategy
Over the last fifteen years, I have talked to hundreds of retail executives about pricing. Most of them say the same thing – their overall pricing strategy this year is essentially the same as it was last year (and the year before that, and the year before that…). If they were using high-low pricing five years ago, then they are high-low today, perhaps with some aggressive competitor monitoring and tactical experimentation on select offers.
Everyone recognizes there has to be a better way, but there is a surprising lack of sophisticated analytical tools to help. At most, retailers find vendors peddling econometric models to measure price elasticity, but these do not address the need for strategic pricing tools capable of taking retailers to the next level. Three years ago, a major department store chain in Canada came to this realization and asked my company, Fusion Analytics, to start thinking about a better way of pricing.
Their biggest pricing question was “Should I move to everyday-low-pricing (EDLP)?” What we found is that the move to EDLP has to be made carefully, with four key considerations to help shape the conversation on whether or not this pricing strategy is appropriate.
- Need vs. Want
- Low absolute price
- Price segmentation
EDLP works best in categories that are predominantly “needs-oriented”. Consumers don't want to constantly invest the time to find the best deal for items they "need". A great example is Walmart, which predominantly sells everyday grocery items and commodities.
Where EDLP becomes less effective is for categories that are predominantly “wants”, like women’s outerwear. Most women already have five jackets and don’t really need another one, so pricing works as a powerful trigger to help push them towards an incremental purchase. Pricing isn’t the only trigger (a new style, trend or new feature can work as well), but pricing is one of the most powerful. Outside of women’s commodity apparel, you rarely see EDLP work in women’s fashion and it is fundamentally why JC Penny was bound to fail as they moved towards EDLP.
EDLP typically works better in categories with low absolute prices, while high-low pricing is most effective in higher-ticket categories. In price-elasticity tests involving discounting, Fusion found that a consumer needs to save at least $4 for them to switch from one retailer to another. For example, if a retailer has a business model that supports no more than 20% off an item, the implication is that the absolute price of the item has to be $20 or higher to get over the $4 discount threshold ($20 x 20% off = $4 savings). Below this threshold, a retailer is typically better off with EDLP to build price confidence as they will not be able to offer enough of a discount to change consumers’ shopping patterns.
This is not a universal rule; price-elasticity tests can, at times, disagree with this rule based on where the category lies on the scale of “need” versus “want.” It is, however, almost always beneficial to have absolute price as one of the criteria when deciding if you should move towards EDLP and how far to move.
The biggest benefit of high-low pricing is its ability to create price segmentation. When you have a consistent, "average" price, which is what EDLP really is, you end up with some consumers that would have been willing to pay more and some consumers who will not purchase because the “average price” is not low enough. This is the main reason why transitioning to EDLP is so difficult.
One hypothetical example is if a jacket is $100 at regular price and $60 on sale (40% off). Let’s assume that 20% of the jackets are sold at regular price and the remaining 80% are sold on sale. The weighted average, or equivalent EDLP, of these jackets is $68.
If this retailer were to move to EDLP, the 20% of customers who paid $100 are now happy since they only pay $68, but because they were going to buy it anyway at the higher price, the retailer missed out on a profit opportunity. The remaining 80% of customers that would have paid $60 are now being asked to pay $8 more at the EDLP of $68. Some will decide to pay up, but many will wait for a sale or hunt for a deal elsewhere. This is why transitioning to EDLP works best when the new price is as low as the previous promotional price.
Staying with this example, an EDLP of $60 or lower would only be possible under situations where there is room to lower gross margins in the category, or in situations where over 95% of the merchandise is sold on promotion. The lower your current promotional mix, the higher your new blended price and the less effective that transition to EDLP will become.
A pure EDLP strategy is rarely the most optimal strategy; having price segmentation is a big win. In fact, through our experience we have found that the biggest advantage of programs like loyalty is not the customer analytics, nor the ability to do one-on-one customized marketing, but the ability to create price segmentation through friction. For example, a brilliant retailer like Shoppers Drug Mart has the Optimum loyalty program, targeted at their price-sensitive customers. The registration process and the need to carry the card forms friction, and the remaining customers who are less oriented towards price don’t bother joining the program and therefore don’t get the discount. With their Optimum loyalty program, Shoppers has created price segmentation.
When used properly, the power of high-low is the power to price-discriminate based on willingness to pay.
Contrary to most opinion we have found consumers rarely expect a certain pricing strategy from an industry as a whole, but they do build up pricing knowledge and expectations for specific retailers. 10% off in apparel at one client can drive a 20% lift in sales, while 20% off at another client translates into minimal sales impact because consumers know that retailer has sales as good as 40% off. In other words, consumers get anchored to a certain price at specific retailers.
Anchoring is the reason why reducing promotions from 50% off to 40% off often backfires. Consumers will continue to wait for the 50% off deal because that is what they expect from the retailer. The key to transitioning away from heavy discount pricing is to make the new EDLP as low as the promotion price and/or de-anchor it. For example, introduce a new pricing and promotional strategy not on existing merchandise but under a new product label that consumers don’t have a discount baseline to compare to. Alternatively, maintain the discount at 50% off, but add friction like the need to use a loyalty card to qualify in order to reduce margin impact without impacting the “50% off” headline.
What about the competition?
What should you do when all your competitors are high-low or EDLP, and therefore consumers expect a certain pricing strategy? The typical gut answer is you need to copy them. What we have found is the larger win is to do the opposite. If everyone is high-low, there is space to be EDLP, assuming the underlying conditions exist (need-orientated category, lower absolute price points, extremely high mix of high-low). Or, if everyone is EDLP, there is a win to be the first to price-segment with a mild form of high-low.
There are two implicit assumptions you make when you follow the competition: 1) you are saying they are making the right move, which in our experience is not often the case, and 2) you are saying that move is so important that the fact that it will be crowded with competitors doesn’t matter.
My first boss used to always say, “you want to be a big fish in a small pond.” 15 years later, after doing analysis on over fifty retailers, I can say he is right. Most retailers are chasing what they feel are large ponds, but often turn out to be small ponds, full of lots of other fish. We were in a meeting with an AVP of Marketing, who said, “If this strategy is so smart, why is nobody else doing it?” But isn’t that the point? Carve out your own pond. If all of your competitors are going to the left with pricing, see if going to the right makes sense.
Should you move to EDLP?
The best strategy is never black & white with a proclamation that EDLP is better than high/low. Instead, the best strategy involves a nuanced discussion to uncover in which situations different pricing strategies work and why. By thinking through the main components that drive consumers’ pricing decisions you compete in you can best optimize your pricing strategy. As a starting point, consider building analytics around the criteria of need vs. want, absolute price, price segmentation and anchoring.