Price cutting is harder than it looks
Price is one of Marketing’s famous 4Ps – Product, Price, Place and Promotion – and arguably the most important, although most marketors prefer the bright lights of Promotion – advertising, PR, and digital communications. Arguably because, if you get pricing wrong you put the business at risk, no matter how big you are.
In 1977 Tesco ran a national Sale and a marketing campaign that nearly put it out of business.
Tesco’s founder, Jack Cohen’s business motto was “pile it high and sell it cheap” so the company thought it understood discounting. It had grown fast and was a successful national budget retailer with ambitions to be No 1.
In 1976 it ran a 10% off everything Sale that was a modest success. So, the following year Tesco repeated it with full on national marketing, so everyone would know about it. But surprisingly, for such a successful company, no one had done the breakeven calculations to find out what extra volume they’d have to sell to make up the discounted margin it was giving away.
Tesco advertised the campaign every day, everywhere, at maximum volume, and in 1977 everyone heard. Queues of people snaked up every high street, every day during the campaign, and sales grew by a phenomenal 55%!
But Tesco had bottlenecked. It could not sell any more because the stores, which were much smaller then, had narrow aisles and they could not fit any more people into them, however much they tried. They were also in difficult-to-access high streets too, so they couldn’t get deliveries fast enough to restock and for periods the shelves were half empty.
But the sting in the tail was that, at traditionally low margins, volume sales needed to increase by 67%, not 55%, to break even, and that was physically impossible. It was a disaster that put the entire business at risk, and for a time it became a marketing case study.
Fortunately, Tesco’s balance sheet was strong, so it survived, but the near disaster changed its thinking and views on positioning. It moved out of town into much larger stores, and in the 1990s, Tesco re-positioned itself from a downmarket high-volume, low-cost retailer to a high volume mid to premium, much smarter retailer. And it always does its numbers first.
Now Tesco discounts traffic-pullers – which account for around 15% of the range – and usually uses OPM (Other People’s Money – meaning suppliers), to fund most of the giveaways and costs ‘price investments’. Less obviously, it raises the prices of some other products by barely noticeable amounts to compensate, knowing no one really looks when it’s promoting big discounts on the traffic pullers. So, it gives away hardly anything and makes lots of money. And it avoids risk and is a lot smarter at its marketing.
I used this as a case study when I ran marketing workshops years ago. I got people to work out the breakeven for their business to see how much extra volume they’d need to sell, to cover these ‘price investments’, if they cut prices across the board by 5%, 10%, 15%, 20% or even 25% as some planned to do. When they did the calculations, people were astonished at the extra volumes they needed to sell to break even, never mind make a profit. It’s especially relevant for firms thinking of discounting, as they tend to have lower prices and smaller margins to start with.
Increasing volume sales by the round-number percentages people automatically think of isn’t easy or no-cost either. Almost no one keeps extra staff hanging around on the off-chance that sales will jump by 15% or 20% – but the extra cost of handling that extra volume helps to push breakeven towards infinity.
Price cutters often focus on value and forget that volume is different, so price cutting can be very risky.
