Family Dollar-When the Price is Right

“We’re constantly looking for opportunities to gain insight into what’s going on in our marketplace,” says Apollo Whited, vice president of pricing strategy for Family Dollar, which has more than 7,900 stores across the country. “We want to be in a position to either profit from or combat the competitive pressures we face.”

Which are considerable. While the sluggish economy has been terrific for discount stores, this same opportunity has created a great deal of competitive price pressure. The major players in the category are all competing for the same customers — and they’re all competing on price.

Customer shopping behavior in this segment is primarily based on value, which, for publicly held chains, presents a dilemma. Retailers need a very sharp price in the right areas of their assortment against the right competitors in the right regions. If they don’t, they’ll quickly start losing customers. But those retailers need margin to remain profitable and need to grow, as Wall Street demands. They can’t sell everything every day at close to (or below) break even.

The issue becomes, what items should be increased in price, when should the increase happen and by how much? At Family Dollar, “There’s long been a team devoted to pricing,” says Whited, “but the balance of our specific roles and responsibilities across the organization has changed somewhat as we’ve focused on making pricing more of a strategic lever for the organization. Long-term, our goal is to implement full lifecycle pricing, which includes markdown and promotional pricing as well as our everyday value pricing strategy.”

To help Family Dollar develop and implement these pricing strategies, Whited and his team enlisted the aid of Revionics.

“What we do,” says Kathy Beck, senior director of product marketing for Revionics, “is study those demand patterns for every product in every store, and predict how shoppers are going to react to pricing decisions. You can use this information to generate a lot more margin, even if you’re taking less margin for each product. Because you’re generating higher volume, you end up making more money.”

Elasticity

The key to price optimization, as Beck explains it, lies in a concept called price elasticity — basically the relationship between price and demand. If the price of, say, orange juice is reduced by 10 percent, there’s a 20 percent increase in demand.

Orange juice, in this imaginary scenario, thus has a price elasticity of two — the change in demand is double the size of the change in price. A high-elasticity product such as this would be a great candidate for a price cut, because of the disproportionate reward in volume. High-elasticity products tend to be what are called key value items; consumers are very aware of those prices and react strongly to any change.

If, on the other hand, canned mackerel has a price elasticity of .5 and the price is raised 10 percent, the result is a 5 percent drop in demand. Mackerel would be a good candidate for a price increase.

In other words, a balance must be struck. The way retailers do that, increasingly, is through price optimization — setting the right price, per item, every day. That requires Whited and his team to balance science, business rules, operational constraints and strategic and financial objectives.

A major component of price optimization is elasticity — understanding how a company’s consumer base will respond to a given price level for a given product. A second component is promotional uplift, a combination of price and the specifics of a promotion, such as page placement of a particular ad or item. Other variables can include seasonality, loyalty and demographic changes and their effect on response to price changes.

Business rules and constraints are where science bumps up against reality. If a retailer wants to change the price of orange juice (or canned mackerel), it can’t just be entered into the barcode database. Someone has to physically change the marked price. Family Dollar, like most companies in this segment, runs a fairly lean ship in terms of in-store personnel: There are limits to how many price changes per day they can actually make.

Another reality has to do with price families. Let’s say a retailer carries five flavors of yogurt. Strawberry’s flying off the shelf and banana’s just sitting there. The science would say to mark strawberry up, mark banana down and price the other three somewhere in the middle. If retailers do that, however, they run a risk of confusing and quite possibly alienating customers.

Rubber meets the road

Price elasticity can also be overridden by competitive position. There may be a product inelastic enough that a 15 percent price increase would give a retailer a nice little margin bump without losing too much traffic. If the retailer does that, however, it could threaten the consumers’ perception of it as a value leader. In other words, effective price optimization has to drive toward the company’s strategic and financial objectives.

Family Dollar, says Whited, is making solid progress toward doing exactly that. “We started out by focusing on our everyday value pricing strategy,” he says. “We wanted to balance our value price perception with our customers’ and to analyze it from a financial standpoint, as well.” As the company moves into promotional and markdown pricing — and eventually to full lifecycle pricing — it is doing so with a firm eye on its core objectives.

“We think there continue to be a lot of synergies in our organization as we look at ways to, for example, pool promotions and clearance pricing together,” Whited says. “But we’re also focused on making sure we continue to resonate with the consumer in our everyday value pricing strategy.”