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Price is more important than you think
Thu, 09/17/2015 - 09:58

Iván Franco

México: mercados de consumo antes y después de la crisis
Iván Franco

Economista del ITAM (México), con estudios de Econometría en la misma institución. Es consultor de negocios para diversas organizaciones en America Latina. @IvanFranco555

Price is a key element in everyone's economy because it is a reference and a monetary limit that impacts our budget. Furthermore, it is the most tangible communication instrument that a company has with its consumers.

In consumer industries, producers use price to compete in the wholesale market and to position themselves in the retail market, while retailers do it to compete with other stores and to generate economic profits. This combination of practices can affect markets, to the extent of promoting anti-competitive environments and an unequal distribution of profits, impacting companies and consumers.

There is not a single price, but millions . Things don't have a single price. In the distribution chain the first price is from the manufacturer. Sometimes there is the wholesale price and finally, the retail price, which is what the consumer pays for the product. These three stages constitute three large price markets. Within each market prices fluctuate depending on the negotiation between the parties and other variables. In the retail market, for example, the price varies according to the region, the chain, the store and also time. These variations have their origin in market factors and the margin required by the retailer.

Suppose that in a country there are half a million points of sale and that in each one we can buy the same bottle of water of a certain brand and presentation. This means that there will be half a million prices for that bottle at some point in time. This is known as price distribution. In reality this happens with all the products we find in a supermarket, without exception. Therefore, it is important to speak in terms of millions of prices whether we are producers, consumers or retailers. It seems like an impossible task since no one has that information.

The reason there are millions of prices - different or not from each other - is optimization. The problem arises when the price of the same product varies 50%, 100% or even 300% from store to store without being offers or discounts. In these extreme cases - but very frequent - the product and its attributes become irrelevant, damaging the brand, its value and its position in the market.

The strategy. Logically, prices do not change by themselves. The two actors involved in setting prices are the producer and the retailer. In practice, the retailer is the only one with the ability to set as many prices as required. He knows the demand in his stores and the prices of his competitors' stores. Therefore, it has an information advantage that helps you make your business efficient and generate extraordinary profits. It is no coincidence that Walmart is the largest company in the world. Whatever you say about its business model, Walmart's profit-generating strategy is to set prices in an exemplary and efficient way.

Technically, the key to maximizing a retailer's economic profits is to set different prices along the demand curve for a product. This marking, however, must be done in an orderly and systematic manner. A necessary condition is to have data to mathematically model the pricing strategy.

A zero sum game. Retailers' pricing strategy can discourage innovation and the existence of substitute products. In addition, it limits competition between producers and encourages the concentration of a market, filling it with identical products that are sold by few companies. This is one of the reasons why there are something like ten consumer companies in the world. It is of little use that there are products that are different from each other and have added value, if the price marking is very broad and invades the competition space. When the retailer sets numerous prices for the same products, it is not convenient for the producer to launch product extensions, at least not to compete on price. Excessive price marking restricts the entry of the new product.

In reality, what the retailer does to be efficient affects the other two players, making them inefficient in their choices. This causes some to win and others to lose. The producer himself loses opportunities to segment his market and the consumer loses due to the limited variety of substitute products and the extensive price discrimination to which he is subject.

Furthermore, the current pricing strategy breaks with some of the assumptions of business and marketing. For example, does the producer really know his demand? Can we differentiate the competitive strategy by distribution channel? Is it possible to know the elasticity of demand for a product by channel? Does the consumer really have the power of choice? Do brands build value?

An information problem. For a consumer, it is confusing that the same product has different prices, regardless of the store format where it is sold. The retailer distorts the communication channel between the producer and the consumer when it intervenes with a varied and sometimes inconsistent price marking with what the product seeks to convey. The ideal for a consumer is to have the possibility of choosing between truly different products that are also offered at different prices. But is not the case.

On the other hand, considering that prices are negotiated, we are facing an information problem. If price information were more complete and used, competition would be more balanced, not only between retailers, but also between producers. Communication with the consumer would also be clearer, promoting informed choice. And a consumer eager for options creates a space conducive to innovation with lower risk.

Sometimes the importance of price is underestimated, favoring other business concepts, perhaps because all of its work in the markets has not been recognized. Although it may sound trite, in the business world good information is power.