Focus on the Segments Before Lowering Prices

jonathan-pielmayer-176664_segments.jpgLast week there was an article in the Wall Street Journal, So Long, Hamburger Helper: America’s Venerable Food Brands Are Struggling which discussed the declining market shares of some of the largest packaged food companies.  It is not a surprise; the large CPG companies have been losing customers for the past few years on multiple fronts.  Although many companies would interpret declining share as an indictment of their pricing strategy and would lower their prices, doing so would likely make the situation worse.  It is much more important to understand what is happening with each customer segment and tailor their actions to the segments.

There is a large segment of customers who are looking for fresher items with fewer processed ingredients.  Many of those customers now shop at Whole Foods or the organic sections of their regular grocery stores.  While price is an issue, it is certainly not the issue for these customers.  It is hard to imagine that any of the customers in this segment would switch back to packaged food for a price reduction.  Their reason for switching was not to save money, it was to eat healthier.  The only way to get these customers back is to create healthier options for them.

A growing part of the population is comprised of people who would like to cook, but don’t have the time to shop, or don’t feel like they can come up with recipes, or don’t want to buy all the tertiary ingredients like spices, greens, etc.  These customers have migrated to Blue Apron, Fresh Direct, Home Chef and others.  Like the first group of customers, these buyers did not switch to save money.  So, cutting prices to get these customers back would be ineffective. 

A third segment that has been lost by CPG companies includes people who eat out more often.  A recent USA Today article reported that millennials eat out 5 times each week.  My kids are in that age group, and they certainly eat out more frequently than I did at that age.  They eat out for two reasons, (1) they don’t feel like they have time to cook, and (2) they enjoy the social atmosphere.  Similarly, retirees eat out much more than they used to.  They have more money than previous generations of retirees, and they prefer not to cook for two people.  Whether for millennials or retirees, a modest reduction in the prices of packaged foods is unlikely to change the trend.

The last segment I want to discuss are the most price-sensitive customers who have switched to store brands.  They are looking to save money, and that is why they have switched.  Furthermore, as store brands have improved in recent years, more of these customers have switched.  A price cut would have a very real chance of bringing these customers back.  The problem is, the largest segment is made up of loyal, less-sensitive customers who value the quality and reputation of the big brands.  A price reduction would lower the price to every customer, and for the CPG company to break even, a very large number of the price-sensitive customers would have to return to offset the profit lost from the price reduction the loyal customers received.  As an example, if the CPG company currently earns 40% margins, to offset a 5% price decrease, they would need a 14% increase in customers. 

Wisely, instead of lowering prices, we have seen a few large food companies modestly increase prices.  The higher prices produce higher margins in the larger loyal customer segment, and partly offset the profit lost from defecting customers.  Although the higher prices do not stop market shares from declining, the additional profit helps soften the blow.

Whenever a packaged goods company or any other company is affected by preferences changing or more defined customer segments emerging, lowering prices to stem customer erosion is usually the wrong answer.  As we have seen, when the customers leave for reasons other than price, cutting prices will not bring them back and will be counter-productive.  Before making any pricing decisions, make sure you have appropriately segmented your customers and make sure you understand what really drives their decisions.  Then develop your pricing strategies accordingly.

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