Everyday Low Pricing May Not Be the Best Strategy for Supermarkets | Stanford Graduate School of Business

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Everyday Low Pricing May Not Be the

Best Strategy for Supermarkets
New research looks at supermarkets everyday low pricing.
December 17, 2011 | by and Marguerite Rigoglioso

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Everyday Low Pricing May Not Be the Best Strategy for Supermarkets | Stanford Graduate School of Business

A Walmart employee stocks shelves in a newly opened Illinois store. | Reuters/Jim Young

When stores like Wal-Mart, Sam's Club, and Costco began their
rapid expansion in the 1990s, supermarkets were thrown for a loop.
The limited service, thinner assortments, and everyday low pricing
of items in these supercenters including foodstuffs created
enormous cost savings and increased credibility with consumers.
What was a Safeway or a Stop & Shop to do in the face of such
brutal competition?
A new paper from Stanford GSB looks at the strategic pricing decisions made by
grocery firms during that period in response to the shock to their local market
positions by the entry of Wal-Mart. The paper answers the age-old question in the
supermarket industry: Is everyday low pricing (EDLP) better than promotional
(PROMO) pricing that attempts to attract consumers through periodic sales on
specific items? Investigators find that while EDLP has lower fixed costs, PROMO
results in higher revenues which is why it is the preferred marketing strategy of
many stores.
The research is also the first to provide econometric evidence that repositioning
firms marketing approaches can be quite costly. Switching from PROMO to EDLP
is six times more expensive than migrating the other way around which explains

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Everyday Low Pricing May Not Be the Best Strategy for Supermarkets | Stanford Graduate School of Business

why supermarkets did not shift en masse to an everyday low pricing format as
predicted when Wal-Mart entered the game.
The unique data set from which the results were drawn covers revenue and priceformat decisions for every single retail supermarket and Wal-Mart in the United
States from 1994 to 2000.
You need a major event to cause a pricing strategy switch that can be observed,
and the entry of Wal-Mart into the grocery market provided that natural
experiment, explains Harikesh Nair, associate professor of marketing at the
business school and a coauthor of the study with Paul Ellickson, assistant
professor of marketing and economics, and Sanjog Misra, associate professor of
marketing and applied statistics, both at the University of Rochester. The
researchers exploited the observed switches in market structure in combination
with an economic model of the industry to measure the cost and benefits to
supermarkets of changing the price positioning.
Costs involved in changing pricing strategies included complex investments to
educate (and advertise to) consumers about the legitimacy of the new positioning.
For example, the Wegman's chain in New York produced a million videos
explaining to customers the benefits of their switch to everyday low pricing.
Repositioning costs also involved internal investments to overcome, such as
resistance to change by managers within the firm and the need to rework channel
relationships.
Running calculations on the
data, Nair and his colleagues
found that for the median store,
PROMO pricing yielded $6.2
million more per year in
revenues than an EDLP
strategy. Moreover, changing
from an EDLP to a PROMO
strategy required only $2.6 million in costs over 4 years, while switching from a
PROMO to an EDLP approach required outlays 6 times as large.

Is "everyday low pricing" better

than promotional pricing that
attempts to attract consumers
through periodic sales on
specific items?

The debate over which strategy is better stems from the fact that EDLP seems to
have its advantages. It enables retailers to reduce inventory costs, better
coordinate supply chains, and reduce the risk of stock shortages by smoothing the
demand variability induced by frequent sales.
Now we have empirical evidence to show why most stores chose PROMO pricing
and stuck with it during a competitive shock it earns more revenues and is too
expensive to change, says Nair.

http://www.gsb.stanford.edu/insights/everyday-low-pricing-may-not-be-best-strategy-supermarkets[22-02-2015 07:58:05]

Everyday Low Pricing May Not Be the Best Strategy for Supermarkets | Stanford Graduate School of Business

Analysis also revealed that the entry of Wal-Mart resulted in a $1.7 million loss in
annual revenues for the median incumbent EDLP supermarket, while it resulted in
a loss of only $690,000 a year for the median PROMO store. The entry of WalMart thus hurt EDLP stores by twice as much, elaborates Nair. A PROMO
strategy, then, proves more resilient to the entry of an undercutting presence, as
well.
Interestingly, in the late 2000s, Wal-Mart began to do selective rollbacks on a
large number of items essentially putting them on sale. Their strategy was a
hybrid between EDLP and PROMO, says Nair. The result? Customers lost faith
that Wal-Mart prices were the lowest in town. Now Wal-Mart has incurred large
repositioning costs to reassure customers of its original EDLP position, Nair says.
The study offers a quantitative framework to evaluate repositioning decisions more
generally. The authors also offer several lessons for supermarket retailers. If
revenues are what you care about, do PROMO pricing, Nair advises. "If you're a
new entrant, be careful about your pricing strategy, because once you're locked in,
its difficult to reposition yourself.
Finally, he says, Price perception is really important. Customers sense of how
you price merchandise drives foot traffic to your store and takes a long time to
build up. Violations of that will be costly in terms of the loss of consumer trust and
the expense it will take to reeducate them.

Marketing,

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Everyday Low Pricing May Not Be the Best Strategy for Supermarkets | Stanford Graduate School of Business

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