Every day low pricing is a high-risk strategy

Recent moves to import the US policy of every day low pricing (EDLP) into the UK have sent shock waves through the retail sector. The theory behind the strategy is that by keeping prices constantly low, without resorting to a confusing array of price promotions, sales will increase over time, and so will profits.

But EDLP has had a rocky time in the UK. When retail giant Kingfisher adopted it across its chains Comet, Woolworths, B&Q and Superdrug, the experiment was a failure, and City observers dubbed it “Every Day Low Profits”. Kingfisher soon dropped the policy.

A series of studies by Information Resources Inc in the US has shown that pure EDLP may not be in the best interests of retailers or manufacturers. In short, it doesn’t always work.

In the studies, the performances of up to 63 product categories were monitored in retail chains with EDLP pricing policies, chains with heavy price promotions and also within different stores in one group where EDLP, Hi-Lo and control groups were set up for 16 weeks. The product categories monitored included butter, beer, carbonated beverages, cereals, household cleaners and shampoo.

Whichever way the studies were run, the results were similar. A ten per cent category price decrease in an EDLP environment resulted in a mere three per cent sales volume increase, while a ten per cent price increase in a Hi-Lo promotional environment only led to a three per cent sales decrease.

Most seriously, because of the low consumer response to changes in every day price there were also large differences in profitability. An EDLP policy reduced profits by 18 per cent, whereas Hi-Lo pricing increased profits by l5 per cent.

One possible reason for the failure of consumers to respond to EDLP is confusion created by heavy promotional activity in store.

Although EDLP store prices were on average nine per cent below Hi-Lo stores, they were still promoting as much as Hi-Lo stores (26 per cent of volume sold with some sort of merchandising support in EDLP stores and 24 per cent in Hi-Lo stores).

Because of the lower everyday pricing, the gap between everyday pricing and promotional offers was much smaller than in Hi-Lo operations, making the impact of the promotion much less obvious.

This was compounded by the fact that EDLP stores relied on displays to highlight their promotions, whereas Hi-Lo stores focused more on high impact feature activity. Basically consumers were conditioned to the greater impact of promotions in Hi-Lo stores.

Obviously, over a longer period of time and if the EDLP policy is advertised, the image of lower pricing can contribute to a more noticeable impact on traffic and sales volume, provided that other elements such as service, stock convenience and choice are right.

Discounters like Wal-Mart in the US have been successful through a consistent chain-wide policy of EDLP which includes advertising that its prices are “always the lowest”.

However, most retailers have adopted EDLP on a more limited level, sometimes labelled Category EDLP, where prices of certain categories, such as soft drinks or disposable nappies, are reduced in an effort to increase traffic in the hope that store-wide sales will benefit.

The indication is that the lower prices in these cases simply do not bring new customers to the store fast enough to compensate for the lower profit margins. Basically a ten per cent price cut needs a 39 per cent volume uplift to break even. That means a third more customers or a third larger average shopping spend.

In some circumstances this can be achieved. For example, if a store is new, there is potential to increase traffic levels and if the store has a high proportion of secondary shoppers they can potentially be encouraged to buy across more categories. This was accomplished by Somerfield in 1994 with a price campaign that was highly effective in increasing average consumer spend per store visit.

The only other way to make Category EDLP effective is to limit price cutting to the few high-price elastic product categories where EDLP is actually more effective than Hi-Lo pricing.

With low and medium elasticity products such as sugar, bread and toilet paper, practically all the products, respond better to Hi-Lo pricing. It is only among the very elastic categories that EDLP has more of an impact and these product areas are therefore the only ones where a consistent EDLP policy makes financial sense in the long term.

Of course, studies like these cannot provide all the answers. If the experiment had been continued for a couple of years and advertising had been included, consumer response to EDLP may have been greater.

In real life though, repositioning on an EDLP platform is risky and expensive and there are many factors more important than price in determining a consumer’s choice of store.