Who would ever have thought that cafés could get away with charging &£1.50 for a cardboard cup of coffee? Or that pubs would be selling lager at &£3 a pint and a packet of pan-fried crisps would set you back 80p?
Exorbitant though these prices may appear, they come as inflation hits an all-time low, and marketers in other sectors despair of pushing through price increases for their products.
The likes of Starbucks and Aroma have shown how superior service, fashionable American image, high-quality coffee beans and central locations can seduce consumers into paying way over the odds if the marketing is right.
But, in many sectors, such inflation-busting rises are harder to achieve. Consumers have got out of the culture of expecting price rises – indeed in packaged goods they expect greater value these days in the form of price cuts and special offers.
If Chancellor Gordon Brown is to be believed, inflation is all but licked. It fell to a six-year low of 1.3 per cent last month and is on course to break below the one-point barrier – to its lowest level since February 1964.
Marketers can no longer increase prices and lazily dub them “inflation-indexed”.
Even when mortgage repayments have been stripped out, the annual underlying rate of inflation in May was 2.1 per cent, down from 2.4 per cent the previous month and well below the official Government target of 2.5 per cent.
Stephen Radley, chief economist at The Henley Centre, says: “Inflation has been so low for so many years that consumers know what the price of things is going to be, so they can keep track.
“There has also been a change in attitude. People are far more demanding. They want bargains and discounts. They are having to take on a lot more responsibility in their own lives, their jobs are less secure. They see it as a right to get more back.”
David Magliano, sales and marketing director of BA’s low-cost airline Go, says service companies have most to gain in this environment. He adds: “During times of high inflation, it is manufacturers of consumer durables that benefit. People invest in cars and washing machines as prices go up and wages lag, so they think they might as well buy sooner rather than later. During low inflationary times, people aren’t so hurried – they can get those goods next month. But companies such as Go and easyJet which offer services – or “experiences” – benefit. Where you can put off buying goods, people still long for good experiences. It is a Nineties thing: consumers are investing in themselves. Companies that provide those experiences benefit.”
But other sectors involving either day-to-day purchases or one-offs are afforded no such luxury. The car market, under investigation by the Competition Commission for the apparent disparity between UK prices and those on the continent, has not pushed through price increases for the past three years, according to Toyota marketing director Mike Moran. Meanwhile, they have been forced to improve specifications to lure customers.
Moran says: “There has been no price increase of any significance in two years. Two and a half years ago prices were among the cheapest in Europe, but the strength of the pound has driven up UK car prices compared with European prices.”
Moran plays down the prospect of Government intervention bringing down car prices. “If prices were to drop suddenly it would be a catastrophe for all car owners because it would affect used-car prices, too. I can’t imagine it would be a great vote-winner.” He says he is content to see prices low. “Low inflation is a virtuous circle, with lower prices leading to greater sales.”
Packaged goods is one area where price rises are hard to sustain, as shoppers are often only too aware of the average prices of every day goods. Nick Shepherd, marketing general manager for coffee and food at Kraft Jacobs Suchard, says that even in a low-inflation economy costs may rise more than the general inflation rate – for example, transportation costs are mushrooming due to diesel tax hikes. But in such a tough sales and marketing environment, innovative and imaginative strategies can still enable brands to thrive.
Shepherd says packaged goods marketers have to add value to products to justify price increases. “It is a challenge to add value to categories. At Kraft, we have been aggressive in freeze-dried coffee, such as Kenco and Carte Noire. It is about finding alternatives to volume growth and also giving extra impetus to the premium end of the market. We have introduced a new category with Dairy Lea Dunkers. We have added a lot of value for a similar amount of eating.”
Shell International global head of brands and communications Raoul Pinnell says losing the ability to raise prices means cost-cutting and company restructures are now standard methods of raising profits. The net result is that marketers are forced to become more accountable in the deployment of their budgets. “Marketing can no longer hide behind excuses as to why we can’t be more cost effective. There is going to be an enormous increase in those offering quantitative research to show the benefits of marketing expenditure,” he says.
James Walker, director at consultancy Edge Marketing, argues that despite the growing difficulties of increasing prices, pricing is still “the strongest lever a marketing director has on profitability”. Walker, whose consultancy specialises in creating modelling techniques that predict the impact of variables such as price changes and advertising support on a marketer’s portfolio, argues that price effects are more immediate than advertising, its gearing on profit is enormous and a brand can be repositioned by price alone.
He adds: “Clients can try to maximise profitability through optimising pack sizes and their price differentials, brand variants versus competitors, variants and variant pricing within brand umbrella and new product development.”
He says as marketers introduce product innovations to appeal to different types of consumer in an attempt to create premiums, the proliferation of variants can cannibalise each other unless the price is right. “You need intimate knowledge of the history of the brand in terms of sales and pricing, looking at TV support by region and by channel [for instance, whether sold through Sainsbury’s or Tesco]…When you change the relative price between two or more brands, history suggests in what proportion sales will move.”
Walker argues that successful innovation need not necessarily involve expensive research and development. “Brands don’t even have to change their content. Look at what McVitie’s has done with Jaffa Cakes. By simply changing the packaging and putting them in a tube, it has created a more premium product.”
There is an argument for “income elasticity” in a low-inflation economy. In other words, certain industry sectors will gain as other companies feel the squeeze. Consumers who spend less on groceries can spend more of their wages on more interesting things, such as cinema and meals out.
But Walker is sceptical. He suggests there is more likely to be a polarisation of pricing in any one market. “All consumers are portfolio consumers. Some things in our larders are twice as expensive as others.”
So if a certain brand becomes cheaper, the consumer is unlikely to buy more of it, but rather carry on buying the same and then treat him or herself now and again to a more expensive brand in that category. In a low-inflation or even deflationary economy, companies with a culture of innovation will have better opportunities to pull away from their competitors.
As Pinnell puts it: “The low-inflation environment doesn’t necessarily mean the dumbing down of marketing – opportunities lie in greater segmentation and offering proper premium products to customers.”
With additional reporting by David Benady
The Economist’s View
In the past fortnight, price-busting US retailer Wal-Mart has bid to take over Asda and inflation has hit a 36-year low. Competition is increasing and prices are being squeezed. But how did we get here and how much further can we go?
As the chart (opposite) shows, the UK has had a chequered inflation history. In the Fifties and earliest Sixties, inflation was rarely above five per cent. However, it rose steadily from 1967, peaking at an annual average of 25 per cent in 1975, and hitting 30 per cent in some months. Since then, both Labour and Conservative governments have had some success in getting it down for a while, but these triumphs proved short-lived and it ended the Eighties in double figures. The low inflation rates since 1992 therefore represent a new era of almost stable prices.
There are a host of reasons why inflation is so low – some economic, others pointing to fundamental changes in consumer behaviour.
Taking the stark economic factors first, the UK has benefited from cheap imports on the back of a strong pound and of low world prices of oil and other commodities. Economic policy has also improved, with the Bank of England’s independence taking interest rate decisions out of the political arena. The economist’s traditional tools of supply and demand also come into the equation. In industries such as cars, clothing and computing, advances in technology and investment in new equipment mean that supply is expanding well ahead of demand.
Once inflation goes low, it can also become self-sustaining. Since 1992, inflation has stayed below four per cent and has often been much lower than that. Prices of many goods have barely changed over this period and consumers have become far more knowledgeable of what they should be.
This has made them far more resistant to price rises. In recent years, sales have plummeted in months when retailers have tried to hike prices. Much greater transparency also makes it easier for consumers to achieve good deals. Though the number of people buying and selling on the Internet is still quite low, it is likely to grow strongly and far more consumers are using it to find out what deals are available. The introduction of the euro in continental Europe and the publicity generated by various investigations by the Office of Fair Trading have also fostered a growing sense that UK consumers are being charged more than their counterparts in the rest of Europe. This is creating pressures for prices to go lower and a recent report by Dresdner Kleinwort Benson suggests that they have started to converge in a downward direction across Europe.
At The Henley Centre, we have also detected an important change in attitudes. Consumers are increasingly demanding value for money as a right. Even when they can afford to pay more, people are looking for discounts.
We believe that this is part of an implicit bargain between consumers and companies. As consumers and workers, we have had to take a lot on board in the Nineties – adapting to less job security, sorting out our own pensions, and organising our own education and that of our children.
In return, we are becoming more demanding as customers, expecting better quality and improved service but a lower price. Not surprisingly, this factor is not a regular feature of the Bank of England’s quarterly Inflation Report, but it is something that we expect to play an important role as we enter an era of falling prices for many goods and services.
Stephen Radley is chief economist at The Henley Centre