Want to Raise Prices? Customer Segmentation Provides an Answer
In an article in the Wall St. Journal entitled, "How Companies Can Get Smart About Raising Prices", Professors Paul Farris and Kusum Ailawadi suggest that many companies will be forced to raise their prices in the coming years, since cost of goods and transportation costs have been rising steadily while prices have remained flat to declining. Cost savings have been benefiting these companies, but now the cost savings are running out.
Since so many customers have become price-sensitive in the past recession, what's a company to do?
Some companies try to "hide" their price increases through a number of strategies: cutting promotions, reducing quality, reducing package sizes, etc. But all of those strategies have been shown to backfire, since consumers have a sense of what is a "good value", and are sensitive to "price gaming", when a few consumers figure out "the trick", they let EVERYONE know. Then the company has to deal with a negative reputation to go with the pricing issue.
So how can you raise prices right?
Professors Farris and Ailawadi recommend that companies use customer segmentation to target their promotions to the right customers. As they write, "After raising prices, companies should rely on discounting to keep their coupon-clipping customers—the ones most likely to jump ship if they think they're getting a bad deal. That means taking a close look at who their customers are and who should get what promotions."
You don't have to tailor promotions on a 1:1 basis, "It's enough to group customers into segments based on things like their purchase history and how sensitive they are to price."
The Power of Customer Segmentation
In fact, promotional sensitivity is one of a number of factors that can be customized through customer segmentation. Product preferences, communication channels, offers, timing, seasonality, messaging/positioning and others also become clear when you group customers by their transaction behavior (see my post "Customer Segmentation: Using Behaviors to Drive Data-driven Marketing" for a deeper perspective on behavioral segmentation).
How do you gain a deeper understanding of your ability to increase price or conversely, reduce promotional activity, at the segment level? Many retailers use some combination of the following three approaches:
- Analyze historical promotional response at the segment level to find out which segments show incrementality and profitable results to price promotions. By taking overall promotional analysis and drilling down to the segment level, it is possible to see which segments actually respond to a promotion at all as well as which segment's purchases are actually incremental, rather than simply replacing existing purchases with a greater discount. If you do not have control groups in your data, there are two ways to roughly estimate how a specific segment responds to different kinds of promotions. The first one is to examine customers using the promotion versus customers that are making purchases without the promotional redemption. Match them by their prior purchases to make them roughly equal and examine what happened during the promotional purchase and beyond. In addition, you can analyze customers who receive the promotion versus new customers who could not have received the promotion to see what the relative lift would be.
- Test and control your way into knowledge. If you want to make sure that your estimate of segment response to promotions is accurate, you can always take a subset of your customer database by segment, break that into a test and control group and run an email marketing campaign. You can even test different levels of promotion versus each other and versus the control group all by building a test matrix, executing the program and reading the results.
- Analyze past pricing actions at the segment level. Identify markets where pricing has changed and evaluate customer purchase patterns before and after the announcement of that change. You will have customers ranging from those that abandon the product category after price increase to those who did not change their behavior at all. By understanding segment response to prior price actions, you can get a sense for what the net impact of a pricing change at this point would be as well.
Professors Farris and Ailawadi lay out a convincing case for retailers to increase prices after such a long period where the retailer (or the manufacturer) have been forced to manage the consequences of a highly price-sensitive market. Now that costs have risen over a number of years, it is appropriate for retailers and manufacturers to cautiously, carefully and deliberately increase prices to help to absorb those margin hits since 2008.
By varying promotions and discounts, the most valuable, most price-sensitive customer segments can be somewhat protected from the impact of these price actions. The strategy of segment–specific marketing programs also benefits the retailer or manufacturer because it communicates to consumers that they are known and cared for by the organization.
Price actions are very scary in today's environment. Follow the guidelines in the Wall Street Journal article, and analyze and execute your marketing promotion and communication plan at the segment level – and you will be just fine.
In fact, customers in the highly protected segments may appreciate the personalized care and attention to their needs. In this way, counterintuitively, you may be able to grow the business while taking a price action at the same time.
Full disclosure, I studied under Prof. Farris at the Darden School of Business at the University of Virginia, and we have kept in contact over the years.