Sunday, December 27, 2015

Who's In Charge of Pricing the Coffee???

Pricing goods on the supermarket shelves is as much an art as it is a science.  More often than not the end result - a price, reflects the logical outcome of all the input factors.  From time to time, however we get an output - a price that seems to defy logic.  We can only conclude one of two things - either our assumptions about the way the world works need to be revisited or - there is just a quirk, an oddity, an outlier.

As an investment manager I'm trained to look for the outliers.  Buying or selling an outlier can make the difference between having average performance and having above average or below average performance.
Finding the outlier makes a trip to the supermarket or shopping mall more interesting and more fun.  It's a bit of a hobby for me.  Some people spot planes and trains.  Some people follow the minute details of sports statistics. I follow prices.

Our journey in search of the pricing outliers begins of course at the manufacturer on the desk of the Product Manager. The Product Manager is in charge of practically every element of brand and product development, from the look and feel of the packaging, timing and delivery of advertisements, wholesale pricing, promotional pricing and finally, MSRP or manufacturer's suggested retail price.

Whenever I go to the supermarket I pay attention to prices, in part because, like every consumer, I want my hard earned dollars, koruna, pounds, rubles and yen to go as far as they can.   Aside from the practical implications of smary buying, I'm always interested to finding what I call pricing idiosyncrasies  - the quirks or departures from would seem to be the norm or logical progression.

Lately the biggest quirk I've seen is in the instant coffee aisle.  I happen to shop in Prague very often.  The local currency is the Czech Koruna, so I'll reference my local currency.  Also to be consistent we will talk about 200g packages. Those of you in other countries can substitute numbers proportionally.  Makes no difference.
When I am in the US I drink Taster's Choice.  Here in the Czech Republic we don't have that brand.  We have NesCafe, which it so happens is a product of the same fine company that makes Taster's Choice.

Pricing in the instant coffee aisle works something like this:  the stuff that tries to be something reminiscent of coffee sells for Kc 60.  Then the store brands sell for somewhere between Kc 75 and Kc 99.  Lidl, a local supermarket I shop in, sells a private label brand called Green Eclipse which is just wonderful.  It sells for Kc 79 and sometimes it's on sale for Kc 69.

I buy Green Eclipse because I like the taste, but also I especially like the price. I the taste were lousy I wouldn't buy it.  Life is too short to drink bad coffee at any price. 
Between Kc79 and Kc 160, there is nearly nothing to speak of.  It's what I call the DMZ - the de-militarized zone.  It is practically an empty, barren wasteland.
After that the mainline brands start.  The major brands include Jacobs, Douwe Egberts,  Tchibo and Nescafe, with prices ranging from 159 to 259.  Premium coffees, including the "Gold" versions of the mainline brands, cost usually between 199 and 259.  The very top of line is Davidoff, which prices at 390.  It's sold in 100g packs at 199.

I think the biggest indication that product managers are getting nervous is when they develop brand line extensions and odd pack sizes.  For example, a number of brands have introduced "velvet" or finely ground variations, are lower priced.  Also some of the brands have pack sizes of 95g, 180g and 190g.  This makes direct price comparisons hard to make and also enables them to meet price point targets.

Pricing Quirk Number 1 - A Range Big Enough to Drive a Truck Through
Pricing variations in the coffee aisle are among the widest I can find in the supermarket.  Producers seem to believe that once the consumer finds the right taste price sensitivity ends.  What producers seem to miss is propensity among consumers to substitute.

I find it hard to believe I am really very different from the average consumer.  I like the taste of NesCafe.  It's my favorite coffee except for Taster's Choice. But it's not my favorite coffee at any price.
For every jar of NesCafe or I can have at least two jars of the Eclipse.  NesCafe is among the less expensive of the mainline bands. For some of the other brands the ratio is more like 3 jars of Eclipse or 1 and a half jars of NesCafe for 1 jar of the main brand.

I just don't understand this pricing case.  If coffees like Eclipse are readily available, why should mainline brands be two, three, four times more expensive.  And why should such large price dispersions occur within the mainline brands. Do people care so much about taste? Shouldn't propensity to substitute be greater or is there something else I am missing here? Consumers respond to the weekly supermarket sales circulars and switch supermarkets at the drop of  hat when they see laundry detergent on sale.  But once inside the market they don't care about what they pay for coffee?

Pricing Quirk Number 2 - The De-militarised Zone in Pricing
Between Kc 79 and Kc 159 the pickings are few and far between. My guess is that the product manager doesn't have a lot of influence at this level and the pricing battle shifts to the supermarkets.  Pricing managers in supermarkets well understand the behavior of consumers and where the elasticity of demand can vary.  Pricing managers also look at gross margin - the the difference between what the price at the cash register and the price from the manufacturer.  Still - why should there be this big gap in pricing  50% - 100% between the bargain  brand and the mainstream brands?

Pricing Quirk Number 3  - Putting the best value for money on sale
Why should something that's already priced well go on sale? This coffee is the best value for money!  I hardly think the sales will change much when it goes on sale.  Demand is probably pretty inelastic at that level.  Makes no sense to me!

And yet - incredible as it may seem, Eclipse sometimes goes on sale, with a big red sign pointing out the 10% discount.

Pricing Quirk Number 4 - Putting the Brands on Sale

From time to time NesCafe runs a promotion.  They price the 200g bottle down to 119.  This is still a hefty 50% premium to Eclipse, but a is a healthy discount to the other main line brands.  At that price my price sensitivity goes out the window and the taste devil drives my decision.  I stock up.  I'll by three or four at that price and keep them in my pantry and draw down the stash until next sale comes around.  Judging by what I observe at the cash register, many other consumers are doing the exact same as I do. When NesCafe is on sale it seems to just fly off the shelves.
I wonder - if NesCafe decided to change it's strategy to everyday low pricing - say the Kc 129 level instead of the 179 or 199 level would NesCafe's revenues go up or down?

Pricing Quirk 5 - Deep Discount Overkill
This week and next NesCafe they are pricing at 79.   They've actually gone through the pricing DMZ and are going head to head with Green Eclipse.  I'm stocking up and how and judging by what I see in the stores, even the twenty-four/seven neighborhood convenience store owners are doing the same.
I don't like to look a gift horse in the mouth.  But I don't understand why NesCafe felt the need go through the DMZ and go head to head with the bargain brand.  Leaving aside the velvet finely ground products, The mainstream brand pricing starts at about 159 and the bargain pricing ends at 99. A price point around 119 for the sale should be more than sufficient to pick up market share from the main competitors.

I Have More Questions than Answers - Don't You?
I'll be interested to hear what my product manager and supermarket executive friends have to say about the enigmas of coffee pricing.  I also will be interested to hear about other pricing idiosyncracies away from the coffee aisle.  E-mail me at if you have suggestions or comments.
I normally write about Angel Investing and P2P Lending.  To learn more about my Angel Investment Fund click here.  To learn more about our P2P Lending Fund click here

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