PRICING IN THE CROSSHAIRS

Supermarkets are settling into pricing strategies that are less like the strapped-in rush of a roller coaster and more like a fireside easy chair.Less thrill, more chill seems to be the watchword for companies such as Raley's Supermarkets, the Sacramento, Calif.-based retailer that backed off from high-low pricing earlier this year and instead lowered everyday prices on more than 5,000 items in an

Supermarkets are settling into pricing strategies that are less like the strapped-in rush of a roller coaster and more like a fireside easy chair.

Less thrill, more chill seems to be the watchword for companies such as Raley's Supermarkets, the Sacramento, Calif.-based retailer that backed off from high-low pricing earlier this year and instead lowered everyday prices on more than 5,000 items in an effort that Bill Coyne, Raley's chief executive officer, told SN was only the beginning of its new pricing strategy.

Raley's, with the move to everyday low pricing -- or rather what consultants today are calling "modified" or "hybrid" EDLP -- joined other retailers such as Giant Eagle, Pittsburgh; Fresh Brands, Sheboygan, Wis.; Clemens Markets, Kulpsville, Pa.; and Wegmans, Rochester, N.Y.; in lowering everyday prices on a selection of known-value goods in favor of the up-again, down-again specials with which retailers have traditionally priced their items.

But the move, observers say, is only part of a larger effort industrywide to address pricing with more precision. Retailers changing pricing strategies require manufacturers to address theirs; and even companies with no real intention of abandoning time-honored, high-low pricing schemes are busy tweaking their pricing strategies. This, according to some, is because the entity most sophisticated on price today is the group known as the shoppers.

"Retailers are now more focused on establishing and implementing comprehensive pricing strategies that enhance their pricing image than they ever have before," Jon Hauptman, vice president, Willard Bishop Consulting, Barrington, Ill., told SN. "This is being driven by the increased competition from a wide range of price- and value-oriented retailers such as Wal-Mart Supercenters, SuperTarget, membership warehouse clubs, limited-assortment stores and dollar stores."

Facing sharper pricing from these formats -- according to studies by Bishop Consulting, Wal-Mart averages a 13% to 18% edge on traditional supermarkets on a total-store basis -- supermarkets have had to address their price image by attacking old pricing strategies, Hauptman said. These range from the "modified EDLP" programs favored by Giant Eagle and Raley's to "laser-focused" offerings to specific customers within a high-low scheme, as increasingly practiced by retailers such as Kroger, Cincinnati.

"There are many roads to roam relative to how to enhance your price image, but all of them have a strong focus on narrowing price gaps on known value items -- the ones they purchase most often and know the price of. A modified EDLP policy is one way to do it, but it's not the only way," Hauptman said. "Weis Markets [Sunbury, Pa.] and Harris-Teeter [Matthews, N.C.] are doing great numbers and crediting it to effective promotions. And they're doing it in the heart of Wal-Mart country."

According to Coyne of Raley's, shoppers voted with their feet for the retailer's new pricing scheme, which involved lowering thousands of everyday prices at Raley's, Bel Air and Nob Hill stores. Around 9,000 items have now been reduced.

"They didn't like running around to different stores comparing newspaper ads," Coyne told SN in an interview. He said Raley's commissioned a study by California State University at Sacramento revealing that shoppers tired of "stocking up" on goods purchased at hot prices to the point where they found themselves running out of pantry space to store them or keeping them past their expiration dates. "This kind of pricing structure, where we stabilize prices and have a consistent, value-based pricing system, is a way to simplify [shoppers'] lives."

If only implementing the strategy was as simple.

RISKS AND REWARDS

Retailers who go to EDLP should be prepared for bumps in the road, experts said. Drawbacks include a potential loss of revenues, diminished drawing power and challenges in communicating the new price message.

The potential of generating less excitement through hot ads, and subsequently, if temporarily, losing shoppers in the store, is one reason publicly traded retailers have been slow to adopt EDLP strategies, analysts said. Unionized retailers also don't have the cost structures to support lower revenue streams, they added.

"To effectively do EDLP, you have to bring everyday pricing much closer to Wal-Mart, and I don't know if publicly traded supermarket operators have the cost structure to do that," John Heinbockel, analyst for Goldman Sachs, New York, told SN. "They would [also] take a huge hit for the first 12 months in comps."

Delhaize America, the Salisbury, N.C.-based retailer, is switching the Victory Markets chain of stores it purchased last year to align with the EDLP strategy of Delhaize's Hannaford Bros. chain. "It's going to take a year of bleeding comparable sales until they get it," noted Mark Husson, an analyst with HSBC World Markets, New York.

However, some feel the store traffic that might erode as part of a switch to EDLP wasn't very valuable in the first place. "You may lose 'cherry pickers,' which I doubt will be detrimental to the ring or to profitability," Don Stuart, managing director of Cannondale Associates, Wilton, Conn., told SN.

Stuart advocates a "balanced" approach, whereby a selection of goods wide enough to generate a low-price image are reduced. Overdoing the strategy, he said, can lead to disastrous results.

"If you do [EDLP] incorrectly, you'll go bankrupt," Stuart said, citing Kmart's move to making its "Blue Light Specials" a part of the everyday experience of shopping there: "It wasn't the sole culprit [in that bankruptcy], but it didn't help. There has to be a balance between attractive icon price drivers in the center of the store and truly differentiated, value-added offerings around the perimeter."

Hauptman noted that one challenge for retailers going to EDLP will be trial and error around the selection and the number of items that are reduced.

"It would be very easy to drop prices on too many items, and I don't think anyone knows what the right number is," he said. "Is it 7,000 items? That's an open question, and if so, what are the right 7,000 items?"

Other risks of EDLP, Hauptman said, are in communicating the price message effectively and in providing reasons beyond price for drawing shoppers to the store.

"Toning down the weekly ad will generate less excitement in the store," he said. "That has to be counteracted by communication to bring excitement back and by helping customers find the new values available. [EDLP] only works if you encourage people to shop your stores more intensively and also attract new customers. All else being equal, by reducing prices you're reducing revenue unless you get people to shop more."

On the positive side, Hauptman said EDLP can cut down on price changes and the labor and logistics associated with it.

DEAD-NET NOT DEAD YET

Jonathan Ziegler, an analyst with J.M. Dutton & Associates, Eldorado Hills, Calif., is a strong advocate of EDLP. He has argued it could differentiate a retailer like Pathmark, Carteret, N.J., which over the last year suffered margin and sales declines amid aggressive promoting by competitors such as ShopRite, operated by members of the Wakefern Food Corp., Elizabeth, N.J.

"There are two reasons I advocate it -- one is that what they're doing isn't working; and two is that if your biggest competitor is highly promotional, it makes sense to differentiate," Ziegler told SN. "Obviously, locations and merchandising are also differentiators, and I am not advocating they take their eye off that, but with pricing such an issue in the market, [going EDLP] will help create a brand that stands for something."

Ziegler, however, said he doubts Pathmark would make such a change, noting that blips in quarterly sales and earnings can have painful repercussions for public companies. "My guess is what spooks the managements of the publicly traded companies is that you can't afford hiccups when you're reporting every quarter," he said. "Wall Street punishes you for that. A public company has to plan quarter to quarter and can't do anything strategically."

Product vendors face similar pressures, Ziegler noted, which interfere with the ability to reach dead-net pricing between suppliers and retailers.

"Let's say you're Campbell or Kraft and you want to make your numbers in the first quarter of '05, so you throw a promotion," Ziegler said. "When you're closing the first quarter of '06 and assuming you want to show growth, you have to promote again. The trouble with EDLP is that everybody is tempted by the promotional monies out there and nobody is able to get dead-net pricing."

Only if retailers and vendors are able to ride out that promotional cycle together will the benefits of EDLP be met, Ziegler contended. "You'll wind up with a smoother logistics stream, you'll reduce your operating expenses, and so you should be able to maintain your gross margin," he said. "The way it is today, you've trained your customer to only buy what's on sale, and they don't pay full price. In effect, that's a pullback on margins."

Product vendors are beginning to examine their pricing strategies more closely, Stuart said. "I was talking just the other day to a vice president of marketing and a vice president of sales for a very large food company, and when we talked about key issues they were wrestling with, pricing strategy was at the top of the list," Stuart said. "Manufacturers know they need a better strategy for pricing with consumers and retailers than they had in the past. It's top of mind with them now."

Some evidence for this mind-set appeared in Cannondale's most recent trade promotion survey, which showed trade spending as a percent of gross sales declined, from 17.4% to 16.3%, for the first time since Cannondale started tracking the percentage in 1999. While Stuart believes that new accounting procedures reclassifying trade spending from marketing expenses to revenue reductions had some effect on those figures, "bottom line, [vendors] know they have to offer a good price."

Coyne told SN that Raley's worked hard with its suppliers over several months to reach pricing levels it could hold throughout the year. "We will still have promotions and weekly ads, and we'll continue to cooperate with our vendors on those opportunities," he told SN. "But what we're seeing is that vendors are becoming more sophisticated about consumer behavior, and they're second-guessing whether the deeply discounted, promotional-based [strategy] is the best way to go to market."

Saying the strategy was a long-term goal, Pathmark enacted an EDLP program among health and beauty products early last year, but analysts have yet to be convinced of its success. "Their same-store sales have suffered and so has gross margin, and they haven't recouped the investment yet," one analyst told SN. "Their return on that investment is going to be very elongated."

TWEAKING EDLP

Heinbockel of Goldman Sachs noted that while EDLP is probably a bad idea for publicly traded retailers, "it would be a good idea to tweak high-low with a lower high and a not-so-low low. This would enhance these companies' pricing credibility."

Regardless of the strategy, pricing programs do not do enough by themselves to drive traffic, observers noted. In a retail world where Wal-Mart makes the rules, the main goal of retail pricing strategies is to take price off the table as a barrier to shopping. This must be supplemented by an effort to win shopping trips by other means. Raley's, for example, will continue to emphasize its service as a point of difference, Coyne said.

"I think customers want excitement, but if you've ever been to Wegmans on a Saturday, you'll see there are lots of ways to build excitement," Stuart noted. "I think the pulling power of Pepsi 2-liter bottles at 89 cents has diminished somewhat. It's been abused and overused."

Traditional high-low players are looking at pricing strategy changes too. Albertsons, Boise, Idaho, last year introduced a program it calls "Check the Price," at stores in competition with a low-price leader like Wal-Mart. The company has cut retail prices on some items by as much as 30%, focusing on those goods the customer buys most often -- around 10% of what Albertsons sells overall. In a recent conference call, Larry Johnston, Albertsons' chief executive officer, described "Check the Price" as a swap of gross margin for customer trust.

"This program of everyday fair price on our highest velocity and highest basket penetration items is already beginning to build new trust levels with customers, assuring them we'll be priced right on the items they need every day," he said. "While we know that price perception is the toughest consumer dimension to change, we believe that this program ... is already beginning to change customer perception on our price competitiveness and most importantly, can be sustained long-term in our business model."

Promotions still play a large role in Albertsons' strategy, but even this is getting a fresh look, Johnston said, noting advances in pricing and promotion strategy across its banners since the retailer engaged Scottsdale, Ariz.-based consultant Khimetrics. "What we're learning to do is to cut the tail off of unprofitable promotions," Johnston said. "We believe promotional optimization is something in this industry that needs to be studied and executed at a higher rate."

High-low retailers often stage sales promotions that hurt their profits and draw the wrong customers, researchers from Chicago-based consulting firm AT Kearney told attendees at the Food Marketing Institute show in May. While value-based competitors have lured away shoppers, winning them back with ever-more-aggressive promotions is a "zero-sum game" resulting in "a vicious cycle of declining share and margin," contended Josh Chernoff, a vice president at AT Kearney, Plano, Texas.

Retailers need to revamp their pricing strategy behind better research, added Mir Aamir, a former vice president at AT Kearney, suggesting for example that they look beyond the velocity report when choosing the right items to promote. Often, he said, choosing items based on attributes such as brand loyalty and household penetration can generate more profitable sales, discourage "cherry pickers" and better serve a retailer's overall price image.

One way to discourage cherry pickers is to bypass them altogether -- a strategy in development by a number of retailers integrating loyalty data with their pricing programs.

"There's a strong opportunity for retailers to begin investing their markdown dollars in their best customers -- offering targeted promotions in key known-value items to the customers they know are purchasing these items," Hauptman said. "These retailers, like Kroger and Ukrop's, use the power of loyalty marketing to target their best savings to their best customers. It's a progressive step forward and where I see pricing going in the future."