This article has two parts to account for its length; this is part one.
I recently wrote an article (here) about my failed investment in J.C. Penney (JCP). In the comment section, I said the following in response to a reader’s comment:
“I didn't look too closely at Amazon (AMZN) or Walmart (WMT) prior to my investment in JCP, but I realized something when I did: the pricing strategies that they employ are beneficial to their brands long term; I'd argue that the pricing strategies employed by others can have the opposite effect. If you have the time, go listen to Walmart's most recent investor meeting; some of Doug McMillon's comments on WMT's pricing strategy are quite revealing. You'll come to a similar conclusion if you read Jeff Bezos' early shareholder letters: there's a lot of focus on trust in the relationship with the customer. No amount of advertising will replace that if properly managed.”
Since then, I’ve spent a lot of time thinking about trust and the role it plays in the relationship between a retailer and its customers. This article will look to address that topic in more detail.
Walmart
A good place to start is with the comments from Doug McMillon, Walmart's CEO, at the investor event mentioned above. What he said is worth thinking about (emphasis added):
“A thing that I believe deeply is that you never want to create a situation where customers think they are playing a game. If they believe they have to shop on Wednesday or do this or that, stand on one leg and snap their fingers to get a deal, you have lost. Because they are going to start shopping around even more. The power of Walmart and the power of EDLP was that people stopped making a choice about where they were going to shop because we had earned their trust - not convinced them that we could be trusted but actually earned it.”
In the annual report, the importance of EDLP and price leadership is discussed further:
“By leading on price we earn the trust of our customers every day by providing a broad assortment of quality merchandise and services at everyday low prices ("EDLP"), while fostering a culture that rewards and embraces mutual respect, integrity and diversity. EDLP is our pricing philosophy under which we price items at a low price every day so our customers trust that our prices will not change under frequent promotional activity. Price leadership is core to who we are.”
If you’ve ever been to a Walmart Supercenter, you know that this commitment to EDLP rings true. As you walk through the store, you consistently get a sense that price points are at least competitive with (and usually much better than) what you would pay elsewhere. As noted above, this is a fundamental part of what makes Walmart different from the competition; no jumping through hoops required. The low prices you see today will be there tomorrow as well.
J.C. Penney
Let’s compare that with J.C. Penney. A few years ago, when Ron Johnson stepped in as CEO, he noted some pretty astounding numbers: first, an extremely small percentage of the company’s products – just 0.2% - were being sold at the listed retail price; and second, more than two-thirds of the company’s revenue came from products that were marked down by at least 50%.
If we invert, we can conclude that (a) consumers clearly don’t find value at the quoted price points, and (b) the company relies upon an endless chain of sales and coupons to win business.
As opposed to a price point that is relatively consistent and “fair” for both parties, this pricing strategy is a constant struggle between the consumer and the retailer to see who can come out ahead.
I’d argue that the Walmart pricing strategy builds trust; I’ve never left Walmart with the impression that I paid substantially more for a product than I would’ve been charged elsewhere (I’ve shopped at Walmart for many years). The approach used by J.C. Penney, on the other hand, reduces or even eliminates trust among consumers. Loyalty and trust are replaced by coupons. The customers who actually purchased products at the sticker price (the 0.2%) probably realized at some point that they were essentially ripped off; as a result, there’s a good chance that individual will never shop at Penney’s again.
The reality of the world we live in today is that the vast majority of products sold by any retailer can be purchased somewhere else with relative ease; with e-commerce, improving delivery options have started to remove the time / convenience barrier as well. To the extent that key players can offer comparable service, price is the most meaningful point of differentiation (particularly in e-commerce).
It seems logical that price transparency will continue to move in the direction that benefits the end consumer (technology should be able to do the leg work for us). As e-commerce and shopping tools continue to evolve, I think a pricing strategy like EDLP looks even better.
Amazon
That brings us to the dominant e-commerce company in the United States: Amazon. As I noted in the intro, I generally believe that the approach they take is beneficial to their brand long term. They’ve done a masterful job on customer service, and realized the importance of shipping costs in the eyes of consumers many years before their competitors (it’s probably more accurate to say that they realized this AND did something about it). They’ve taken the next step in that evolution with Amazon Prime, which has managed to add millions of users year after year.
However, despite all they do well, I think there’s one glaring exception: the company’s use of dynamic pricing is misguided, and could ultimately result in an impairment of customer trust. It’s important that I note at the outset that Amazon is not alone in this practice; in fact, based on what I’ve read, it would be hard to find a retailer that doesn’t use dynamic pricing. I only single out Amazon because (a) they’re the clear industry leader and (b) I think they have the most to lose as a result of this practice. To the extent Walmart uses this pricing strategy, I think it should be greatly reduced or eliminated as well (the marketing implications are clear; a recent addition to Walmart's website - "Dare to Compare" - is a great example).
Dynamic pricing is the practice where retailers (or airlines, hotels, etc) offer goods or services at price points that change according to demand, the customer type, or other factors.
I wanted to see this in action, so I tracked prices for six different items on Amazon over the past seven days (I checked the prices once each morning); each of the items were randomly selected at the start of the week, and I haven’t added or removed any items since day one.
These are the products I selected: (1) Tide Liquid Laundry Detergent, Original Scent, 50 ounces; (2) Dove Men + Care Deodorant, Cool Silver, 3 ounces; (3) Bounty Select-A-Size Huge Rolls, 12 count; (4) Planters Dry Roasted Peanuts with Sea Salt, 34.5 ounces, 3 count; (5) HP 951 Color Ink Cartridge Combo; and (6) Titleist Pro V1 (2015) Golf Balls, One Dozen.
Some of the data turned out to be uneventful: the Bounty paper towels were the same price every day; the price for the Dove deodorant changed once, but by a relatively small amount (~5% increase in price). The Planters peanuts were a bit more volatile (three different price points, with the high more than 10% above the low), but the absolute change was small ($1.68).
The three other products, on the other hand, showed some interesting changes. On the ink cartridge combo and the golf balls, the movements were especially noticeable due to the higher price point (products priced in the ~$50 range). On the ink cartridge combo, the difference between the high and the low price was ~8%; in dollars, that was a nearly $4 difference in the product cost. On the golf balls, the difference between the high and the low price was ~15%; it would’ve cost me seven dollars more to buy the dozen on Wednesday than it did on Thursday.
The final product is the Tide detergent. I think this was the most interesting product for a couple reasons: most people have a good sense of what’s “fair” for this products due to the frequency of purchase, it’s offered by multiple retailers, and the price changes were pretty sizable (in percentage terms). Here’s the data:
http://userupload.gurufocus.com/706683094.jpg
Two or three bucks isn’t much – but I still wouldn’t be happy knowing that I paid $14.50, while the guy who bought five minutes after me paid less. On CamelCamelCamel.com, which shows the price history for products on Amazon going back a few years, the high point for that bottle of Tide detergent was 117% higher than the low point. It should also be noted that this bottle, per ounce, is much more expensive than at Walmart, Costco, Target, etc; if you read the reviews, you'll see many people are unhappy about that. As the price points start to move higher, the values start to become material: I’ve seen TV’s with price variations that exceeded $1,000 between the high and the low over a short period of time (not expected reductions over time as you always see in consumer tech). This sounds more like J.C. Penney than Walmart.
This is starting to get lengthy, so I’m going to stop here. I’ll release the second half tomorrow.
