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Study: Lowering prices will not increase profits

A Banana Republic customer looks at her receipt as she leaves a store in San Francisco

TEXT OF STORY

Kai Ryssdal: A lot of companies are finding themselves caught between a sluggish consumer market, in this economy, and rising production costs. Procter and Gamble said today profits are down and margins are getting squeezed by high commodity prices. But P&G says it's not planning to raise retail prices.

Marketplace's Alisa Roth explains why that might not be the corporate world's best strategy.


Alisa Roth: Like a lot of small business owners, Liz Walters started running into trouble around the time the economy fell apart in 2008. She owns a yarn shop in San Diego.

Liz Walters: My customers seem to be very price-sensitive. Everyone is stepping down one quality level in what they're buying.

She started cutting prices, about 10 percent for expensive yarns. And she's still frequently has 25-percent-off sales.

But an analysis from McKinsey, the consulting firm, suggests that might do more harm than good for small businesses like Walters, and big ones like Procter and Gamble.

McKinsey created a model based on 1,200 companies. It found that increasing the price of a product or service by 1 percent could boost the company's profits by almost 9 percent if sales stayed the same.

But lower the price enough to make customers notice -- by say 5 percent -- and the company would have to increase sales by double digits, just to break even.

That just isn't realistic in today's economy. Mike Marn is one of the authors of the McKinsey report.

Mike Marn: The message here is that the basic math of decreasing price to increase volume, to increase profits, just does not compute for almost every large and small company in the world today.

John Zhang is a marketing professor at Wharton. He says a lot of customers don't even notice when companies charge a little bit more.

John Zhang: Not all the customers really care about the prices.

Which means companies may actually have more pricing power than they think.

In New York, I'm Alisa Roth for Marketplace.

Log in to post3 Comments

I was glad to read the comments that stated the McKinsey report was erroneous. But I think that the key part of the report was "making a profit". Right now, my business is lowering prices just to stay in business...to stay afloat. We aren't making much of a profit but we're still in business, still paying our bills, and still employing 100 folks.

I disagree that customers don't notice price increases. Not only do I personally notice when prices on my usual purchases go up, but customers at my business notice. Once every two years our vendors raise the prices on skincare products by 10-20%. We, in turn, raise our prices. Our customers definitely notice. When we run promotions on our products, we sell more. Do those increased sales translate into greater profits? I haven't run the numbers recently, but I know that certain products move more when they're discounted. I also know that our customers price shop for our skincare products and even some of our services. If we raised our prices simply to increase our profits (not due to supply increases), there are definitely some customers we'd lose. Our customers trust us to give them good products and services without gouging them and we'd lose not only customers but our integrity.

Kiddo, if you think that companies are not raising their prices for consumer goods, then you are not paying close attention to the basics: unit size, weight, and volume. In the summer of 2009, a ten-bar bonus pack of Dial soap (back-to-school special) contained 1.27kg of soap, i.e., each bar weighed 4.5oz. In the summer of 2010, the same sale package contained 1.13kg of soap, each bar weighing 4.0oz. And those cartons of ice cream at the supermarket are not getting smaller just to help you keep your trim figure.

I, too, like to buy high-quality yarns when I can afford them. Those little skeins of alpaca blended with merino wool in multicolors just right for nubby crochet sweaters send me. But I've cut back on those purchases, too, even though I'm still employed. You see, a friend in a minimum wage job with no health insurance is facing a layoff sometime around Thanksgiving because the alcoholic owner has run the business into the ground. Given a choice between living on the street until a berth opens at Faith Mission here in Columbus, OH, or bunking in with me, she'll bunk in with me. At least I live at the intersection of two public transit lines (albeit in a bad neighborhood) while she pounds the winter pavement to look for a new job.

So I'm still squeezing every penny three times before I let it go just to make ends meet and to help a friend in a society that has yet to institute meaningful bank reform. This in an economy whose only growth industry is to prostitute itself through shadowy political action groups laundering Lord only knows how much money from what foreign powers.

So please don't encourage retailers to increase their prices. Some of us in this country still work very hard for a very modest living.

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