Our third and final article on product pricing continues to look at the psychology of product pricing. The what, when, why and how to change prices can be a daunting task and decision. Even though some foodservice and vending operators just randomly change prices, it is best to have a pricing strategy in place that will provide improved product performance as it relates to popularity (quantity sold) and contribution margin (product profit).

The what of pricing. This is directed toward individual products you sell in any type of operation. Periodically you are going to ask yourself, what product prices should I change? Keep in mind that while you are going through this review process, you should definitely be looking at products that are slow movers -- the unpopular items that are not generating reasonable contribution margins.

The why of pricing. After you identify the what factor, the reasoning for pricing change comes into play. There are key reasons why you might change a price: (1) the cost of the product and/or packaging have increased and you want to recover that cost in the selling price; (2) there is a price reduction of the product tied into a promotion allowing you to reduce its price for the promo duration; (3) your pricing strategy is to gently raise all product pricing regularly, and this is usually done once or twice a year; (4) the product is an unpopular slow mover; and (5) the product has the lowest contribution margin in its category.

The when of pricing. Product prices change after the why has been established. If your product price increases, your first thought might be how soon and how much you can raise its price. Most operators have a theoretical product cost goal that's the target for all pricing. Usually these goals are established by product category and are not the same across all categories -- at least this is how it should be done. In this case, the selling price is raised to the level that will yield, at least, the theoretical product cost goal.

An example of this approach would be as follows:

If the theoretical product cost goal is 45% and the current selling price is $2.50 (the cost is $1.12) and the product cost goes up by 20¢, the cost would then be $1.32 so the selling price then becomes $2.93. That said, you would hopefully round up to $2.95, or better, $2.99.

If a product's cost increases, when to raise the price usually follows soon after. Most operators have a variance factor that helps determine the timing on implementing a price increase. For example, if a product's cost increases by 5%, or less, no price increase would take effect until regular scheduled adjustments are made. Any increase above 5% may require an immediate review of the product in terms of renegotiating the cost with the manufacturer or distributor; changing the size of the product (smaller product to keep the same price or larger product to increase the price); raising the price immediately to recover the cost increase; or replacing the product with a similar item at the current cost and keeping the price the same.

The how of pricing. One benefit of technology, particularly with micromarkets, is that you can change prices over the Internet from your office -- as long as there are no price tags on the items. Another key how factor involves bundling products so you can take an item that has a higher cost and promote it with other items, which have lower costs. This can be very effective when you have an item that is popular but yields a contribution margin below the category goal. Bundling generates higher dollars for a sale -- and that's a good thing.

Beyond the product cost surges that prompt pricing increases, I have some clients that automatically raise prices twice a year: July 1 and Dec. 1. Why these months? According to these clients, July and December price increases have generated less resistance than other months when prices were raised. By the way, they do not do wholesale (all) price increases, but methodically identify those items that are stars (high-contribution margin and high popularity) which can withstand a gentle price increase without damaging popularity. They tweak the pricing of those products that are below the contribution goal. At the same time, these clients look at dropping prices on all items that are unpopular, or they replace them altogether. You should never have a product in a category that sells less than 10 units per month.

In many cases, operators review product performance on a quarterly basis to monitor the popularity and contribution of each product within every category so that the bad performers can be removed or replaced.

Operators often validate price increases by adhering to the belief that they are selling convenience, i.e. time vs. money. This concept supports the strategy of reducing the SKUs in any category to focus on the most popular items with higher contribution margins. A "mega" operation with 30 SKUs in each category is often unnecessary.

When pricing products $1 or more, keep in mind that the customer reads these numbers from left to right, so an item priced at $2.99 is perceived as a better deal than a $3 item. This is called the "left digit effect." Interestingly, more 60% of most prices end with a nine (9). I think there can be too many 9s and where do you go from there? However, I have one client that prices all products ending in 9, whether it is 99¢, $1.99 and so on. This strategy works for this client.

There is now a trend to not use the dollar sign on labels. Hence, PRICE: 1.99, rather than PRICE: $1.99. I am not sure what influence this has on a customer's decision to make a purchase, but it is another example in which operators are trying different pricing strategies in an effort to sell more products.

Another key factor to consider when establishing product pricing within a category is related to merchandising. Where you place a product within the category will impact how many are sold. So location, location, location is very applicable in product placement. Hence, you place a star-performing product in the very best location within a category display that will draw immediate attention to it.

When setting up your planogram by category, separate lower-priced categories from the higher-priced ones. For example, avoid placement of gum and mints near the refrigerated fresh food. Gum and mints are really impulse items and should be near the point of sale.

As you plan your pricing strategy and have identified the right products to sell in each category based on the contribution margin, keep in mind that the other key factor -- popularity -- can only come from how many of a product within a category your customers will buy. Part of your pricing strategy must be to know who your customers are at each location; understand their likes and dislikes, and their needs vs. their wants.

The psychology of pricing is tricky and complicated, but spending time analyzing which products perform best in each category, and which need price tweaks or replacement, can positively impact profits and customer satisfaction. I recommend you take a few minutes and examine your current pricing strategy. First, determine if you even have one; second, look at the mechanics, how does it work?; and third, ask yourself, "how well is it working?"

SEE ALSO:

The Psychology Of Pricing: Leverage Perceptions And Pennies To Execute Gentle Increases

What Is Your Pricing Strategy? Establish A Product's Cost, Then Apply Fundamental Valuing Methods

JERRY McVETY is founder of McVety Associates, an international foodservice and hospitality consulting firm. He has held a variety of executive positions in the foodservice industry. McVety, a Knowledge Source Partner in the National Automatic Merchandising Association, is also an active speaker on the industry lecture circuit. He can be contacted at jmcvety@mcvetyassociates.com.