The Pricing Straightjacket

This week, I found myself pondering the future of $2 shops. While $2 shops are often associated with tacky, low-quality goods, they are also essential when the need arises for gift bags, wrapping paper and P-plates (am I correct?). $2 shops are an example of a price-point retailer, where all the products in a store are sold for the same price. International examples include Japan’s Daiso, UK mega-chains Poundland and 99p Store, and old-school American “nickel and dime” stores. They typically stock a range of inexpensive household goods, and are also known as “variety stores”.

How does inflation affect them? Inflation erodes the purchasing power of money over time. Since these stores receive a fixed price for their goods, in real terms they receive less and less each year. This, in turn, puts pressure on the cost of doing business.

What can they do about this? They could raise their prices, but somehow “the-two-dollar-and-five-cents shop” just doesn’t have the same ring to it (not to mention that the name will have to change continually). One might even say that the flat pricing structure is the signature of such stores. Commercial Director of 99p Stores Hussein Lalani insists that “We’re sticking to 99p. We understand that’s what gets our customers excited”.[1]

One might think that inflation will eventually put these retailers out of business. Yet there seems to be longevity in the business, with examples such as Poundland operating for over 20 years. There are clearly some things working to the advantage of price-point retailers. Here are some of their strategies:

Strategy #1, economies of scale: Many of these retailers are large chains. For example, Daiso has over 2500 domestic stores and 500 international stores.[2] Poundland has 381 stores across the UK, while 99p Store has 173. The sheer volume of the goods sold allows them to purchase from suppliers at low unit prices, which means they can make profits even when inflation occurs.

Strategy #2, special packaging: It should not come as a surprise that, in order to counter inflation, these stores are continually reducing the quantities they sell for the same price. While most businesses generally tend to do this, large price-point retail chains have the advantage that suppliers are willing to cater to their needs. Knowing that $2 shops will not raise prices to consumers, suppliers specially package goods such that each unit can be sold for that price. When inflation sets in, these companies simply reduce the weight or volume of each unit.

Strategy #3, changing the mix of products: As inflation occurs, price-point retailers continue to re-evaluate the goods they offer. Something which sells in a supermarket at just under $2 will eventually sell for over $2 when inflation occurs. At this point, $2 shops find it attractive to offer that good. As an example, in 2008, Poundland considered including grocery essentials such as milk, eggs and bread as part of its product mix.

Strategy #4, buy from overseas: When the cost of overseas products (including freight) is lower than the cost of similar domestic products, it makes sense to import them. Thus, in $2 shops, one often sees imports from Asia, where manufacturing costs are lower. This commonly includes products of multinational companies where the same (or a similar) product is also produced domestically.

Strategy #5, raise prices: Although not an optimal strategy (and contrary to Lalani’s view), some price-point retailers have raised prices. In September 2009, the 99 Cent Store in the US changed its prices to 99.99 cents. Similarly, in 2010 in the UK, business owner Colin Sharp changed the name of his chain of pound stores from “Famous ₤1 Shop” to “Famous ₤1.20 Shop”. There should minimal damage to profits as long as these stores are still the cheapest place to buy the products they sell, so arguably the only negative impact of raising prices is the catchiness of the store name. Of course, one can minimise this by avoiding mention of price in the name altogether. Hence the chain Family Bargains, owned by 99p Stores, which has the freedom to change prices as inflation occurs. (As a side note, Family Bargains also sells household goods such as vacuum cleaners which would never sell for 99p anyway, differentiating it some more from 99p Stores). In Australia, The Reject Shop has this same advantage.

Examples of price-point retailers increasing their prices are telling of the pressure that they face. While the economic hardships of the GFC benefited them as consumers had to tighten their budgets, economic recovery in the future means that these businesses will have to work hard to maintain profits while continuing to offer value.

References

[1]http://www.bbc.com/news/business-16469761

[2] http://www.daisostore.com.au/corporate.html

General reference

http://news.bbc.co.uk/2/hi/business/7680302.stm