Product, Price, and Substitution Effects

When does the customer love the product, and when do they love the price?

A daunting moment for any pricing manager or product line manager is the point where it becomes necessary to move a product which price sensitive customers are attached to over a significant price barrier.

We faced just since a major challenge back when I was the pricing manager for Wendy’s in 2010 to 2012.

(I think it’s a great example to talk about, both because fast food is something nearly everyone can relate to and because it’s long enough ago it’s not revealing any sensitive information. However, talking about fast food prices 14 years ago may give you a sense of yearning for the good old days.)

Bacon prices increased rapidly during 2010, and as a result one of our highest volume items, the Jr. Bacon Cheeseburger had become a dangerously low margin item.

If you want to be successful in running a fast-food restaurant, you want food cost to be only about 30% of your price. The next 30% goes to cover labor, and another 30% to cover your site costs like rent, utilities, franchise fees, etc. If you run things well, the remaining 10% can be your profits.

The Jr. Bacon Cheeseburger was on our 99¢ Menu, which meant it was already a lower margin than our full-size sandwiches. But with the rapidly increasing cost of bacon, it was fast becoming unsustainable.

So we did what any responsible marketing department would do: we conducted some market tests. In select markets we took the JBC off the 99¢ Menu, and we measured the effects.

In the markets where we made changes, when we took the JBC off the 99¢ Menu, we immediately lost half our volume on the product. If the average store had been selling 1200 JBCs a week, they were now only selling 600.

However, those 600 units were not going away. Customers who really wanted to buy a small size hamburger for $0.99 instead bought the Double Stack (which featured two small-size patties instead of the JBC’s one, but no bacon) another 99¢ Menu item which until that time had not sold nearly as well as the JBC. The customers who really wanted their beef, bacon, cheese, tomato, and lettuce fix, went with the JBC even if it was priced at $1.19 or $1.29. The total number of sandwiches sold did not fall.

What we learned from this was that some customers were attached to the product and were willing to buy it even at a 30% higher price. Other customers, however, were attached to the price point, and if the JBC increased in price, they would buy another product at the $0.99 price they were attached do. So long as we offered both the original product at the higher price and the substitute product at the lower price, we could keep both customers.

This is why knowing why your customers are attracted to specific products is so important. You may have multiple segments of customers who are buying the same product for different reasons. If you make a change, in the product or the price, those segments of customers may respond differently.

In this case, one group of customers wanted bacon while the other group of customers wanted to spend no more than $1 for a sandwich. If we had treated those customers as just one group, we would have either lost customers (if we increased the price of the JBC while offering no cheaper alternatives) or lost money (if to retain customers we kept selling the JBC at an unsustainably low price.)

Testing and having the right product assortment allowed us to satisfy both groups of customers while also satisfying our need to pay our bills and still make a profit.

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