[Pricing Nugget #046] Let’s talk strategy, HILO or EDLP?

Assume you work in retail and are responsible for the general pricing strategy. What should it be?

Should it be EDLP? Like "everyday low prices." 

Or HILO pricing - setting higher prices in general and particularly low prices on a few items?

Is there any general guideline?

We will find out today.

We talked about EDLP and HILO, but what is "everyday low prices" or "high-low pricing"?

Think of a promotional budget of $100. You can reduce prices for 100 items by $1 or 20 items by $5.

EDLP is a low-variance pricing strategy in which price discounts relative to competitors are spread broadly across a large number of offerings and are relatively stable over time.

For HILO, on the other side, HILO stores tend to have somewhat higher prices than competing stores on many items but also have less frequent large price advantages on discounted items - the "low "in the high-low pricing strategy.

Hence, EDLP leads to frequent small price advantages over competitors, and HILO leads to rare but large price advantages over competitors.

EDLP or HILO: what is better?

Past research confirmed that there is a frequency advantage for EDLP price strategies.

Customers count the number of price advantages and conclude that the retailer with more "points" has overall better prices.

And this simple heuristic is called the "frequency heuristic." If customers can compare prices between competitors, they just count how often competitor A has a better price than competitor B? And this general perception of having a better price in general, is also called "price image."

Overall, past research confirmed that the EDLP pricing strategy wins.

Is this realistic? 

But if you look closely into the experiments, you find out that in these past research studies, participants in the experiments compared prices for the same item across different stores SIMULTANOUSLY.

You had an item, and the participants saw the price of retailer One vis-a-vis retailer Two.

You might wonder, is this really realistic that customers always compare prices simultaneously for the same item across stores and competitors?

What happens when people actually evaluate prices in stores SEPARATELY and not simultaneously across stores?

The researchers set up a couple of experiments.

In this experiment, they created ten different product categories and included four brands in each product category.

Then they created two sets of stores. The Depth stores had 36 items - out of all 40 items - set at prices that were 20 Cents higher than the Frequency stores. But the Depth stores had four items that had a particularly low price, being $1.80 lower than the Frequency stores. So, Depth stores are synonymous with HILO prices, and Frequency stores are synonymous with EDLP prices. The total prices across both groups of stores were the same.

Now, they asked for the Price Image. You can measure the Price Image in various ways. In this case, they asked participants about the estimated average price per product category. The participants had to move a slider and determine what the average price in the product category was.

Now, the Price Image was compared between the Depth stores with HILO pricing and the Frequency stores with EDLP pricing.

The researchers calculated "average prices for Depth stores" minus "average prices for Frequency stores."

If the Price Image score is above zero, the Frequency stores would perform better because they lead to a lower price estimate.

If the Price Image score is below zero, the Depth stores, with HILO prices, would perform better because they lead to lower price estimates.

And finally, they split the whole experiment again into two more groups. One half would evaluate prices jointly, like seeing the prices of retailers A and B at the same time, and the other half separately not seeing prices at the same time but in a sequence.

What happened?

DA DA DA DA, the original effect reverses. So, still in a joint evaluation, EDLP pricing strategies would perform better and lead to a better price image, but if prices were evaluated separately, the HILO, the depth price strategy would perform better.

Why is that?

It depends on the assumptions you make about consumer behavior.

In this case, in the joint evaluation setup, customers can and would compare prices across stores and the across competitors. And they would even notice small discounts because they see prices vis-a-vis.

In the separate evaluation case, customers do not compare prices across stores, and they actually do not remember past prices for the same item they buy today. What they would do is they would compare prices to other products in the same category, but they would not notice if the price discount, the price difference were small. They only notice large discounts.

In the joint evaluation case, competitor prices serve as reference points. In the separate evaluation case, prices of other products in the same category serve as reference points.

This is why the EDLP pricing strategy is better in the joint evaluation case because it produces more small, noticeable price discounts. And the HILO pricing strategy is better in a separate evaluation case because it produces the large price discounts that are necessary to be noticed.

What did we learn today?

Today, we learned that EDLP pricing strategies are better when your customers evaluate prices across competitors simultaneously. And we learned that HILO pricing is better when your customers evaluate prices across competitors separately.

What about your customers and the average customer journey?

Does your customer simultaneously evaluate prices in price comparison portals like Google Shopping and therelike? 

Or does your customer enter your store, look around, shop around, and separately compare prices in your store?

This is important because it gives you insights into whether you should lean towards an EDLP strategy or a HILO strategy. Think about it.