28 Jun 2004  Research & Ideas

How to Avoid a Price Increase

Consumers hate price increases, but what is a company to do when material costs skyrocket? One answer: Think small. Professor John Gourville considers the alternative in this Q&A.

 

When product companies see the cost of materials rise, the result for consumers is often a price increase (gasoline) or, less often, a smaller amount of product at the same price (potato chips).

Which option is more likely to turn off your customers? For many products, it's better to reduce quantity than raise prices, conclude Harvard Business School marketing professor John Gourville and University of Texas professor Jonathan Koehler. They recently published their findings in a working paper, "Downsizing Price Increases: A Greater Sensitivity to Price than Quantity in Consumer Markets."

Gourville discusses the price-versus-quantity dilemma in this e-mail interview.

Manda Salls: When prices for raw materials increase, companies need to compensate to keep their profit margin on target. What are the typical responses?

John Gourville: Companies often face rising costs. Most choose to pass that along to consumers in one form or another, the most common being an increase in the retail price. Other times, they may redesign the product to lower production costs or replace more expensive ingredients with less expensive ingredients (e.g., switching from cane sugar to corn syrup). In the cases of downsizing price increases, firms have chosen to maintain the sticker price of a product, but have reduced the quantity contained in that product. Thus, a tin of coffee stays $2.99, but shrinks from 14.5 ounces to 13 ounces, for an effective price increase of over 10 percent.

Q: You looked at downsizing versus price increases from two perspectives: how manufacturers and the public think consumers behave, and how consumers actually behave. What did your research show?

A: The research Jay Koehler and I have conducted shows that some manufacturers anticipate that consumers will be more sensitive to differences in price than differences in quantity. In the case of breakfast cereals (described in this pdf), for instance, the variance in price of a box of cereal is relatively small, while the variance in the quantity contained in that box is quite large. It's almost as if cereal manufacturers are deciding that a box of cereal should cost, say, $3.29, and then adjust the quantity accordingly. If the cost to make the cereal is high, the result is a box with fewer ounces and fewer portions. If the cost to make that cereal is low, the result is a box with more ounces and more portions.

Our data on consumers seems to support this logic. First, consumers themselves report a greater sensitivity (or awareness) of price than of quantity. Second, in tracking the sale of snack foods we found that consumers reacted greatly to periodic changes in price, but not at all to periodic (yet systematic) reductions in quantity. As a result, one manufacturer was able to reduce its package sizing by 10 percent to 20 percent over the course of three years with little to no negative consumer response.

Q: Can you share some product-downsizing success stories? What made the strategy work for these products?

A: First, we have to define "success." If we define success from the perspective of the manufacturer, then there have been success stories. For instance, I think coffee is a product category that has successfully used downsizing. For the longest while, ground coffee came in one-pound containers. Then, in the 1980s, several coffee companies reduced the size of their containers by an ounce or two. At first, there was substantial backlash—the one-pound container was so well entrenched in people's minds, it was easy to notice the change in quantity. But with time, the uproar died down and coffee manufacturers have been free to reduce quantity by small amounts ever since. Today, the standard tin may contain as little as eleven ounces of ground coffee.

Consumers themselves report a greater sensitivity of price than of quantity.

We are now starting to see the same thing with ice cream. While ice cream has traditionally come in one-half gallon (or two quart) containers, Breyers and Edy's are now selling their ice cream in 1.75-quart containers. This allows these brands to sell at a sticker price comparable to its lower-cost competitors, while maintaining its per-unit margins. While it is still too early to say for certain, I suspect that other ice cream manufacturers will soon follow suit.

Q: The practice of reducing quantity while keeping price the same could be perceived as dishonest by consumers. Have any companies experienced a backlash after decreasing product quantity?

A: I would agree that consumers may perceive the practice of downsizing to be dishonest. This perception is made worse by manufacturers who try to hide the downsizing by retaining the same size container or outside packaging, but not filling the container as much. We often see these items chastised in the back of Consumer Reports.

And in the short term, almost any firm that downsizes its packaging may experience a backlash. We saw it with coffee, with Dannon's yogurt, with diapers, and with snack foods. However, while I don't have broad data on this, I suspect that this backlash is short lived.

Q: Are there types of products for which customers are more quantity-conscious than others? What products won't this work for?

A: There are certainly categories where a change in package size is more noticeable. These would include any category where a certain quantity of something is required. Motor oil comes to mind—a car needs a certain quantity regardless of what the package sizing is. If the Quaker States and Pennzoils of the world were to shrink their packaging from a quart to something less than a quart, it would force consumers to buy more units.

There are also product categories in which there is a standard size, as in the case of eggs and butter. If dairy firms were to sell butter in slightly less than one-pound packages, consumers would notice. In these cases, one could expect more resistance and backlash. With that said, however, coffee and ice cream are two examples where the manufacturers were able to overcome a standard package size and still downsize.

Q: The strategy of downsizing products must have an inherent endpoint—a bag of potato chips can only get so small! What else can manufacturers do to defray product costs without increasing prices?

A: True, you can only shrink a specific package so much. At some point, however, you can eliminate a product from your product line and introduce a "new, larger size" container and start the whole process over again.

Other ways to defray costs, as mentioned above, is to reengineer the product process to reduce costs, to replace more expensive ingredients with less expensive ingredients, and finally, to simply raise price.

Q: What other research are you working on?

A: At this time I have several other projects going on. In one bit of research, I am looking at the counterproductive effect of variety. Quite simply, we find that firms sometimes drive consumers away (e.g., to their competitors) by offering too many alternatives.

In other research, I am trying to understand how and why mail-in rebates work. The curious thing about mail-in rebates is that they often influence choice, but rarely get redeemed. You would think that consumers would learn about the elusive effect of mail-in rebates over time, but they don't seem to. The result is a promotional tool that drives demand, yet results in limited payouts.

About the author

Manda Salls is Web editor for Baker Library.