Flanking In A Price War

Article Main Points Summary

This article was written to analyze a pricing experiment in the Quebec, Canada grocery industry. The "Hometown Prowd" IGA supermarket chain was the pioneer and facilitator of the experiment.

The article's main focus is on the Steinberg grocery chain. Steinberg's was the market leader until approximately 1980. The beginning of the article also explains and provides a summary of each retailer's history. Steinberg's became notorious for slashing prices and creating many obstacles for competitors in the industry. Thus, the president of IGA used academic resources from the United States and Canada to help comprehend the price relationship between goods and price modifications. This research was performed so IGA could form the most effective pricing strategy for the market. Hudon and Deaudelin (owners of the IGA name in Quebec) did not want to utilize the normal, typical price reduction scheme used by most grocers.

The Bayesian Theory was what the experiment was based on. The Bayesian Theory was, "named for Thomas Bayes, an English clergyman and mathematician, Bayesian logic is a branch of logic applied to decision making and inferential statistics that deals with probability inference: using the knowledge of prior events to predict future events."

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The experiment revealed two main categories of grocery products, those being stock-up goods and non-stock-up goods. Each category had different price sensitivity. In essence, the result of the experiment was that IGA was able to use the data and erudition gathered to develop the most effective pricing strategy during the price war.

Pricing Experiment Design

In essence, this experiment was developed to examine the concept of inventory stockpiling and in turn, its response to price modifications. Generally speaking, the average consumer believes that price affects sales. For example, when prices decrease, sales increase.

In order to conduct the experiment, grocery goods were divided into stock-up goods and non-stock up goods. Stock-up goods being non-perishable merchandise such as chips, canned vegetables, deodorant, Kleenex, etc. Non-stock-up goods being perishable items such as produce, meats, milk, etc. Generally, stock-up goods can be stockpiled in large quantities as they have a longer shelf life.

The experiment was designed to test the theory that the sale of stock-up goods is more delicate price wise than those non-perishable items. Further, the experiment also tested the hypothesis that demand is less elastic to price increases and more elastic to price decreases. Finding the most profitable pricing scheme was the jest of the experiment.

Perhaps just as important as determining the most profitable pricing method, was the important notion that the experiment could be halted at any time so the store would not experience any more losses than absolutely necessary. After the completion of each week the respective store managers were to review and analyze the sales. This was performed to determine if the experiment was worthwhile or too expensive.

To conduct the experiment there were 72 products chosen. Throughout a six-week period the prices of these products were modified. Next, different price strategies were implemented: regular prices placed on all products during the first two-weeks, raising prices of stock-up/non-stock up goods by 20%, and then selling those products at that price level or 20% beneath the price level. The experiment was not advertised or communicated to the employees. In essence this was done to defend and protect the soundness of the experiment.

Pricing Experiment Results

After two weeks, the experiment was stopped as the facilitators felt they had enough data to analyze.

The numbers revealed that a 20% increase in the prices of stock-up items resulted in a 24.1% decrease in sales. On the other hand, the numbers revealed that a 20% decrease in the prices of stock-up goods resulted in a 54.95% increase in sales. Thus, the conclusion - in terms of stock-up goods - was that consumers were more sensitive to price reduction versus price increases.

The results for the non-stock up items revealed that a 20% increase in price caused a 7.6% decrease in sales. Conversely, a 20% decrease in price resulted in a 10.55% increase in sales.

In essence, the results clearly depict that a specific, price reduction scheme using stock-up items would be "head and shoulders" more profitable than a blanket price reduction.

The Quebec Grocery Market and the Forms of Competition

Four retailers controlled the Quebec grocery retailing industry in an oligopolistic form. These four grocery giants dominated 84.5% of the market. Provigo held 31% of the market share, Metro-Richelieu held 25%, Steinberg with 20%, and IGA with approximately 8.5%.

These four competitors offered essentially the same types of products; produce, dairy, meat, and frozen foods. High entry barriers into the market were created by internal and external economies of scale. Thus, they could engage in price wars to bully new businesses out of the industry. Price gouging by one store affected the others as this meant a significant percentage of business was being redirected. The competitors reacted prompt to this tactic by altering their prices to match them, if not lowball them.

Oligopolies have many characteristics. The Investor Dictionary defines an oligopoly as, "a market form in which a market is dominated by a small number of sellers (oligopolists). The word is derived from the Greek for "few sellers". Because there are few participants in this type of market, each oligopolist is aware of the actions of the others. Oligopolistic markets are characterized by interactivity. The decisions of one firm influence, and are influenced by, the decisions of other firms. Strategic planning by ologopolists always involves taking into account the likely responses of the other market participants." (http://www.investordictionary.com/definition/Oligopoly.aspx)

Government regulation was evident in the grocery retailing industry in Canada. For example, alcohol sales were limited to small chains with five stores or less as well as limited operating