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Punch line: Relatively small increases in price can generate large increases in profitability … that’s called price-profit leverage.  And, relatively small increases in prices are low hanging fruit for practically all products and companies since consumers have “zones of price indifference” or, in other words, a “latitude of price acceptance”.

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Price-profit Leverage

According to McKinsey Increases in price typically have 2 to 4 times the effect on profitability as proportionate increases in volume.

More specifically, given the cost structure typical of large corporations, a 1% boost in price realization yields a 5% to 15% net income gain.

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Latitude of Price Acceptance

Customers have a latitude of price acceptance —  a range of possible prices within which price changes have little or no impact on their purchase decisions.

Customers frame their LPAs from the price range that they observe, say, in-store vs. online, or regular vs. sale prices.

LPAs vary for different categories of products that customers buy.

A McKinsey & Co. study shows that LPAs can range widely: from 17% for branded consumer health and beauty products to 10% for engineered industrial components and apparel to only 2% for some financial products.

The 2% for financial products may seem paltry, but the McKinsey study indicates that a financial services company moving from the middle to the top of a 2% LPA band for personal loan products would generate an 11% increase in operating profits for those products.

Source

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Buyer behavior & LPAs

Scanner panel data analyses for sweetened and unsweetened drink      categories support the presence of a region of price insensitivity      around a reference price.

• Consumers with higher average reference price have a wider latitude of price acceptance.
• Consumers with a higher frequency of purchase (i.e., shorter average interpurchase time interval) have a narrower latitude of price acceptance, because they are more aware of the range of price distributions.
• Consumers with a higher average brand loyalty have a wider latitude of price acceptance, demonstrating greater tolerance of price fluctuations.

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Takeaway: Know the LPA … then go for it … don’t leave easy $$$ on the table.

Source

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Tags: latitude of price acceptance, LPAs, Price-profit leverage, zone of indifference

This entry was posted on November 26, 2012 at 6:59 am and is filed under Mktg - Pricing, Profit Models. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.