Anyone who has ever shopped understands the challenge. Summer is here and you suddenly need to pick up a few items for the house and yard: an air conditioner, bug spray, lawnmower bags, a garden hoe, a new hose and of course a hammock. The neighborhood hardware store is conveniently located a block away. Its aisles are easily navigated due to its small size and the customer service can’t be beat. The local Home Depot requires a 20-minute drive, not to mention that its size and layout are overwhelming even to the most avid handyman. But, unquestionably, Home Depot offers better prices, and you wouldn’t mind picking up a few garbage cans while you are there. As the smart shopper, which store would you choose? This is exactly the type of question that Wharton marketing professors
Anyone who has ever shopped understands the challenge. Summer is here and you suddenly need to pick up a few items for the house and yard: an air conditioner, bug spray, lawnmower bags, a garden hoe, a new hose and of course a hammock. The neighborhood hardware store is conveniently located a block away. Its aisles are easily navigated due to its small size and the customer service can’t be beat. The local Home Depot requires a 20-minute drive, not to mention that its size and layout are overwhelming even to the most avid handyman. But, unquestionably, Home Depot offers better prices, and you wouldn’t mind picking up a few garbage cans while you are there. As the smart shopper, which store would you choose?
This is exactly the type of question that Wharton marketing professorsDavid Bell and Teck-Hua Ho, and Christopher Tang, professor at the Anderson School at the University of California at Los Angeles, tackle in their new study, "Store Choice and Shopping Behavior: How Price Format Works."
As part of their research, the authors take a close look at the shopping behavior of consumers to determine what makes shoppers choose one place over another and how retail managers can drive traffic to their stores. While the authors offer a complex explanation of consumer behavior, their message is simple: In order to improve store performance, retailers must begin to think like shoppers.
Research on retailing typically attributes the success of a store to its location. At the same time, marketing experts have focused a great deal of attention on the role of pricing in store performance, but without considering location. In this recent study, Bell, Ho and Tang provide managers with a new shopping framework that takes both criteria into account. By weighing such factors as distance to the store, customer service, familiarity with layout, product assortment and pricing strategies, a store manager can begin to predict how and where people will shop.
EDLPs and HILOs
Given the importance of pricing to decision-making in the retail environment, the authors start with a look at the various retail price formats. A wide range of possibilities is available in terms of pricing strategy, with the "Every Day Low Price" (EDLP) store on one end and the store which offers promotional pricing, known as the HILO store, on the other. Retailers like Wal-Mart employ the EDLP strategy and typically offer low prices all the time. As a result, there is minimal variability between the regular price and discount price. In contrast, a HILO store, such as Ann Taylor, has a greater disparity between the highest and lowest price, relying on sales and promotion strategies to entice the buyer.
Certain characteristics are associated with each pricing format. For example, the EDLP store often has a large number of items but a smaller selection of brands, less convenient format and very small fluctuations in prices. Using their shopping framework, the researchers characterize EDLP stores as mostly having a low fixed utility (less assortment, less convenient) but a high variable utility (lower prices). "Fixed Utility" captures costs and benefits that are essentially independent of the specific items purchased on a given trip, while "variable utility" captures factors that change according to the items purchased.
The "Every Day Low Price" format generally appeals to the cost-conscious buyer. People who shop at the EDLP stores often buy a large number of items each trip and shop less often than their counterparts at the HILO stores, the study found. Because EDLP shoppers normally buy many things in one trip, they benefit from the small average cost savings on individual items.
On the other hand, the promotional pricing or HILO format has been associated with a high fixed utilitythat is, convenient format, high quality service, good assortment of productsbut, in general, a low variable utility because these stores tend to have higher prices. In contrast to the EDLP stores, the HILO store competes on service and assortment, not price. The consumers who like to make small and frequent shopping trips are more likely to go to the HILO store for two reasons. First, they can benefit from the large disparity in prices. If the price of an item is high on one day, the person can just defer his or her purchase until the price drops and then stock up on the item. Second, these are the consumers for whom shopping convenience, good service and large assortments are appealing, according to Bell, Ho and Tang.
Most retail areas lack a dominant price format. If there is an adequate mix of both types of people in a community, both formats will survive. It is only when a population of shoppers moves to either of the extremes and becomes polarized that one format will be more effective.
Hassle-free Online Shopping
The Internet is one such example. Because the large majority of online consumers are time-conscious and convenience-driven, many online retailers have focused most of their attention on providing a high level of fixed utility or hassle-free shopping. Because the benefits to online shopping are high for this segment of shoppersno lines, no travel, no cartsthe online retailers are less concerned with offering the cheapest prices. Netgrocer could charge more for tuna because it gives consumers the fixed benefit of not having to go to the store. In addition, when it comes to trying to improve performance, many Net retailers stay focused on fixed benefits and improved product assortment, rather than cost.
Bell predicts that online retailers will begin to differentiate themselves in terms of the merchandise that they carry. A net grocer may start carrying products that typically cannot be found in a conventional market. Or you may get niche retailers who carry everything that Kraft has. The strategy is focused on providing a fixed benefit through product differentiation.
While a focused strategy, in which a store only appeals to one segment of shoppers, can be successful, it is also more vulnerable to changes in market preferences. The store that can be different things to different people will ultimately be the big winner, says Bell. It is possible to do that through the right assortment of products and positioning. For example, the person who normally shops at the EDLP store, Wal-mart, could view a supermarket with moderate fixed and variable utility as a HILO option. On the other hand, the person who frequently shops at a Whole Foods store, generally viewed as an upscale HILO option, may view the standard supermarket as an EDLP option when he or she wants to buy more items.
Once retail managers understand how consumers view the shopping process, they can find ways to drive more traffic to their store and improve its performance. For EDLP stores, typically the ones that are not convenient but cheap, the key is to improve access to the store by improving product assortment, overall shopping experience and in-store product information. Take, for example, Home Depot. By expanding its service, creating a garden department and improving the assortment of products it offered, the store was able to bring in a new range of customers. Home Depot became a one-stop shopa store for both garden and hardware needs. By becoming more accessible, or increasing its fixed utility, Home Depot was able to expand its customer base at the expense of its competitors.
Likewise, Comp USA launched a new concept store that features an open and spacious design divided into several departments, each with its own image and ambience. Why? To make it easier and more enjoyable for the consumer to shop. Walgreen’s also became more accessible by opening more than 900 stores and remodeling 500 existing locations, each time focusing on larger stores and improved assortments.
Promotions, Coupons and Private Labels
On the other hand, in order to reach more customers, HILO stores can do product-specific things like lowering prices through promotions and coupons and offering private labels. Safeway aggressively moved to expand its customer base through a carefully targeted Safeway Savings Program, which rewarded loyal customers through selective discounts. By doing this, Safeway not only brought in more customers, but it also increased their basket size by encouraging them to spend a larger fraction of their shopping budget at Safeway. As a result, the store increased its sales dramatically.
Although already known as an "Every Day Low Price" store, Costco further improved store performance by focusing only on a limited assortment of products with vastly reduced prices. The result: a 47% increase in net revenue in 1998. Continuing with the strategy, Costco has also begun offering private labels.
Ideally, a store could improve both fixed and variable factors simultaneously, but even increasing one of the components could directly improve the performance of the store.
As a result of studying the behavior of consumers, the researchers also discovered that a tremendous amount of inertia exists among shoppersthat is, people don’t switch stores easily or often. Although Bell attributes this inertia mainly to psychological factors, the finding is especially significant for EDLP stores. Once consumers have settled into satisfying the major share of their needs at one store, it is very difficult to get them to switch. Because EDLP shoppers tend to buy most of their things at one main store, the EDLP managers can take steps to retain their customers and develop a loyal customer base. A HILO store, however, is more vulnerable because people shopping at those stores generally buy smaller amounts and end up filling their needs in multiple locations.
People also develop store loyalties for particular products, according to the study. Although a consumer may do half of his or her shopping at store A and half at store B, the purchase proportion of certain products is not necessarily 50/50. For example, a person may buy 90% of his soda from one store, even though he buys half of his shopping list at another store. Stores can use advertising, promotions and private labels to create a draw on a particular category of products that causes people to perceive the benefit of buying a product at one store to be higher than it is. And, if you are able to do this over enough categories, you will eventually tip the scale so those shoppers do all their shopping at your store.
"The lesson for everyone," says Bell, "is that it is always cheaper to keep customers than to try to attract new ones. Therefore, all stores should be creative about enhancing store-specific benefits in ways that keep customers coming back."