Platt Perspective on Business and Technology

Rethinking price points and the economies of scale: a modest case in point

Posted in strategy and planning by Timothy Platt on November 29, 2014

We can often find our best teachers and our most important lessons from our experience of the worst, or of the at least problematical – if we really look and listen with an open mind and if we take the time to think through why a manager was ineffective, a business process was flawed, a customer relations practice was ineffective…. When everything is going smoothly and nothing particularly stands out as a challenge or as a source of opportunity, it can be too easy to simply ignore the details and miss any potentially included lessons. This, I add, does not necessarily only mean lessons learnable from big mistakes or problems. This is about always looking for and seeing opportunities and ways for improving what is there, big and small alike.

I begin with these points, which I add I have made quite a few times in the course of this blog already, because they involve business mistakes that do stand out – and that all but beg for more detailed thought as to what went wrong and on how to do things better. So I begin my discussion here with what in a larger sense goes beyond the specifics of this posting, and that might be considered a take-home lesson for this blog as a whole.

• We all face challenges and problems in our lives and for purposes of this blog and this posting, in our work and professional lives. These essentially always contain within them the seeds of opportunity to learn and to grow, and to come to understand how things can go wrong and how they can be fixed.
• In this, and focusing here on our work lives, our best teachers in how to manage and lead can be the worst managers and leaders we have to work for, or at least with. Our best teachers for how to manage and run customer relations systems can be found in the experiences we have with bad examples, and either while working for those businesses or as a customer of one of them. The range of examples, of opportunities for learning and growth that I could add to this starting list is essentially open-ended. Think through your own best/worst examples and ask yourself how and why they were so irksome and how you would systematically do them better if you had to set up and run a more effective counterpart to them.

To take that out of the abstract, I would offer here one of those possible additional list entries with some thoughts as to my analysis of what went wrong and how it could be fixed. And I begin by setting the contextual stage by briefly outlining select details of a very real and well known big box retail business with multiple large storefronts that are very widely distributed geographically. This business, which I will refer to here as BigStore sells a wide range of inventory that would appeal to home shoppers, with small household appliances, household supplies such as paper towels and other paper products, household cleaning supplies, groceries and food supplements (e.g. vitamins, herbal and other dietary supplements, etc.) They also sell home entertainment equipment and have their own pharmacy, eye glasses store, and even liquor stores in-house (in areas where liquor sales are allowed and can be cost-effective for their type of business.) They have even branched out to have their own travel services where they enter into sales agreements with big name cruise lines for travel and vacation on their ships, and with select vacation resorts. And some of their outlets have gas stations and tire replacement shops, and sell general purpose auto supplies too. Most of these outlets at least sell cans of motor oil and other make and model-independent auto supplies, that a car or truck owner could purchase and use themselves as do-it-yourselfers. So when I chose to identify this business by the name BigStore that is appropriate, and particularly when you look at both the range of inventory products and services offered, and I add the size of the store outlets that offer all of this. But I have one more reason for calling this business BigStore. They differentiate themselves from their more usual supermarket and department store competitors by offering larger sized units for a significant fraction of the SKU offerings in their overall inventory.

This includes bundled packages of several dozen rolls of toilet paper or of paper towels, to cite two consumer product offerings from their selection of paper products. It includes giant sized containers of laundry detergent and the largest size offered from their manufacturers for a host of other types of items as offered throughout these stores as well. And one important detail here that I will be coming back to is that with only select exceptions these large product size offerings are packaged and size-determined by the original manufacturers, and not by BigStore or its outlets. They order and carry these sizes for these many SKU offerings but they do not package them, in general, at these sizes themselves. This large scale per item offered approach is seen to be a core element of what sets this business apart and it, as a basic unexamined approach is a core component to their overall self-image as a business and of their corporate culture. I will come back to that point too.

BigStore outlets all have in their grocery area an in-house bakery and their quality there tends to be very high. Their inventory turnover is very fast so everything is always very fresh and their quality standards for selecting ingredients and for producing their baking products are high and adhered to. And I said above that I would take this discussion out of the abstract and general, but up to here I have still followed that pattern. That is because I have started outlining some pertinent details of a very real and specific business – but I have been discussing their very generally stated and even abstractly considered approach to who they are as a business and how they operate. And this business is successful because their general rules for what they offer and for how they do so apply well enough in most circumstances so that they can meet the basic needs of most of their customers – who all join in as members of this business’ customer community with annual membership fees – in exchange for closer to wholesale reduced prices on essentially all that they buy there. But I turn here to consider a specific example, as drawn from a specific service area of this overall business and its array of store outlets: their bakery and particularly how they package and sell one poster-child example product of what they produce and package themselves: muffins.

• How BigStore packages and sells its in-house baked muffins is a very minor issue for this business as it encompasses so small a percentage of its overall sales and cash flow as to be readily lost as a rounding error in any store financials calculations and both for BigStore as a whole and for its individual outlets. Specific here means very small-scale but that does not matter for purposes of this discussion or to the general points that I would draw from it.

I really like their muffins, but I almost never buy them even though my wife and I shop there roughly once per month. My reason is very simple; these muffins are packaged in-house in trays of six and I would buy one of those. But these stores only sell their muffins by the dozen, and my wife does not eat them so we would have to freeze most if not all of them. And with our standard sized kitchen freezer we usually have room for six but not for twelve. Yes, I said this was a minor issue, but when you look into the details, every business can be divided into a perhaps vast assemblage of interconnected “minor issues” – local processes and practices and their immediate here and now impacts.

And this brings me back to those two points that I noted earlier and said I would come back to. I stated that as with most retail businesses, BigStore purchases most of its inventory and both by selection of items offered and by sales volume from others. In this case and for this store with its buying power that means better wholesale prices for them, but they still primarily buy standard manufacturer offerings, even if they do tend to buy and then resell their larger sizes. The second is that selling big on a per-item basis is part of their corporate culture and self-image. And here I begin to draw out and analyze a crucial point distinction.

I recently found opportunity to speak with the general manager for a BigStore outlet and in the course of that conversation I raised the issue of how they only sell big, even for their own in-house manufactured products such as their baked goods. This was not the storefront I usually go to but they all bake and sell those muffins and only by the dozen. I told him how I and I presume others would buy six but find twelve to be too many – so if they sold the individual six-pack trays they would probably increase their overall sales – and without any operational cost increases as they already package and handle those six-packs the same way now that they would have to follow if they sold them individually. The only new cost resulting from that change, such as it would be, would be in updating their computer based pricing lists in their store databases that their employees use at checkout when calculating total due from their customers. And that would be negligible as they have employees updating their price listings all of the time as new items are added and costs to BigStore and prices charged by them change (e.g. for their wide assortment of produce items.)

This is a small issue, the question of how to sell muffins. But this reflects a confusing of the operational dynamics and the costs of selling outside manufactured, and inside produced inventory items at new package sizes. And the reason why I really began thinking about this and the reason why I chose to give this posting the title it has: Rethinking Price Points and the Economies of Scale, is that this manager began justifying his large size-only approach there on the basis of price points and what the business could charge per-item as an economy of scale issue. But that only applies where offering and selling smaller quantities per package would mean significantly increased marginal costs. In this case, and I chose my example carefully, switching sizes would carry essentially no cost-to-store increases whatsoever.

So BigStore sells big as part of their image – but according to a single less than fully considered understanding as to what that means, and both to themselves and to their customers. As a fix, or at the very least as an updating review of business practices I would recommend reconsidering how BigStore manages and sells their own in-house products as distinct from their outside-sourced inventory. And I would recommend rethinking where economy of scale savings and profit opportunities actually arise and what they would actually be, numerically – and how their current big-only limits customer choice to no benefit to the business.

This is a small specific issue that I have been delving into here. But as I have been noting throughout this posting, an overall business and its operations and strategy arise out of the cumulative consequences of a myriad of little and individually seemingly inconsequential details and from how all of those ongoing here and now decisions and actions and their consequences play out – collectively. Sometimes it makes sense to begin with the specific issue that in some way stands out and go on from there. I chose muffins here for that.

And with that I finish one of my longest postings to this blog, on one of its smallest issues. You can find this and related postings at Business Strategy and Operations – 3 and also at Page 1 and Page 2 of that directory.

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