The Wrong Way to Profit
Years ago I was in Singapore visiting companies that stood to profit from the rise of the Asian consumer class. One was an operator of bakeries and restaurants that owned and operated several different concepts that they were planning to grow into China, Thailand, and other fast-growing emerging markets. It was a promising story and the fundamentals looked solid. Of note was the fact that gross profit margins had stayed relatively consistent despite rising ingredient costs, a sign – I thought – of the company’s pricing power.
Meeting with management I brought this up and asked about it. They were quick to point out that they weren’t raising prices. Indeed, they didn’t think their target consumers would tolerate regular price increases. Instead, they said, they had surreptitiously been shrinking portions while keeping prices the same, and they seemed to think that was a very clever strategy (and one that’s popping up again in today’s inflationary environment).
Ultimately the math of shrinking portions versus raising prices works out the same way, but one strategy is much more sustainable than the other (eventually the customer will notice how tiny their cupcake got). What’s more, while the idea of passing on price increases may seem untenable, if a business is able to do so successfully, it’s a sign of how important its product or service has become to its customers. And if it’s not, it’s an indicator that you need to work on your core offering, not your pricing strategy.
As for the company in question, it’s since gone private without ever creating much value for shareholders. That’s because, over the long run, gimmicks like portion shrinking don’t create sustainable value. That only happens when your customer’s business is so well-earned that price is not the main reason that customer works with you.
– By Tim Hanson
