MIT pricing research applied to fuel pricing strategies

MIT pricing research applied to fuel pricing strategies

• Dec 19, 2012
• John Keller
• 0

There is a terrific article published by the MIT Sloan School of Management titled “Is It Time to Rethink Your Pricing Strategy?” found here, and though it is based on research across a broad spectrum of companies, it has direct applicability to the specific business of setting fuel pricing strategies.

The paper explains that effective pricing is achieved not through luck, but through discipline. The MIT research finds that while few companies have functions dedicated to pricing, their research shows “…small variations in price can raise or lower profitability by as much as 20% or 50%.” Nowhere is this more true than in the fuel price management arena, where optimized prices executed quickly to the street can have a dramatic impact on the bottom line, sometimes simply $0.01 at a time.

This MIT paper calls out two components to effective pricing strategies: price orientation and price realization. Price orientation is defined as the methods companies use to determine prices. Price realization is defined as the ability for companies to get the prices they determine.

Price orientation, when applied to fuel pricing strategies, equates to the analysis of store performance, margins, and competitor pricing to determine what prices are best for each commodity at each store. Price realization, when applied to fuel pricing strategies, is the execution of price changes across the enterprise, confirming that every store has implemented the price changes and the proper prices are in place at the POS, sign and pump. Taken together, these two concepts affirm the four stage process of fuel price management: Collect, Analyze, Change, and Confirm.

The MIT researchers define three types of price orientation, also known as price setting,:

1. Cost based pricing – in the world of fuel price management, this would be pricing based on margin targets, without paying attention to competitor pricing. This type of pricing is easy to calculate, but does not provide a complete picture of the environment in which the c-store operates, and is likely to be less than optimized.
2. Competition based pricing – this would be a fuel pricing strategy based exclusively on the price of the competition. This is another easy calculation, but is less than ideal because it can lead to a price war. We’ve all heard of real world scenarios where c-stores across the corner from one another get into a price drop spiral where each store is in a race to the bottom.
3. Customer value based pricing – this would be the fuel pricing ideal because it takes into consideration data based on perceived customer value. As the article states, the question with this pricing strategy is “How can we create additional customer value and increase customer willingness to pay, despite intense competition?” The article continues, “Customer value based pricing approaches are driven by a deep understanding of customer needs, of customer perceptions of value, of price elasticity and of customers’ willingness to pay.” In the world of the c-store, this includes location including traffic patterns, fuel brands, cleanliness of restrooms, food service, and overall customer experience.

The research in this article goes on to say that customer value based pricing is especially relevant to competitive industries where managers believe they are competing in a commodity business, and these managers resign themselves to competing only on price. “…seeing your product as a commodity tends to be a self-fulfilling prophecy” the authors contend.

In the second half of the article, the authors list three key factors to achieving price realization, also known as price getting: pricing rules specifying maximum discounts, the extent to which these rules are followed, and systems with tools to monitor and control pricing. From a fuel price management perspective, these factors speak to the critical price change execution elements of a fuel pricing software system:

1. Business rules that propose prices based on competitor movement, with strategies that provide discount guardrails. Guardrails include such conditions as “margins never less than $0.05 above cost”.
2. Price execution to the street, including to the POS, sign and pump; removing the store manager from the process, so there is no conflict of interest or bottleneck in the fuel price change process.
3. Price change confirmation allowing alerts and notifications when a price change is hung up so the right stakeholders can be notified, and a historical record of when the price change was completed.

The answer to the question posed in the title of this article is clear: if your pricing strategy is based on accounting rules such as cost plus, or if your pricing strategy is solely based on the price of the competition, you’re not optimizing your fuel pricing strategy; it’s worth analyzing a more holistic view of the markets in which you compete including pricing relative to other company stores, and overall price elasticity. There is only one way to effectively gain access to this holistic view: a robust fuel pricing solution that provides quick insight into store and market performance via a series of analysis views, including margin and volume history, competitor pricing relationships, and operational efficiency regarding the price change process.

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