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on 11 Nov 2019 12:54 PM
  • pricing
  • strategy
  • margins

On Oct. 18th the US began imposing a 25% tariff on a range of EU goods including Single Malt Scotch, Italian cheese, French wine and Spanish olive oil. At first sight, this leads to two options, both unsatisfactory: you can protect margins and increase retail price, but volumes will fall. Or you can protect volumes and maintain current retail price, but this will erode margins. Read here about what to do in the case of a tariff imposition.

To understand the impact of a 25% import tariff introduction, let us make a theoretical estimation on a Single Malt Scotch. With an import price of (e.g.) $15, in the US distribution three tier system (Importer / Distributor / Retailer), this malt can end up at $32.90 on a Florida shelf (i.e. approx. twice import price). An additional import tariff of 25% may push the import price to $18.75. If the increase is passed onto consumer, the shelf price could end up at over $40.00. However, depending on the distribution strategies, to maintain volumes and margins, the final retail price may increase for instance by 20% to $39, just below a $40 threshold...

If this scotch has a relatively healthy brand equity, a Price Elasticity (PE) of “-2” would not be unreasonable. In this case a relative 20% retail price increase could result in a volume drop of -40%, which will undermine returns and investment strategies. That is, in a scenario where other competitors do not increase price.

Alternatively, if the whole category increases its prices in a similar way, market shares stay unchanged, but consumers will very likely switch from one category to another, for instance from Single Malt Scotch to Blended Scotch (*) or Bourbon. Remember, our Scotch here went from $32.90 to $39.00 per bottle overnight! The scale of the impact can be seen when Bourbon whisky imports into Europe suffered an EU tariff of 25% in June 2018 and volumes subsequently declined 21%. 

Tariff increases cause volumes to drop and put enormous pressure on margins, particularly if there is resistance to taking price. A brand owner must either anticipate or react quickly to these external factors and have their responses prepared. If you think this is a "nice to have", do some quick and dirty calculations on the possible margin impact on your business!

At Brand Reveal we propose simple steps to build informed decisions when it comes to your pricing responses:

1. Understand your  pricing landscape: first, create a picture of where your Brand plays vs. competition, plot volumes by price ladders and identify Price Psychological Barriers. This is key, especially if your current retail price is close to a psychological threshold. Overstepping critical price points can have very unpredictable volume consequences.

2. Understand your Brand price behaviour: assess how your Brand responds to price changes. Consider Perceived Value or Brand Strength (PE vs. share) analysis. If your brand has a strong market share by volume and is highly elastic (i.e. rather sensitive to price variations), then rigour must be applied when considering price hikes.

3. Understand your P&L evolution: once you know where the opportunities and risks are, and how your Brand reacts to Pricing, simulate your brand P&L in different pricing scenarios. This will allow you to spot the best case for optimising market share and margin. Model the simulation for your distribution chain, as this will help trade customer conversations. It also demonstrates that you are taking into account the implications on your partners.

4. Formulate a clear strategy and implementation plan: this is the step where the “how” needs to be developed in order to get the organization and field force aligned and equipped with the right arguments and tools.

Pricing  (and promotions) can be complex and often need to accommodate volatile and external situations such as tariffs or tax hikes. Planning responses ahead through better understanding of your Brand pricing behaviour can give you a big competitive advantage and build brand value. For more on how Brand Reveal can help you, contact henri@brandreveal.net or call Henri at +351 913 779 822.

(*) Whilst the Single Malt Whisky producers are stressing over the possible impact, the Blended Scotch brands could well be rubbing their hands together as they "nose" the opportunity to gain volume from substitution - and even take a little margin! And if your are producer of both Scotch Single Malt and Blends, this may be a good time to review your investment strategy to capture the switchers.