It's Not Only about Low-Cost: Prices Are Polarizing

The logic of low-cost permeates many sectors of our economy. Low-cost has captured the growing interest of customers for no-frills goods and services. All you buy is an airplane ride: all other services are proposed separately (e.g. food, drinks), according to the logic of unbundling. In marketing, the phenomenon has been studied in terms of retail pricing policies, contrasting the Every Day Low Price (EDLP) with the High-Low (Hi-lo) pricing approach. The first characterizes the supply of retailers such as Wal-Mart, who have made low prices a key to their positioning. This way, long-term loyalty of consumers is usually encouraged, improving the company's consumer levels. High-Low pricing is based on price promotion, by placing a discount premium only on certain products for a limited period of time.
Hi-Lo rests on a weak assumption, though. It is about attracting customers with a few well-known branded products, often sold below cost, seeking to expand their in-store purchases on other, fully-priced products. This pricing policy could turn out to be dangerous for distributors and manufacturers if it is not well managed, since it rewards consumer opportunism and the segment of so-called cherry-pickers, who somehow benefit from value created by loyal customers. Cherry-pickers only buy products that are on sale, and thus maximize their advantage vis-à-vis the retailer. Summing up, the Hi-lo approach risks motivating infidels and demotivating loyalists. Over the long term, it negatively affects customer loyalty and business performance. In 2009, Nielsen highlighted the fact that more than 25% of the products sold by large-scale retailers where sold with price promotions, reaching 30% in giant supermarkets (hypermarchés). The EDLP approach instead offers the client a proportional return on the value of his/her purchases, warranting a good deal on each and every product, thus creating a solid and stable relationship of loyalty. This is the reason pushing many firms to adopt low-cost pricing policies. Another element highlighted by marketing studies is the apparent paradox of a low-cost economy. In fact, empirical studies show a polarization of markets, in which both low-cost goods and services and premium priced products expand their market share, with a consequent reduction of market share for the medium-priced ranged. Looking at mass consumption items, and setting at 100 the average price of each category, one can see that the market share of products priced at less than 70 represented 12.6% of the sales volume, while products with prices higher than 130 account for 30% of total sales. We can thus finally talk about product differentiation, from no frills to full frills good and services, which expands the consumer's freedom of choice and his/her welfare. It is also good news for firms, which can innovate by knowing that customers will be able to seize on the elements of differentiation being offered.