Pricing: Balance on the fulcrum

January 1, 2003 By    

To prepare for this article on pricing, I surveyed a region in the country – similar to the market most of you live in – that is healthy, both in terms of the retail market environment and the general economy. This multi-county region is comprised of the expected mix of retail propane marketers: 10 independently owned propane distributors, four multi-state marketers and two cooperatives.

The survey’s purpose was to see what kind of pricing differences existed for homeowners who use propane for their primary heating needs. A homeowner living in any part of this region can choose from three to five companies as their propane supplier. Any of the suppliers will lease the tank to the homeowner.

On the day I took the survey, the retail propane price offered to the residential homeowner varied from 89 cents to $1.39 per gallon. This represents a 50-cent per gallon absolute spread, or as a percentage of the lowest price to highest price of 56 percent!

Consider the magnitude of this spread to the other major consumer energy purchase: gasoline. In this same market place the price variance for similar octane levels for unleaded self-service gasoline was 12 cents per gallon, or a variance percentage of just 10 percent.

Margin vs. customer retention

While this significant variation in retail propane price could be explained by varying service levels provided by the marketers, I don’t believe it fully explains the gap.

Each company is managing its prices by balancing two often conflicting objectives as old and as common as capitalism: achieving the highest gross profit while remaining competitive enough to retain customers. What makes the retail propane industry different from others is the unique business types that make up our industry. Price is the tool – or fulcrum – that is used to balance these vastly differing marketers’ strategies.

Let’s assume the lowest-priced marketer is selling at 89 cents per gallon because its threshold of customer loss is so low that it would forgo any amount of additional gross profit to insure that no customer would ever have a price reason to switch.

On the other hand, assume the highest-priced marketer at $1.39 per gallon has a priority of getting the greatest gross margin possible, and has calculated an acceptable loss of customers in order to meet those objectives. For whatever reason, the higher return in total gross margin is sufficient to warrant the loss of some customers to lower-priced competitors.

Balancing the objectives
In concept and in practice what I believe is happening is that both the high and low marketer have established an acceptable balance that meets their objectives, using price as the tool. It’s what all U.S. propane marketers do, perhaps without looking at it in exactly this way.

I am not saying that price is the only evaluation by which customers decide to switch suppliers. But all pricing philosophies in retail propane are driven by a strategy to balance on price the conflicting objectives of maximizing returns and retaining customers.

Let’s face the fact that pricing decisions to achieve this balance between a desired profit margin and retaining a stable customer base are one of the most difficult aspects of retail propane management. These decisions take courage and are not for the faint of heart.

If the person making pricing decisions is the same one who takes the customer calls after a price hike, he will be biased toward smaller, less frequent increases. In fact, he will almost always misread the reaction of the larger, more important customer base.

Pricing decisions that are made hundreds of miles away from the local plant will be so out of touch with the customer base that they will almost always be biased toward higher and more frequent price increases. There is a disconnect between decisions made from afar and the local customer feedback in a competitive retail propane environment.

In my opinion, pricing decisions should not be made by those too close to the fray taking customer complaints or those at a distance who are too far removed from the local situation. Either way, their vision will be clouded and they will likely choose the wrong one.

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