Inflation, rising prices: why companies raise their prices: because they can

Despite the steady increase, shoppers still bought their favorite breakfast cereals, paper towels and other consumer goods in the decade and a half before the pandemic began Image: Shutterstock

gRockery bills can be ridiculously high these days, but supply chain issues, energy costs and inflation aren’t the only factors to blame. New research suggests companies are raising prices just because they can.

In 2021, American companies recorded their most profitable year since the 1950s, as many took advantage of economies of scale and other more efficient production processes. Yet companies have increasingly retained the savings from these reduced costs, rather than passing them on to customers in the form of lower prices.

Instead, markups — the difference between the prices charged at the checkout and the marginal costs incurred by a business to make a product — increased by about 25% between 2006 and 2019, according to a study by Alexander J. MacKay, assistant professor at Harvard Business School.

Despite the steady increase, shoppers still bought their favorite breakfast cereals, paper towels and other consumer goods in the decade and a half before the pandemic began, write MacKay, Nathan Miller of the Georgetown University and Hendrik Döpper and Hendrik Döpper of the Düsseldorf Institute of Competition Economics. Joel Stiebale in Rising Markups and the Role of Consumer Preferences (pdf). The research sheds light on how mark-ups on key household items had already taken off in the years before the Covid-19 pandemic.

“I was surprised to see that product margins grew as much as they did,” MacKay says.

Rising prices don’t stop consumers

To test consumers’ willingness to continue buying more expensive everyday products, the researchers looked at Kilts Nielsen scanner and consumer panel data for approximately 14.4 million retail products across 133 categories. The researchers focused on the top 20 brands in each category, including private label products.

The data included unit sales and revenue by Universal Product Code, or UPC, for each week and physical store. Products included everything from cereal, bottled water, paper towels and over-the-counter cold medicine to specialty soaps, coffee and frozen pizza.

Researchers came to a startling conclusion: consumers were 30% less price-sensitive—that is, less likely to abandon their favorite brands and seek out cheaper equivalent products—in 2019 than they expected. were in 2006.

“Here’s one way to think about it: how much should you be paid to switch from your favorite brand to your second favorite brand?” MacKay said. “Maybe you value a few dollars here and there a little less than before. Maybe your preference for your flagship brand is even stronger than it was 15 years ago. in this component of price sensitivity. Regardless, our results indicate that consumers should be paid more.

Consumers cut fewer coupons

The authors looked at several possible reasons for this shift, including whether the shift to online sales during this period prompted consumers to pay more for the products. While they found that some categories were more impacted by online shopping than others, web shopping “doesn’t really seem to explain the price sensitivity trend,” MacKay says.

To investigate whether the decline in consumer sensitivity was part of a longer-term trend, the researchers turned to coupons because their use requires effort from the consumer and shows a willingness to seek higher prices. low for similar products.

They found that the use of coupons dropped from the early 1990s after decades of rapid growth. Consumers redeemed about 7.7 billion coupons in 1992, about double the amount of the previous decade. In 2006, that number fell to 2.6 billion, the authors found using data from NCH Marketing and Inmar Intelligence.

In 2019, the last year included in the research, consumers redeemed 1.3 billion coupons, half of 2006, despite the abundance of coupons available to cut, MacKay notes.

“The number of coupons redeemed has declined faster than the number of coupons issued by businesses,” MacKay notes. “It’s not 100% conclusive, but it’s consistent with consumers becoming less price sensitive.”

Will prices rise even faster?

Meanwhile, business costs have fallen over time as companies have extracted more productivity from increasingly efficient operations. Since 2006, marginal costs have fallen by an average of 2.1% per year, the authors estimate. In the latter part of the study period, from 2017 to 2019, business costs were around 25 percentage points lower than in 2006.

The rise in margins comes either from price increases or from reductions in marginal costs. These reductions can come from investments and economies of scale that make it cheaper to produce larger quantities. The authors find that falling marginal costs are the main driver of rising profit margins, in part because cost reductions are not passed on to consumers.

“What we’re seeing, at least in our article, is that companies are already realizing this to the extent that they can determine what price they can charge for their products,” MacKay says. “If you knew your costs were going down, but you didn’t have to lower your price, they’re already internalizing that consumers are a little less price-sensitive.”

This can ultimately mean companies can cut costs and continue to raise prices without losing a lot of customers, MacKay says. Take consumer products giant Procter & Gamble, one of the largest companies in the study. In 2012, P&G announced a “productivity and cost reduction plan” to cut $3.6 billion in expenses by 2019.

In 2021, long before the economic disruption caused by the pandemic, P&G management announced price increases for a range of products, from adult diapers and baby care products to laundry detergents and household cleaners. .

“Despite rapid price inflation since the start of the pandemic, consumers continue to buy, likely reflecting lower price sensitivity. This could continue to allow businesses to raise prices more quickly,” said MacKay.

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[This article was provided with permission from Harvard Business School Working Knowledge.]

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