Click to read the original article for details. Source: Chaos University (ID: hundun-university)
Most people believe that low prices lead to high sales, but actual data contradicts this: The sales loss from a price increase is often far less than the revenue gain; companies that try to improve profitability through discounts or price cuts often fail to meet expectations.
Fuling Zhacai: Why Can It Raise Prices Year After Year?
Fuling Zhacai is a leading enterprise in China's appetizer side dish industry, located in Fuling District, Chongqing. Relying on 2-yuan packages of pickled vegetables, it has built an empire with annual revenue of 1.9 billion yuan and a market value of over 20 billion yuan.
However, the pickled vegetable market is not a rapidly expanding one. According to Securities Market Weekly in its article "Fuling Zhacai: Small Pickle, Big World," the total national consumption of pickled vegetables has seen near-zero growth over the past decade: 689,000 tons in 2007 and 750,000 tons in 2018.
During the same period, Fuling Zhacai's sales volume grew from 81,600 tons to about 130,000 tons, an average annual growth of about 4.3%, which is also relatively low.
In stark contrast, the company's net profit grew from 56 million yuan in 2010 to 662 million yuan in 2018, a compound annual growth rate of nearly 32% over nine years.
On one hand, the national total sales of pickled vegetables remained basically unchanged for over a decade, and Fuling Zhacai's sales growth was very slow (4.3%). On the other hand, the company achieved years of ultra-high growth (32% annualized). How did Fuling Zhacai do it?
The secret lies in the two words: "price increase."
According to an analysis report by Great Wall Securities Research Institute, from 2008 to 2018, Fuling Zhacai raised prices at least 12 times, with an average annual increase of 10%.
There are two main methods of price increase: one is directly raising the ex-factory price and retail price; the other is indirect price increases through packaging upgrades and specification adjustments.
However, in the public eye, no matter how you look at it, pickled vegetables do not seem like a category that can sustain price increases.
First, it is not scarce enough and has many competitors.
Fuling Zhacai is the largest pickled vegetable company in the industry, with a market share close to 30%, but there are still many highly competitive rivals, such as Yuquan and Tongqianqiao. This is only the statistics for the packaged pickled vegetable segment; bulk pickled vegetables are also a huge market, and consumers have multiple purchasing options.
Furthermore, the product does not contain high-tech elements.
From a technical standpoint, the pickling and production of pickled vegetables cannot be linked to high-tech elements. In the vast southwest and southeast regions, there is a tradition of eating pickled vegetables and kimchi, and many families can pickle them at home.
Although Fuling Zhacai repeatedly emphasizes its advanced "three pickles, three presses" process, this only demonstrates the company's advanced industrial production capacity. It is necessary for large-scale production enterprises, but not for self-sufficient family workshops, reflecting that the product's technical content is not high.
So why does Fuling Zhacai dare to raise prices frequently? Is there an analytical framework for product pricing that can reveal its pricing logic?
The answer is that Fuling Zhacai has mastered the method of obtaining "price advantage."
"Price advantage" refers to a company gaining an advantage over other companies through its product pricing. In reality, Fuling Zhacai's "price advantage" strategy has been successful: against the backdrop of slow sales growth, it relied on price increases to create considerable profit growth.
So how can a company achieve "price advantage"? Is there a methodology to learn from?
The "3+1" Analytical Framework for Price Advantage
This framework was proposed by McKinsey and includes three aspects of pricing management and the pricing foundation. By analyzing these elements, companies can manage prices to achieve price advantage.
▍Market Strategy Level
Market strategy mainly considers the overall price level of the market.
The main issue here is how market factors cause price changes across the industry. Market factors include supply, demand, costs, scale, technological changes, and competitor behavior.
Companies that excel at this level are always better than competitors at grasping market trends and the underlying drivers.
What is Fuling Zhacai's market strategy?
Fuling Zhacai discloses its product cost structure in its annual financial report, with the highest proportion being raw materials at 75.68%, followed by wages at 13.19%. Therefore, the key to production and cost management is managing raw material costs. The raw material for pickled vegetables is a vegetable called "qingcaitou" (mustard tuber).
Public data shows that the largest production area for qingcaitou is located in Fuling District, Chongqing, where Fuling Zhacai is based. The planting area here accounts for 42% of the national total. Thanks to geographical location and climate, the quality of qingcaitou in Fuling District is higher than in other production areas, and the purchase price is lower.
As the largest pickled vegetable company in the area, Fuling Zhacai benefits from being close to the production area and from the oversupply of qingcaitou relative to demand, giving it strong control over upstream raw materials.
Compared to peers in other regions, Fuling Zhacai has an advantage at the market strategy level, laying the foundation for establishing its price advantage.
▍Customer Value Level
Customer value mainly considers the company's price positioning relative to competitors.
For the company's specific market segment, how should price levels be positioned to achieve the best value for customers? Companies must deeply understand user perception. Let's continue using the Fuling Zhacai case to analyze.
1. The company prioritizes price increases in the South China region, then rolls them out nationwide.
Fuling Zhacai's strong market is in the South China region. According to the company, consumers in South China have the highest loyalty to the company, with the "Wujiang" brand holding about 90% market share in South China. For such a mature market, Fuling Zhacai has a more complete sales network and execution team locally. Prioritizing price increase tests in this region to observe user perception and reaction, then rolling out nationwide, is a feasible plan.
In the era when pickled vegetables cost 1.5 yuan, the company's two price increases followed this logic.
2. Pickled vegetables are individually packaged, so consumers have weak perception of price increases.
Each package weighs only about 100g, so the unit price is very low. Even a 10% increase is just a few cents, which is hard for consumers to notice. If indirect price increases are used—raising the price while also increasing capacity—it is even more confusing to consumers. In Fuling Zhacai's price increase history, half were indirect.
3. As an appetizer side dish, pickled vegetables have a specific consumer base.
For such a frequently consumed product, consumers with long-term eating habits find it hard to stop, while those without such habits are unlikely to develop interest. This is why national consumption has remained stable over the past decade. Therefore, pickled vegetables have a basis for price increases among existing consumers.
4. The main consumer group of pickled vegetables is shifting from migrant workers to families with stronger purchasing power.
Ten years ago, the main consumers were migrant workers. However, with the decline in migrant population since 2015 and consumption upgrades, the consumer base has shifted to families, who have stronger purchasing power and lower sensitivity to price increases.
▍Transaction Level
The transaction level reflects more on the management of transaction prices and the management of downstream distributors.
In other words, it is about how the company decides to use discounts, payment terms, sales bonuses, and other forms of incentives.
According to Great Wall Securities' research report, Fuling Zhacai raised prices while also increasing distributor profit margins.
When the company directly raises prices, the retail price increase is greater than the ex-factory price increase, and the difference between ex-factory and retail prices is the retailer's gross margin space.
Channel gross margin = (terminal price - ex-factory price) / terminal price. According to Great Wall Securities statistics, the channel gross margin for Fuling Zhacai's distributors has been rising over the past four years, as shown below.
This greatly boosted distributors' enthusiasm for stocking and terminal promotion, becoming a key factor in the success of Fuling Zhacai's price increases.
▍Pricing Foundation
The pricing foundation is an important support for the three aspects above. Without it, the above discussions are empty talk.
The pricing foundation mainly includes the following issues:
What kind of pricing decision process should the company establish?
What kind of pricing organization should be built within the company?
How should pricing advantages be discovered and what returns should they bring?
What supporting tools (IT tools and others) are needed for pricing advantages?
Why Pricing, Not Sales Volume or Cost?
The "3+1" framework helped Fuling Zhacai establish its price advantage, but does it work for other companies? If a company chooses to invest more resources in expanding sales volume and reducing costs, would it be more effective?
The answer is likely no.
Three senior McKinsey experts proved this through a series of statistical and mathematical analyses. McKinsey conducted statistics on the five-year average economic indicators of 1,200 global companies (a collection of 1,200 large listed companies worldwide): On average, a 1% price increase leads to an 8.7% increase in operating profit, a leverage of 8.7 times. Therefore, price increases are the biggest lever for profit growth for these companies.
How was this conclusion derived?
In accounting, operating profit = revenue - fixed costs - variable costs.
Assume the initial price index is 100. For the global 1,200 companies, the average fixed cost index is 20.5% of price, variable costs are 68% of price, and the average sales profit margin is 11.5%.
If the price increases by 1%, the new operating profit composition is as follows:
At this point, the growth rate of operating profit is:
(12.5 - 11.5) / 11.5 = 8.7%
That is, assuming last year's operating profit was 11.5 (ignoring units) and this year's is 12.5, the year-on-year growth of 8.7% is entirely due to the 1% price increase.
Similarly, if you adjust other parts of operating profit, you can derive the corresponding profit increase, as shown in the figure below.
If business operators have limited resources, should they invest in pricing capability, cost reduction, or sales volume increase?
From the analysis above, the answer is to seek price advantage.
If we consider the sales volume issue, will a price increase cause a significant drop in sales volume, leading to profit decline? Or, in other words, can a price cut significantly increase sales volume and thus increase profit?
The same sample statistics show that the impact of sales volume is minimal.
For the global 1,200 companies, if the average product price decreases by 5%, sales volume would need to increase by 18.5% to avoid losses. At this point, the price elasticity is -3.7. That is, for a 1% price decrease, sales volume must increase by 3.7% to break even.
However, experience shows that the maximum price elasticity is generally between -1.7 and -1.8, occasionally reaching -2.5, and only for consumer goods subject to impulse buying. A price elasticity of -3.7 is extremely rare.
Therefore, we conclude: companies that try to improve profitability through discounts, price cuts, or other low-price, high-volume strategies often fail to meet expectations.
The priority order for profit growth methods should be:
Price increase > Reduce variable costs > Increase sales volume > Reduce fixed costs
Summary
In daily life, discounts and promotions are everywhere, and business operators and consumers never doubt the power of "low price, high volume." But research on 1,200 companies shows results that are very counterintuitive.
Most pricing problems ultimately have the solution of raising prices; the key is how you prove it.
Insight 1:
If you are an investor, pay special attention to companies with the ability to continuously raise prices. The reverse is also true: companies that frequently sell products or services through discounts and promotions should be treated with caution.
Insight 2:
If you are a business operator, you should allocate more resources to cultivating the ability to raise prices for products and services. Identify the core value point of your product for consumers and seek the right time to raise prices. This is much more efficient than blindly expanding sales through price cuts.
Insight 3:
It is not only high-value-added, extremely scarce, or high-tech products or services that have the ability to raise prices. Many products with low technical content and high substitutability can continuously raise prices without being noticed, simply because they fully understand the core selling points of their products and seize the opportunity to raise prices.
The concept of pricing can also be applied to professionals. Every professional hopes to "sell" themselves to employers at a higher price through self-management, but few would lower their "price" for an easier job.
So why not set a more advantageous price for your company or yourself?
This article is sourced from the public account @ Chaos University.