July 31, 2022
The other morning my youngest son and I went on a breakfast bike ride to Panera for his favorite…the Four Cheese Souffle. As we got up to the cash register to order, my jaw just about dropped, “Wow, $6.79 for the souffle, that is crazy!” Only a few years ago, that same souffle was $3.89.
While inflation is on a tear as we tetter into recession, the leadership teams of many companies are making short-term decisions that will severely injure their brand for years to come. They are chasing gross margin percentage and short-term revenue gains under the guise of price increases, instead of focusing on incremental gross margin dollars. This old-school managerial focus on gross margin % and short-term revenue bumps from price increases is driving many traditional retailers and service providers out of business against the likes of Amazon, which focuses on gross margin dollars. I sadly saw this dynamic up-close and personally while I led Store Operations and Marketing at Sports Authority, where the leadership and buyers were so concerned about gross margin % and the current quarter’s revenue that they priced themselves out of existence as customers left in droves.
Let’s get back to Panera. Let’s say that the souffle cost went from $1 to $2. When it was priced at $3.89 with a $1 cost, the margin percentage was 74%, while the gross margin dollars were $2.89. Now with a $2 cost and a $6.79 price, the gross margin percentage goes down to 70%, but the gross margin dollars goes to $4.79. But, this is what I call “math in a vacuum” because it isn’t taking to account the price-demand dynamic. The shock to me to see a simple souffle almost double in price has permanently damaged my brand perception of Panera, as I am sure it has for millions of other once loyal patrons of Panera.
Now, managerial incentives are typically aligned to this year’s performance, and in a downturn, the individual incentive of managers is often to raise prices to keep intact the financial gross margin story and try to hit revenue targets. It is easy to leverage the organic traffic you have in a quarter and raise prices to make everything look good, but beware of next quarter and next year’s traffic.
The companies that will come out of this downturn even stronger will focus on doing right by the customer and using this opportunity to gain share by keeping prices in check with reality, while potentially taking a short-term hit on gross margin percentage, but picking up incremental brand equity and gross margin dollars.