In case you missed it, Chipotle’s already expensive burrito is going up in price again starting in January. What is going on? Are margin’s shrinking, costs going up? The answer to Chipotle's pricing power lies in the strength of their brand and it is a good lesson for banks.
Chipotle is one of the best performing fast food chains in the industry in part because they have one of the best pricing strategies in food services. The Company achieves near-optimized levels based on their data which is made possible because of their marketing and brand. Where most fast food places go through pricing changes every couple of years and usually as a result of cost increases, Chipotle manages their pricing based on three items: supply, demand and strategy. This is radically different than basing pricing strategy on cost.
As supporting evidence, Chipotle’s revenues are up 17%, their operating margins are a healthy 27% and their net income is up 14%. They may say their price increase is related to food costs, but as near as we can tell, most of their food inputs (proteins, tomatoes, etc.) are holding steady to possibly an immaterial 4%. Labor and real estate are up a similar amount, but their net costs on many of these items are going down as their larger buying power and greater number of customers has decreased both marginal and fixed unit cost margins. Not only are their margins some of the best in the business, but their prices are rising faster (an estimated 10% in January). All this leads us (and analysts) to the conclusion that their price increase is more than about cost.
In fact, it is. After a price increase last year, demand for their products went up, instead of down. That is against economic principals, but it means other energy is being applied and that energy is in the form of marketing. Their simple ads, promotions, content strategy, and most of all their service, all serve to move consumers to overcome higher prices. In other words, it is their brand and culture that makes demand more inelastic, or price insensitive.
Not to put too fine a point on it, Chipotle has found out that by looking at the data, it needs to keep all the prices the same for consistency with the consumer experience within a region, but that different regions have different price elasticities. New York, for example, is much more inelastic so their prices are about 40 cents higher than pricing in the South, which is the most price sensitive (followed by the West). The net result is that by testing prices and sales, Chipotle can optimize pricing and increase net margins.
Baja Fresh, their nearest competitor and inventor of the mass market casual dining Mexican food category is jealous both because of sales and margins. While understanding pricing analytics help, the real takeaway here is that banks need a better and more robust understanding of marketing, brand and price strategy. For every bank that is concerned about why loan pricing is so competitive or they can’t cut deposit costs we ask this question – “How much are you “investing” in marketing and what is your return on that investment?”
Chances are the bank that is concerned with pricing, hasn’t taken the time to even try to quantify what their marketing return is. For example, we often hear – you can’t track marketing return. We respectfully disagree. We won’t go into all the ways in this day and age that you can exactly track marketing return through conversion. Let’s just start with the fundamental difference between how Chipotle looks at marketing return and how the average community bank looks at it. While banks still look at marketing as an annual expense, Chipotle is looking at marketing as a long term investment.
Consider that Chipotle looks at their return on marketing investment as the lifetime value of a customer divided by the cost to acquire that customer. Note that we are talking lifetime value. This is a shift in understanding at most banks and one that Chipotle knows in its very DNA. When Chipotle posts an online ad or does a promotion, it knows that if the food and service is good, that customers will come back time and time again. Thus, the justification for the marketing cost is a repeat customer.
Compare that mentality to a bank that thinks in terms of an annual expense line for marketing. For every bank looking to gain efficiency, marketing costs are easy to cut, but how can you cut an expense without understanding what that expense buys you? In Chipotle’s case, that marketing expense is a material core value proposition and what allows it to not only grow revenue (by growing customers), but enjoy a 27% operating margin. If Chipotle can get away with charging $9 for a fast food burrito, maybe a bank should think twice about its marketing investment before it complains about shrinking net interest margins?
Banks do a great job at service, but need to get serious about marketing and pricing. Marketing and brand go hand-and-hand with pricing which is the key to increasing margins in a competitive market. The first step is making sure there is an understanding of customer lifetime value and then honing the value proposition to make sure the market knows what the brand stands for. If those two things are clear, then the investment in the brand becomes easier. If we do all that just moderately successfully, we can start to achieve the pricing elasticities that Chipotle enjoys.
Submitted by Chris Nichols on December 09, 2013