Value Deflation

A practice by retailers and service providers to reduce the size of products while retaining the price

What is Value Deflation?

Value deflation refers to a practice by retailers and service providers to reduce the size of products while retaining the price. This way, the business reduces its operational costs by selling smaller portions of a product for the same price as a way of stealthily increasing profit margins in a market where consumers are price-conscious.

 

Value Deflation

 

Most businesses engage in value deflation when operational costs are on the rise, but the company does not want to pass the additional cost to consumers in the form of price increases. Therefore, businesses provide less for the same price as a way of maintaining the price level.

This practice is common in the food and beverage industry, where companies reduce the quantity of products without an increase in product prices as a way of stealthily boosting the profit margins while retaining their market share.

 

Summary

  • Value deflation is a common practice where retailers and manufacturers reduce the quantity of a product or service while keeping the same prices.
  • It may also involve reducing the quantity of raw materials used in the manufacturing of a product or replacing the active ingredient with a lower quality ingredient.
  • Value deflation is common in the food and beverage industry, where consumers are sensitive to changes in the price level.

 

Value Deflation Explained

Value deflation is an alternative to increasing prices for products and services. It may take the forms of reductions in the amount of content in a package, reduced portions per plate, reduction in customer support, or using low-cost ingredients.

These strategies can be successful in retaining customers since most customers are usually sensitive to price changes as opposed to changes in the quantity and quality of goods and services.

A small reduction in quantity may often go unnoticed by consumers, as long as there is no change in the price sticker. If there is a change in the pricing of a product, consumers will find cheaper substitutes for the product, and it will result in lower sales.

 

What Causes Value Deflation?

 

Rising cost of inputs

One of the main causes of value deflation is increased production costs in the manufacturing of a product. Some of the components of production costs that may increase product prices include raw materials, labor costs, and energy costs.

An increase in the price of one or more of the components directly impacts the profit margins of the company. Rather than increasing the price of the product, a manufacturer may decide to switch to lower-cost input costs to reduce the cost of production.

For example, a manufacturer of chocolate bars may reduce the size of the bar, or switch to a less expensive sweetener to reduce the overall cost of raw materials.

Similarly, a household goods maker may switch to a low-cost customer service to handle customer complaints and inquiries, resulting in longer waiting times for customers calling customer service.

A small reduction in the quantity or quality of a product or service may often go unnoticed, and it is unlikely that consumers will change their purchase behavior.

 

Purchasing power of large retailers

There exists a high competition in the retail industry, and retailers often need to strive hard to keep their prices down. Any changes in the prices of goods and services can easily affect consumer behavior, who may be inclined to find substitutes that are favorably priced.

Therefore, rather than pass the price increases to consumers, retailers go for alternatives that are less likely to affect consumer behavior and still retain their profit margins.

One of the options is to reduce the quantity of each product by a small proportion. For example, a chocolate bar can be reduced from 60 grams to 55 grams. The change may go unnoticed since consumers are more sensitive to pricing changes rather than the size of the product.

 

Impacts of Value Deflation

The following are some of the implications of value deflation:

 

Reduced consumer trust

When faced with increased input costs, manufacturers opt for quantity reduction rather than price increment, which will likely force consumers to shift to substitutes. Although small changes in quantity may go unnoticed, consumers will feel ripped off when they find out about the changes.

When it happens, there will be reduced trust between the consumer and the retailer/manufacturer, and consumers will be more inclined to find alternative products that cost less and are at the standard quantity.

There is a limit on the number of times a company can make such changes before consumers protest and bolt out to the competitor’s products. As a result, retailers and manufacturers will suffer reduced profit margins and will struggle to regain the trust of consumers who are angered by the sneaky tactics.

 

Difficult to compute inflation

The rate of inflation at any time is calculated by determining the changes in the average price level of goods, assuming that the quantity of goods remains constant. Value deflation works against inflation since the product size is not considered when measuring inflation.

Since the price sticker remains constant, the measured inflation is distorted.

 

Health benefit

From a health perspective, reducing the size of select products or some of their ingredients may have a positive impact on consumers. For example, reducing sugar as an ingredient in confectionery products such as cookies, cakes, candy, and chocolates can help reduce obesity and other health conditions associated with excess sugar.

 

More Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Consumer Products
  • Market Sentiment
  • Customer Satisfaction
  • Substitute Products

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