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Smaller Sizes Equals Price Hikes

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There's a photo of a less than adequate “foot long” Subway sandwich running around the Internet. The 11 inch long sandwich has brought the privately held chain some bad publicity. Perhaps rightly so, but trimming the size of the sandwich follows a traditional game plan for passing rising input costs on to customers without raising prices. While you might not like it as a consumer, knowing what companies are good at this sleight of hand can make you money.

A Delicate Dance
Pricing a product is a delicate dance between the cost of making and distributing the product, the profit a company would like to earn on the product, and what customers will pay for it. While to the normal person it may seem as simple as sticking a price on something, there is a science around it and the decision can have long lasting implications. Well run companies take pricing very seriously.

Once a product has a price, however, it can be very hard to change it. Very few people willingly pay more for something. Lowering a price, of course, is acceptable, but going up! This creates a notable problem for companies that are experiencing input cost inflation. If it costs more to make something, either profits go down or that cost has to be passed on to customers.

Tricks of the Trade
One notable trick for increasing a product's cost is to have a sale. That may sound counter intuitive, but it's really just a slight of hand trick. Companies from Dow-30 giant Procter & Gamble (NYSE: PG) to snack king PepsiCo (NYSE: PEP) use this little subterfuge. Here's how it works: Advertise the current price as a sale price while posting the new, higher price as the actual price. Once the “sale” is over, the price jumps up to the higher level. Sneaky, but effective.

That, however, isn't what got Subway into hot water. Subway shrunk its product by about 8%. Of course, the real issue is that it sells the product as 12 inches, which the company claims is actually just a name, not a measure of size. However, 8% can mean big money for a company.

Shrinking it
For example, anyone who has paid attention to the decline of newspapers and magazines will have probably noticed that many have shrunk over the years. Not just page length, either, height and width have actually decreased. Rolling Stone used to stand out because of its odd, oversized pages—but it doesn't have the same look anymore. Less paper, less cost. Some experts at size changes include P&G, Pepsi, Kellogg (NYSE: K), Hershey (NYSE: HSY), and Heinz (HNZ).

Sticking with paper as an example, a couple of years ago Procter & Gamble trimmed out 10 sheets from its Bounty brand towels, a 7% reduction, to help offset paper cost increases. It “covered up” the effort by fluffing up the towels and claiming they were thicker. Kellogg, meanwhile, reduced the amount of cereal in its boxes five or so years back to avoid raising prices.

Doubling Up
Unfortunately, Kellogg's move wasn't enough and prices had to go up anyway a couple of years after the size change. The cereal aisle is very competitive, however, and price increases can lead to customer switching if the entire industry doesn't follow along. In fact, backing a size reduction up against a price hike can be a turning point for customers who might be willing to accept one but not both in a short period of time.

In Demand
Some products, however, don't have the same kind of competition or customer scrutiny of anything but the enjoyment they get from consumption. These lucky companies have to be careful, but can pass along input cost increases without as much hassle. Hershey and its many confections is a great example. Do you really care if the Reese's candy you are throwing in your mouth is slightly smaller, overall, than it used to be? Probably not. That said, small products can often face an artificial price wall, like one dollar for a candy bar, that can be hard to break.

PepsiCo has worked similar magic with its Frito Lay chips. Trimming a few ounces out of the package is hard to notice when you are shoving chips down your face. However, other areas of Pepsi's business are less protected. For example, orange juice boxes have also gotten smaller over the years. This has been more noticeable because OJ is a drink that people often buy regularly and consider an important part of their day. Shifting away from the long standing industry sizing also made the change more obvious. 

Smaller is Good, Sometimes
Sometimes, however, smaller sizes make more sense. For example, in emerging markets where customers often don't have much disposable income, Procter & Gamble and others often sell soaps and other products in single serve portions. Smaller food portions are also sold for this reason. While that single serving may cost the consumer more than buying a normal package size, the full size is often just too much money.

Size Does Matter
As consumers we hate to get less for our hard earned dollars. However, as investors, knowing what companies are good at passing their costs along without getting caught can help differentiate good companies from great ones. No one fools all the people all the time, but some companies are pretty good at getting away with it most of the time.

Yours,

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ReubenGBrewer has no position in any stocks mentioned. The Motley Fool recommends PepsiCo and Procter & Gamble. The Motley Fool owns shares of PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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