This post is part I of our series on Key Value Items, or KVIs.  Read Part II here.  If you’re looking to get a better handle on your KVIs, drop us a line.

The standard definition of a Key Value Item (KVI) is “an item which drives the price/value perception for customers.”  But we’ve found a wide variation in the actual interpretation and usage across our retailer clients.  In this post (the first of three on KVIs) we’ll lay out four common definitions and grades each of them on how well they can actually be put to use.

Why is this important?  Every single time a customer sees a price on your shelf, they update their opinions on your price and value equation.  Understanding which products have large impacts and which have small is crucial to optimizing your pricing strategies (both promotion and everyday).

So what defines a KVI?

Definition 1: Shelf Price

Grade: D.  Defining KVIs as simply “high-priced items” has the benefit of being easy, and certainly true at the far ends of the spectrum: price perception is driven more by the higher-ticket items than the pack of gum at the checkout line.

Impact on pricing:  Those that use this definition keep very low margins on their high-ticket items, and high margins on their low-priced items.  The reason this falls apart is because it fails to capture the value of KVIs- those items where the price perception impact is larger than the actual dollar. The standard KVIs in grocery, like a dozen eggs, a gallon of milk, and a loaf of bread, are all lower ticket items that have a large impact on perception.

Definition 2: Margin Rate

Grade: F.  It is telling that the Wikipedia entry for “Key Value Item” redirects to “Loss Leader.”   That assumes, falsely, that customers have a feel for the retailers’ margins and therefore any item with a high margin rate is hurting price perception.  Like definition 1 above, this is a broad oversimplification- there are plenty of high-margin SKUs that shoppers see as a bargain.

Impact on Pricing:  Like definition 1, this misses the idea that the perception impact is not the same as the actual price, which is the key underlying concept of a KVI.  But even worse, retailers effectively flatten their margin rates across products, which ends up looking a lot like cost-plus pricing.

Definition 3: Reference Price vs. Actual Price

Grade: B+  A huge leap forward is the idea of a “reference price,” or the price that exists in the mind of the customer before they step foot in the store.  This is likely a blend of the last purchase, a competitor’s price, or sometimes a simple mental estimate by the shopper.  The most direct way to measure reference prices is through surveys, which is convenient in that it gets directly at the price.  It can be costly, noisy, and shoppers often bias prices downward in any survey.

Impact on Pricing:  This definition directly measures the two sides of a KVI: the perception and the actual price.  Knowing the products in which those two measures diverge is the key to winning the long-term pricing game.

Definition 4: Price Engagement x (Reference Price – Actual Price)

Grade: A  This definition adds the last piece of the puzzle: Do shoppers care?  Gasoline is famous for having a very high price engagement.  In some markets the local TV newscast has segment that calls out the cheapest gas in town!  And yet those same shoppers will often spend more than the savings from gas on the coffee or soda in the attached convenience store, all because of the difference in price engagement.

Impact on Pricing: Of course, the hardest part is measuring price engagement.  Best-in-Class retailers use near-term elasticity metrics as proxy measures for how much shoppers pay attention to price.  But armed with measures for all three drivers of KVIs, retailers can truly optimize price for both short- and long-term objectives.