September 5, 2018

How to Tell If You're Contributing to Fuel Price Volatility

Fuel Pricing, 2018

By Mark Hawtin, Managing Director, Pricing

If you're lucky, the gas prices in your market change only once or twice a week. In some markets, however, prices can change up to twelve times a day, presenting a major challenge to fuel retailers trying to navigate the market effectively. It's a fact of life that the volatility of fuel retail markets vary — and experience shows that markets evolve to become more volatile — but what triggers it? And how do you know if you're contributing to fuel price volatility in your market?

What Triggers Fuel Price Volatility?

The first thing that tends to trigger volatility is the belief that there are different demand cycles throughout the day — off peaks and on peaks. It's broadly recognized that there's some opportunity to capitalize on profitability by meeting these varied demand periods. But more often than not, retailers approach this process using merely gut instincts. To prevent differentiation, competitors in the area will follow suit.

Additionally, some markets progress toward volatility because retailers miscalculate who their true competitors are. If there's a major brand, let's say Brand A, across the street from you, your instinctive belief tends to be that Brand A is your main competitor. But without using fact-based analysis, you can't know for sure who your real competitors are. You'll be compelled to respond to changes in their fuel prices, but that's a risk, because they may not be the brand you should mark your strategy against.

Some retailers even aim to stimulate volatility under the mistaken belief that it benefits them. Although you may get a very short-term volume gain in the time before the market reacts, dropping prices like this often creates a downward spiral in the market by dragging all players to the lowest common denominator — and vice versa, if you're driving prices up. In reality, it's rare that anyone actually benefits to a great extent from leading that volatility cycle. And once it begins, it's difficult to break.

Others may not want to operate in volatile markets as price followers. If you can't move fast enough in response to price changes, you might lose out on volume or margin. Generally, fuel retailers with this mindset will have better long-term success — but only by understanding the volatility in their market and its influence on their sites' performance.

Understanding Your Contribution to Fuel Price Volatility

It can be tough to know for sure whether or not you're contributing to volatility in your market. However, by conducting internal analysis, you can answer questions like:

  • When I move my fuel prices, am I actually influencing my performance?
  • If I've dropped my price and others dropped their prices to follow me, what have I achieved? Did I reduce the net in the market with no gain to volume?
  • If I raised my price, did I increase margins to offset volume loss or did I lift the market so that all competitors gained margins?

These concerns are key to understanding volatility and informing your pricing strategy. Here are the four steps to conducting an effective internal analysis of fuel price volatility in your market:

1. Understand competitive dynamics

First, figure out who your true competitors are. Analyze the strengths and weakness of all of the other fuel retailers in your area and determine the major players. This way, you can understand who to mark your prices and performance against.

2. Understand demand cycles

Next, understand if there are, in fact, significantly different demand periods throughout the day. If there are no unique periods within the day, then volatility is not a positive thing for a retailer — and it's certainly not positive for the consumer either.

3. Understand the Seven Elements

Analyze the other elements in your network, including location, brand and merchandising, to see if price is truly the best lever to pull to achieve your performance goals. You may find that you could achieve the same volume and margin by offering a new in-store product or changing your hours of operation — and these benefits will be more sustainable in the long term.

4. Understand timing

If the market is volatile, and you feel you have no option but to follow the trend, then think about the timing of when you make the changes. How long can you wait before you change your price? Is there a dwell time? If prices are moving upward, it may be in your favor to move quickly to increase unit margins. If they’re moving downward, however, then you may want to look at the timing of your moves to balance volume and margin more effectively.

Data Science for Insight into Fuel Price Volatility

Conducting an effective, comprehensive analysis to understand and manage volatility will be impossible by hand — and that's where machine learning comes in. The most recent wave of scientific capability, machine learning allows retailers to understand more deeply their contribution to fuel price volatility in their markets. It measures price against other factors on demand and sensitivity, such as weather, and gives you better, more actionable insight.

By compiling all of the data points that could be relevant, including weather, traffic patterns, sporting events, etc., machine learning can tell you the true extent that these things impact demand and whether or not changing price would be the right response. This fine-grain understanding of demand will help you understand how significant your contribution is to volatility.

With data and machine-learning analytics tools, you can understand volatility's effect not only on your own performance, but also the performance of other retailers as well. You can take a more scientific, fact-based approach to understanding the dynamics of volatility and its true impact on your performance — rather than relying on your instincts to determine how to respond.

However, there is a significant risk in trying to analyze too deeply — the more factors you look at the more tempted you might be to respond to them, thereby increasing volatility. The answer is to find the right balance between understanding market and consumer dynamics and how you respond to them.

Responding to Volatility

Much of whether or not your caught up in volatility depends on your role and position in the market. If you're a price follower, then it's going to be very difficult for you to reverse the clock on volatility. By using data science to understand volatility and create a better, more-informed strategy for dealing with it, you can grow your brand and increase your influence.

However, if your brand is big enough to be the market leader, and you have high presence and power, then you're in a position to control it. It's up to you to exert your influence and dampen volatility, because it's not beneficial to anyone, consumers and retailers alike. Use data science to understand and better respond to fuel price volatility in your market — and ultimately, improve your retail network's performance.

Download White Paper:  3 Steps for Increasing Pricing Productivity

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