12 Retail Pricing

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Pricing

Merchandise Management

BuyingSystems

PlanningMerchandiseAssortments

BuyingMerchandise

Pricing

RetailCommunication

Why is Pricing Important?

Pricing decisions is important because customers have alternatives to choose from and are better informed

Customers are in a position to seek good value

Value = perceived benefits

So, retailers can increase value and stimulate sales by increasing benefits or reducing price.

Considerations in Setting Retail Prices

The four factors retailers consider in setting retail prices:

• The price sensitivity of consumers• The cost of the merchandise and services• Competition• Legal restrictions

Considerations in Setting Retail Prices

Price Setting Approach Used by Retailers

• Need to set price for 1000’s of products many times during year

• Set prices based on pre-determined markup and merchandise cost

• Make adjustments to markup price based on customer price sensitivity and competition

Price Sensitivity and Demand

When increases

can decrease

as fewer customers feel the product is a good value

Types of Price Discrimination• First Degree – Set unique price for each customer equal to

customer’s willingness to pay– Auctions, Personalized Internet Prices

• Second Degree – Offer the same price schedule to all customers – Quantity discounts– Coupons– Markdowns Late in Season– Early Bird Special – Over Weekend Travel Discount

• Third Degree – Charge different groups different prices– Kids Menu– Seniors Discounts

Results of Price Experiments

Quantity Sold at Different Prices

Profit at Different Prices

Price Elasticity

Elasticity = percent change in quantity sold percent change in price

Price Elasticity

Elasticity = percent change in quantity sold percent change in price

= (new quantity sold – old quantity sold)/old quantity sold (new price – old price)/(old price)

= (1100-1500)/1100 (10-9)/9

= -0.2667 .1111

= -2.4005

Price Elasticity

For products with price elasticities less than -1, the price that maximizes profits can be determined by the following formula:

Profit maximizing price = price elasticity x cost price elasticity +1

Competitive Price Data

How Can Retailers Reduce Price Competition?

• Develop lines of private label merchandise

• Negotiate with national brands manufacturers for exclusive distribution rights

• Have vendors make unique products for the retailer

PhotoLink/Getty Images

Legal and Ethical Pricing Issues

Price Discrimination

Predatory Pricing

Resale Price Maintenance

Horizontal Price fixing

Bait and Switch tactics

Scanned vs. Posted PricesPhotoDisc/Getty Images

Example of Markups

Retail = Cost + Markup

100% = 70% + 30%

Retail = $10.00 and markup = 30%

Retail = Cost + Markup

$ 10.00 = $7.00 + $ 3.00

Retail Price and Markup

Retail Price $125

Cost of Merchandise $75

Margin $50

Markup as a Percent of Retail Price 40% = $50/$125

Retail Price = cost + markup

Markup Percent

Markup percent is a markup as a percentage of the retail price.

Markup percent = retail price – cost of merchandise retail price

= 125 – 75 125 = 40%

Markups

Initial markup – retail selling price initially set for the merchandise minus the cost of the merchandise.

Maintained markup – the actual sales realized for themerchandise minus its costs

Rob Melnychuk/Getty Images

Initial and Maintained Markup

Initial Retail Price $1.00

Cost of Merchandise $.60

Maintained Markup $.30

Maintained Markup as a Percent of Retail Price 30% = $.30/$1.00

Reductions $.10

Example of Setting theInitial Retail Price

Cost = $100 Planned Initial Markup = 56.85%

Retail Price = $100 + (56.85% x Retail Price)

Solve for Retail Price

.4315 x retail price = 100

Retail Price = $100/.4315 = 231.75

Initial Retail Price = Cost of Merchandise (1-markup percentage)

Reasons for Taking Markdowns

• Get rid of slow-moving, obsolete, uncompetitive priced merchandise

• Increase sales and promote merchandise

• Generate cash to buy additional merchandise

• Increase traffic flow and sale of complementary products generate excitement through a sale

Liquidating Markdown Merchandise• Place merchandise on Internet auction site• Sell the remaining merchandise to another

retailer• Consolidate the unsold merchandise• Give merchandise to charity• Carry the merchandise over to the next season

Breakeven Analysis

Understanding the Implication of Fixed and Variable Cost

BEP quantity Fixed cost =

Actual unit sales price - Unit variable cost

Unit Sales

Fixed Costs

Contribution/UnitBreakeven point

Illustration of Breakeven Analysis

American Eagle Outfitter is interested in developing private label cargo pants that will sell for $24.99. The cost of developing the pants is $400,000. This includes the cost of salaries, benefits, space for the members of the design team. The variable cost of manufacturing the pants is $13.00. How many cargo pants does American Eagle Outfitter have to sell to breakeven on its $400,000 investment?

15-28Cargo Pants Illustration of Breakeven Analysis

Breakeven Quantity = Fixed Cost

Unit Price – Variable Cost

40,040 units = $400,000

$24.99 - $15.00

RubberBall Productions/Getty Images

15-29Making a Profit on Cargo Pants Illustration of Breakeven Analysis

What if American Eagle Outfitter does want to just break even. It wants to make a profit of $100,000 on the cargo pants. How many units does American Eagle Outfitter need to sell then?

Making a Profit on Cargo Pants Illustration of Breakeven Analysis

Breakeven Quantity = Fixed Cost

Unit Price – Variable Cost

50,050 units = $500,000

$24.99 - $15.00

15-31Percent Sales Increase Needed to Breakeven on a Price Decrease

The Gap has bought 60,000 women’s tee shirts at $5 a unit. It was originally going to price the tee shirts at $12.00, but is considering reducing the retail price to $10.00 – a 16.67% price reduction. How much does sales have to increase for The Gap to make the same profit at the lower price?

15-32The Gap Considers a Price Cut of 16.67%

Breakeven % = 100 x (-%price change) Sales Change % initial margin -% price change

39.78% = 100 x – (-16.67) (7/12) + (-16.6)

The McGraw-Hill Companies, Inc/Ken Karp photographer

Using Breakeven Analysis for Other Retail Investment Decisions

An independent retailers with one store is using breakeven analysis to consider several options. The retailer wants to know what the breakeven sales she will needs if she:

Move to a new location with higher rent

Reduces prices by 5%

Wants to make a $50,000 profit

Retailer’s Income Statement

Net Sales $1,000,000

COGS 800,000 80%

Gross Margin 200,000 20%

Operating Expenses

Variable 100,000 10%

Fixed 80,000 8%

Profit 20,000 2%

15-35Retailer’s Variable and Fixed Operating Expenses

Variable Fixed

Wages & Salaries

Manager 20,000 20,000

Sales 60,000

Clerical 20,000 10,000

Rent 20,000

Maintenance 10,000

Total 100,000 60,000

Retailer’s Assets

Current Assets

Inventory $300,000

Accounts Receivable 75,000

Cash 25,000

Fixed Assets 100,000

Total $500,000

Sales $ Retailer Needs to Break Even

Profit = Sales - COGS-Var Cost - Fixed Cost

0 = Sales - COGs% * Sales - VC%*Sales - FC

Break-even Sales * (1-COGS% -VC%) = FC

Break-even Sales = FC/(1-COGS% -VC%)

Break-even Sales = FC/(GM%-VC%)

= $80,000/(.2-.1)

= $888,888

15-38What Is the Breakeven Sales To Move To New Location?

Rent Increases to $50,000

Digital Vision / Getty Images

15-39What Is the Breakeven Sales To If the Retailer Wants to Reduce Prices?

Reduce Prices By 5%

What Is the Breakeven Sales If the Retailer Wants to Make a Specific Income?

Make $50,000/Year

Maximize Profits through Price Discrimination

Want Charge Every Customer the Maximum They Are Willing to Pay

Problem– Don’t know willingness to pay– With list prices, can’t prevent high

willingness to pay customers from buying at low price

15-42Solution to Problems in Implementing Price Discrimination

• Set prices based on customer characteristics related to willingness to pay

• Fashion sensitive customers will pay more so charge higher prices when fashion first introduced – reduce price later in season

• Price sensitive customers will expend effort to get lower prices – coupons

• Elderly customers eat earlier and are more price sensitive so offer early bird specials

Types of Price Discrimination

• First Degree – Set unique price for each customer equal to customer’s willingness to pay– Auctions

• Second Degree – Offer the same price schedule to all customers, but customers have to do something to get lower price

• Third Degree – Charge different groups different prices– Markdowns Late in Season– Seniors Discounts

Price Discrimination through Coupons Documents that entitle the holder to a reduced

price or X cents off a product or service.

Purpose

Reduce price to price sensitive customers who will spend the effort to clip coupons

Induce customer to try products for first time

Convert first time users to regulars

Encourage large purchases

Increase usage

Protect market share

C. Borland/PhotoLink/Getty Images

Markdowns Are a Form of Price Discrimination

Occurs when a firm sells the same product to two or more customers at different prices.

Generally illegal with a vendors sells to retailers except:

costs are different

quantity and functional discounts

changing market conditions

Generally legal when retailer sells to consumers.

Advantages of the Hi/low Pricing Strategy

Increases profits through price discrimination

Sales create excitement

Sells merchandise

Hi-Lo Pricing

• Most Department Stores, Publix, Kmart

• Benefits to Consumer– Spend Time to Find Lowest Price

• Benefits to Retailer– Maximize Profits -- Price Discrimination

– Problem: Trains People to Buy on Deal

Advantages of EDLP Pricing Strategy

Assures customers of low pricesReduces advertising and operating expensesReduced stockouts and improved inventory management

The McGraw-Hill Companies, Inc./Luke David, photographer

• Wal-Mart, Category Specialists, Dillards, Food Lion

• Benefits to Consumers– Assured of Low Price on Every Visit– Less Stockouts

• Benefits to Retailer– Lower Advertising Expense– Lower Labor Costs

Everyday Low Pricing

Pricing Strategies

EDLP• Builds loyalty –

guarentees low prices to customers

• Lower advertising costs

• Better supply chain management– Fewer stockouts– Higher inventory turns

Hi-Lo• Higher profits – price

discrimination• More excitement• Build short-term

sales and generates traffic

Determining Service Quality

Customers are likely to use price as an indicator of both service costs and service quality. This can depend on several factors:

Royalty-Free/CORBIS

Other information available to the customerWhen service cues to quality are readily accessibleWhen brand names provide evidence of a company’s reputationWhen the level of advertising communicates the company’s belief in the brandThe risk associated with the service purchase

Variable Pricing

• Application of price discrimination– By location – zone pricing– Early Bird Special – Seniors Discounts– Over Weekend Travel Discount– Quantity Discount

• Electronic channel has potential for charging a different price to each customer

Using Price to Stimulate Sales

• Leader Pricing

might attract cherry pickers

• Price Lining

• Odd Pricing

• Certain items are priced lower than normal to increase customers traffic flow and/or boost sales of complementary products.

• Best items: purchased frequently, primarily by price-sensitive shoppers.

• Examples: bread, eggs, milk, disposable diapers.

Leader Pricing

Allan Rosenberg/Cole Group/Getty ImagesDennis Gray/Cole Group/Getty Images Ryan McVay/Getty Images

Price Lining

• A limited number of predetermined price points.

• Ex: $59.99 (good), $89.99 (better), and 129.99 (best)

• Benefits:– Eliminates confusion of many prices.– Merchandising task is simplified.– Gives buyers flexibility.– Can get customers to “trade up.”

Benefits of Price Lining

• Confusion that arises from multiple price choices is eliminated

• The merchandising talk is simplified• It gives buyers greater flexibility• It gives can be used to get customers to “trade

up” to a more expensive model

Guidelines for Price-ending Decisions

When the price sensitivity of the market is high, it is advantageous to raise or lower prices so they end in high numbers like 9.

When the price sensitivity of the market is NOT high, the risk to one’s image of using 9 is likely to outweigh the benefits. Even dollar prices and round numbers are appropriate.

Upscale retailers appeal to price-sensitive segments of the market through periodic discounting. Combination strategy works best: break from standard of using round number endings to use 9 endings when communicating discounts and special offers.

Odd Pricing

• A price that ends in an odd number ($.57)or just under a round number ($98).

• Retailers believe practices increases sales, but probably doesn’t.

• Does delineate:– Type of store (downscale store might use it.)– Sale

Internet and Price CompetitionThe Internet offers unlimited shopping experience.

Seeking lowest price? Use shopping bots or search engines.

These programs search for and provide lists of sites selling what interests the consumer.

Retailers using the electronic channel can reduce customer emphasis on price by providing services and better information.

The Three Most Important Things in Retailing

Location, location, location

Now, it is more :

Information, information, information!!