Chapter 10 Retail Pricing

Learning Objectives Discuss the factors a retailer should consider when establishing pricing objectives and policies. Describe the differences between the various pricing strategies available to the retailer. Describe how retailers calculate the various markups. Discuss why markdown management is so important in retailing and describe some of the errors that cause markdowns.

Pricing Objectives and Policies Interactive pricing decisions Pricing objectives Pricing policies LO 1

Exhibit 10.1 - Interaction Between a Retailer’s Pricing Objectives and Other Decisions LO 1

Pricing Objectives Profit oriented objectives Achieve either a certain rate of return or maximizing profits. Target return objective States a specific level of profit, such as percentage of sales or return on capital invested. Profit maximization Seeks to obtain as much profit as possible. Skimming Price is initially set high on merchandise to skim the cream of demand before selling at more competitive prices. Penetration Price is set at a low level in order to penetrate the market and establish a loyal customer base. Sales-oriented objectives Seek some level of unit sales, dollar sales, or market share but do not mention profit. Status quo objectives Adopted by retailers who are happy with their market share and level of profits. LO 1

Pricing Policies Rules of action, or guidelines, that ensure uniformity of pricing decisions within a retail operation. Below-market pricing policy - Regularly discounts merchandise from the established market price in order to build store traffic and generate high sales and gross margin dollars per square foot of selling space. LO 1

Pricing Policies Pricing at market levels Price zone - Range of prices for a particular merchandise line that appeals to customers in a certain market segment. Above-market pricing policy - Retailers establish high prices because nonprice factors are more important to their target market than price. LO 1

Pricing Policies Factors that permit retailers to price above market levels: Merchandise offerings Services provided Convenient locations Extended hours of operation LO 1

Specific Pricing Strategies Customary pricing The retailer sets prices for goods and services and seeks to maintain those prices over an extended period of time. Variable pricing Recognizes that differences in demand and cost necessitate that the retailer change prices in a fairly predictable manner. Flexible pricing Encourages offering the same products and quantities to different customers at different prices; used for personal selling; costs can dramatically increase, and revenues decrease, as customers begin to bargain for everything. One-price policy Establishes that the retailer will charge all customers the same price for an item; speeds up transactions and reduces the need for highly skilled salespeople. LO 2

Specific Pricing Strategies Price lining - Established to help customers make merchandise comparisons and involves establishing a specified number of price points for each merchandise classification. Trading up - Occurs when a retailer uses price lining and a salesperson moves a customer from a lower priced line to a higher one. Trading down - Occurs when a retailer uses price lining, and a customer initially exposed to higher-priced lines expresses the desire to purchase a lower-priced line. LO 2

Specific Pricing Strategies Retailers select price lines that have the strongest consumer demand. Price lining helps buying more efficiently, simplifying inventory control, and accelerating inventory turnover. LO 2

Specific Pricing Strategies Odd pricing Practice of setting retail prices that end in the digits 5, 8, 9—such as $29.95, $49.98, or $9.99. Multiple-unit pricing Price of each unit in a multiple-unit package is less than the price of each unit if it were sold individually. Bundle Pricing Selling distinct multiple items offered together at a special price. Bait-and-switch pricing Advertising or promoting a product at an unrealistically low price to serve as ‘‘bait’’ and then trying to ‘‘switch’’ the customer to a higher-priced product. Private-label brand pricing A private-label brand can be purchased by a retailer at a cheaper price, have a higher markup percentage, and still be priced lower than a comparable national brand. LO 2

Specific Pricing Strategies Leader pricing - High-demand item is priced low and is heavily advertised in order to attract customers into the store. Loss leader - Extreme form of leader pricing where an item is sold below a retailer’s cost. High–low pricing - Use of high every day prices and low leader ‘‘specials’’ on items typically featured in weekly ads. LO 2

Using Markups Markup - Selling price of the merchandise less its cost, which is equivalent to gross margin. The basic markup equation: SP = C + M Where: C - dollar cost of merchandise per unit M - dollar markup per unit SP - selling price per unit LO 3

Exhibit 10.3 - Relationship of Markups Expressed on Selling Price and Cost LO 3

Exhibit 10.4 - Basic Markup Formulas LO 3

Initial Versus Maintained Markup Initial markup = (original retail price – cost)/original retail price Maintained markup = (actual retail price – cost)/actual retail price LO 3

Initial Versus Maintained Markup Reasons for the difference between initial and maintained markups: The need to balance demand with supply. Stock shortages. Employee and customer discounts. Cost of alterations. Initial markup may be different from maintained markup is cash discounts. LO 3

Planning Initial Markups start Initial markup percentage = (operating expenses + net profit + markdowns + stock shortages + employee and customer discounts + alterations costs - cash discounts)/ (net sales + markdowns + stock shortages + employee and customer discounts) OR Initial markup percentage = (gross margin + alterations costs - cash discounts + reductions)/ (net sales + reductions) OR LO 3

Planning Initial Markups Initial markup percentage = (gross margin + alterations costs + reductions)/ (net sales + reductions) LO 3

Planning Initial Markups Rules of markup determination As goods are sold through more retail outlets, the markup percentage decreases and vice versa. The higher the handling and storage costs of the goods, the higher the markup. LO 3

Planning Initial Markups Rules of markup determination The greater the risk of a price reduction due to the seasonality of the goods, the greater the magnitude of the markup percentage early in the season. The higher the demand inelasticity of price for the goods, the greater the markup percentage. What will the market bear LO 3

Markdown Management Markdown - Any reduction in the price of an item from its initially established price. Markdown percentage = Amount of reduction / original selling price LO 4

Markdown Management Retailers do not possess perfect information about supply and demand factors; as a result, the entire merchandising process is subject to error, which makes pricing difficult. Buying errors Pricing errors Merchandising errors Promotion errors LO 4

Markdown Policy Early markdown policy Advantages: Speeds the movement of merchandise. Enables the retailer to take less of a markdown per unit to dispose of the goods. Markdowns are offered quickly on goods that some consumers still think of as fashionable, and the store has the appearance of having fresh merchandise. Allows the retailer to replenish lower-priced lines from the higher ones that have been marked down. LO 4

Markdown Policy Late-markdown policy - Allowing goods to have a long trial period before a markdown is taken. Avoids disrupting the sale of regular merchandise by too frequently marking goods down. The bargain hunters or low-end customers will be attracted only at infrequent intervals. LO 4

Markdown Policy Amount of markdown Rule of thumb for early markdowns is that prices should be marked down at least 20 percent in order for the consumer to notice. Just noticeable difference important. Retailers are able to have their suppliers supplement their markdown losses with markdown money or some other type of price reductions. LO 4

Markdown Policy Amount of markdown Maintained markup = (actual selling price – cost) / actual selling price Maintained markup percentage = initial markup percentage – [(reduction percentage) (100% - initial markup percentage)] Where: Reduction percentage = Amount of reductions/net sales LO 4

Compute the markup on selling price for an item that retails for $49 Compute the markup on selling price for an item that retails for $49.95 and costs $31.20 What is the necessary formula?

Exhibit 10.4 - Basic Markup Formulas LO 3

Compute the markup on selling price for an item that retails for $49 Compute the markup on selling price for an item that retails for $49.95 and costs $31.20 What is the necessary formula? (SP-C)/SP Work it out

Compute the markup on selling price for an item that retails for $49 Compute the markup on selling price for an item that retails for $49.95 and costs $31.20 What is the necessary formula? (SP-C)/SP Work it out (49.95-31.2)/49.95 = 18.75/49.95 = 37.5%

Compute the markup on selling price for an item that retails for $49 Compute the markup on selling price for an item that retails for $49.95 and costs $31.20 What is the necessary formula? (SP-C)/SP Work it out (49.95-31.2)/49.95 = 18.75/49.95 = 37.5% What would the markup on cost be (the cost plus)?

Compute the markup on selling price for an item that retails for $49 Compute the markup on selling price for an item that retails for $49.95 and costs $31.20 What is the necessary formula? (SP-C)/SP Work it out (49.95-31.2)/49.95 = 18.75/49.95 = 37.5% What would the markup on cost be (the cost plus)? 18.75/31.2 = 60% So, cost of 31.20 plus 60% of 31.20 = 49.95 (some rounding error might exist)

Complete the following (11): Dress Shirt Sport Shirt Belt Selling Price ($) 40.00 49.99 15.00 Cost ($) 23.00 25.35 6.50 Markup in Dollars ($) Markup Percentage on Cost (%) Markup Percentage on Selling Price (%)  

42.5 49.3 56.7 Complete the following (11): Dress Shirt Sport Shirt Belt Selling Price ($) 40.00 49.99 15.00 Cost ($) 23.00 25.35 6.50 Markup in Dollars ($) 40-23=17 24.64 8.50 Markup Percentage 17/23 24.64/25.35 8.5/6.5 on Cost (%) =.739 = 97.2 = 1.31 Markup Percentage on Selling Price (%) 17/40 24.64/49.99 8.5/15 42.5 49.3 56.7

A buyer tells you that she realized a markup of $50 on an interview suit for a college senior. You know that her markup is 25 percent of retail. What did the suit cost her What formula do we need?

Exhibit 10.4 - Basic Markup Formulas LO 3

What formula do we need? (I’m great on manipulation) A buyer tells you that she realized a markup of $50 on an interview suit for a college senior. You know that her markup is 25 percent of retail. What did the suit cost her What formula do we need? (I’m great on manipulation) R-C=50 50/R = .25 .25R=50 50/.25 = 200 R = 200 Cost = 200-50 = 150

The buyer for men’s shirts has a price point of $45 and requires a markup of 45 percent. What would be the highest price he should pay for a shirt to sell at this price point? SP = 45 MU on SP = .45 It doesn’t say MU on SP – in which case I would assume SP (should I not say – tell me which you assume)

SP = 45 MU on SP = .45 (45-C)/45= .45 45-C = .45*45 45-C = 20.25 The buyer for men’s shirts has a price point of $45 and requires a markup of 45 percent. What would be the highest price he should pay for a shirt to sell at this price point? SP = 45 MU on SP = .45 (45-C)/45= .45 45-C = .45*45 45-C = 20.25 45-20.25 = 24.75 (45-24.75)/45 = .45

Exhibit 10.4 - Basic Markup Formulas LO 3