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 Pricing - Is an interactive decision made in conjunction with the firm’s: Mission statement Goals and objectives Strategy Operational and administrative management Yield management Focuses on optimizing the total sales revenue or yield from its capacity to provide services (hotels) 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. LO 1

Pricing Objectives 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.

Pricing Policies Guidelines, that ensure uniformity of pricing decisions within a retail operation Types of policies Below-market pricing: Discounts merchandise from the established market price to: Build store traffic Generate high sales and gross margin dollars per square foot of selling space Discourage competitors from entering a given trading area 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 Pricing at market levels Above-market pricing policy Price zone: Range of prices for a particular merchandise line that appeals to customers in a market segment Size of a retail store affects its ability to compete on price Above-market pricing policy Retailers establish high prices because nonprice factors are more important to their target market than price 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 Helps customers make merchandise comparisons and Specifies number of price points for each merchandise classification Trading up Retailer uses price lining and a salesperson moves a customer from a lower priced line to a higher one Trading down Retailer uses price lining, and a customer exposed to higher-priced lines purchases a lower-priced line LO 2

Specific Pricing Strategies Retailers select price lines that have the strongest consumer demand Advantages Helps buying more efficiently Simplifies inventory control Accelerates 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 Requires careful evaluation Strategy ineffective if consumers are limiting their purchases to only leader items 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 featured in weekly ads LO 2

Specific Pricing Strategies 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 Is considered illegal by the Federal Trade Commission when: The low-priced model used as bait is unavailable to shoppers LO 2

Specific Pricing Strategies Private-label brand pricing Permit the retailer a large degree of pricing freedom because: Consumers find it difficult to make exact comparisons between the private and national brands LO 2

Using Markups Markup: Selling price of the merchandise less its cost, which is equivalent to gross margin 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 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) Initial markup percentage = (gross margin + alterations costs - cash discounts + reductions)/ (net sales + reductions) 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 Higher the handling and storage costs of the goods, higher should be the markup Greater the risk of a price reduction due to the seasonality of the goods: Greater is the magnitude of the markup percentage early in the season Higher the demand inelasticity of price, greater the markup percentage 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 Merchandising process is prone to: Buying errors - Retailer buys: The wrong merchandise or buys the right merchandise in too large a quantity Pricing errors - Price of the item is too high to move the product at desired speed and quantity LO 4

Markdown Management Merchandising errors Promotion errors Failure by the buyer to inform the sales staff of how the new merchandise: Relates to the current stock Ties in with the store’s image Satisfies the needs of the store’s target market Improper handling of the merchandise by the sales staff Ineffective visual presentation Promotion errors Promotion activities are too weak or sporadic to elicit a strong response from potential customers 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 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 Bargain hunters or low-end customers will be attracted only at infrequent intervals LO 4

Markdown Policy Amount of markdown Prices should be marked down at least 20 percent in order for the consumer to notice Suppliers supplement retailers 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