Winter 2009

The Price is Right! Or is it? By Lynn Switanowski

Pricing is Critical

While retailers understand that pricing is a necessary component to doing business, do all retailers understand the critical importance of pricing as it relates to the branding, profitability and the long-term success of their business? Find out where you stand by answering True or False to this pricing quiz:

• Pricing is a critical success factor for your business.
• Everything you need to know about pricing your products / services can be found in standard pricing directories.
• Pricing is influenced by supply and demand.
• It is possible to charge a high price for a low-cost product or service.
• As a startup business, it is always recommended that you set your prices low—then raise them later.

The answers to these questions will be a critical factor to your business success. The key is to know what the best price is that you can get for any product you sell and then to determine how that price fits into an overall pricing strategy for your business.

Let’s start with the basics. It helps to view pricing in terms of four factors: profitability, sales volume, customer traffic and store image. Every retailer needs to understand how changing any of these variables can and will have an effect on your business. The right price for any product is the one that customers are willing and able to pay and retailers are willing to accept, in exchange for merchandise and services.

Two overall pricing strategies drive retail prices in the marketplace: internal and external. Determining which one is right for your business will be critical for your business success.

Internal pricing

This strategy of pricing is based on determining the total “real” costs associated with bringing product from market to your customers. These costs factor in: actual wholesale cost of product, labor, and supply. Retailers would also factor in additional business costs: employee expenses, marketing campaigns, rent etc.

Internal pricing, in turn, is deduced three different ways: keystone, profit margin and discount pricing. While some methods are simpler to implement than others, there are costs (reduction of profits) associated with using only one for your business. So think carefully before choosing one.

Keystone pricing

This is the most common method of internal pricing in retail today. Keystone pricing is simply the doubling of the wholesale cost of any item. So if you bought a candle wholesale at $5 each, you would sell it at $10 each. The advantage to keystone is that it is simple and can therefore be instituted by staff members rather easily.

The challenge with employing this as the only method of pricing is that it doesn’t account for all of the real costs. This can lead to low profit margins and eventually to restricted cash flow.

Profit margin pricing

If you use this method, you would identify profit targets for your store and then set prices to meet them.

The advantage to this pricing model is that you do cover the total costs of the product and of doing business. The disadvantage to this model is that there is a chance that your prices may not be very competitive. Especially if your business is located in an area where other businesses might carry merchandise similar to yours, it’s a risk to worry about. With prices for any product being readily available on the Internet today, determining retail pricing solely based on desired profit targets, may position your store unfavorably in the eyes of potential customers. Customers are savvier than ever regarding pricing so you can’t overprice just to keep your profit margins high without risking losing them to another business nearby.

Discount pricing

This method of pricing works best for high volume retailers or if you sell a high volume on certain products in your store. This pricing method employs price reductions (temporary or permanent) to stimulate sales activity. Incentive pricing includes discounts on special introductions and volume purchases. Customer loyalty programs and sales affiliate programs fall under this umbrella too.

While this method might have you selling more in terms of volume, remember that it is almost impossible to raise your prices on items once you have established low day-in and day-out prices. Your customers will expect that your prices stay low. This sets up a lower profit margin for your store on high-volume products, which is very difficult to overcome later. Equally important, you also run the risk of positioning your store as lower in quality versus most of your competitors.

External pricing strategy

This strategy de-emphasizes the cost of a particular product. Instead, it focuses on the market and on what value customers see, in the products you offer. Here, you determine a product’s value and hence its retail price by understanding how it meets your customers’ needs.

While this method is more subjective and therefore, a bit more difficult to implement, it will always result in the best overall profitability and is well worth the time and effort.

The two most popular types of external pricing are competitive pricing and value-based pricing.

Competitive or market share pricing

In competitive pricing, you set prices to help obtain a certain target market share. Typically used to drive customers to a particular store for certain products, most retailers use this pricing strategy on a certain segment of products and will use these products as “loss leaders” (below regular margins) to take away customers from another store. The idea is that once customers walk in to buy the “loss leader,” they will then pick up other, higher-profit margin items.

Warning: Market share pricing works especially well with high volume stores. If you don’t have large customer traffic, and there is limited local competition, you may end up forfeiting profits if you use this method on too many products in your store.

Value-based pricing

Arguably, the most challenging pricing method to set up, but it is the one that will deliver the highest results: in sales, profits and customer retention rates. This method provides for different prices for different products based on the perceived value of your products and/or services by your customers. Value-based pricing can be used for high-demand or unique items such as luxury items, impulse (feel-good) items and unusual or rare items that you carry in the store. Value pricing can also be used on private label products where stores have exclusivity on products in a local selling area.

Markdown time?

So now you’ve put together an overall pricing strategy that aligns your business goals and implemented it for your store. Then your customers talk. They vote “yes” for the products and prices you are offering by purchasing the merchandise and ringing the cash register.

Or not. What if the products you choose and the prices you charge, don’t meet your customers’ needs and they aren’t buying? What should you do? Most retailers understand that it is now time to take the dreaded markdown. But are markdowns really that bad?

Markdowns can be a great way to generate sales for any business. It can also be a great way to liquidate “mistake” merchandise, or simply to liquidate merchandise that is no longer seasonally appropriate and to make room for new merchandise to flow in.

How much of a reduction to take, and when to take the reduction, becomes the next important decision a retailer needs to make. When products sell, every retailer wins, but having a strategy for dealing with merchandise that isn’t selling, after everything you have tried (correct pricing, marketing activities) is where retailers like you can either maintain, or give away their ultimate profits.

There is no single right answer for when you should reduce prices in your store. Whether you choose to go with a temporary markdown or a permanent one, it helps to analyze each product as it relates to your overall pricing strategy. Here are some key factors to look at when reviewing when to take markdowns and by how much:

• Type of merchandise
• Store image
• Length of selling season
• Nature of target customer
• Size of initial markup
• Availability of selling and storage space
• Sales promo policies—”mini” sales vs. “big-event” sales

A general rule of thumb is that seasonal products should sell through at a minimum rate of 5-7% per week. When you get to a 60 percent overall sell through, take a first markdown, usually a 25% reduction. This cycle should generally take 10-12 weeks. If you think about how many times you go to market (two major markets and perhaps two smaller markets in between) this makes sense. Each time you go to market, you are purchasing a season’s worth of merchandise, so after 12 weeks, if the merchandise doesn’t sell, is typically time to get marked down.

If you have slower-moving merchandise (a sell thru of less than 2-3% per week) you may want to consider taking a markdown with a greater discount—somewhere between 33-40% off. And you may decide not to wait the entire 10 or 12 weeks. Remember this: Merchandise is not like fine wine; it does not get better with age. If your customers have “talked” and they don’t like the products you have chosen, no matter how you have priced them, they will not sell. This could lead to a serious lack of cash flow, which in turn, could lead to a lack of new products on the shelves (since you need money to buy more product!).

Remember, a good overall pricing strategy and a coordinating markdown strategy is a key component to your store’s ultimate success. Take the time to choose a strategy that aligns with your business goals, and then continue to monitor how the strategy is working on a monthly basis. This effort on your part will go a long way to building your brand as a unique and important store in the marketplace—one that keeps your customers coming back time and time again.

Lynn Switanowski

Lynn Switanowski-Barrett is the founder of Creative Business Consulting Group, a retail-consulting firm based in Boston, MA. CBCG works with businesses of all size to create and implement profit-improving sales, marketing and inventory management strategies. For more information, please email lynn@cbc-group.net.