Lecture Retailing management (6/e): Chapter 15 - Levy Weitz

Lecture Retailing management (6/e): Chapter 15 - Pricing. This chapter presents the following content: Why is pricing important? Considerations in setting retail prices, price setting approach used by retailers, types of price discrimination, how can retailers reduce price competition?...

Retailing Management, 6/e Copyright © 2007 by The McGraw­Hill Companies, Inc. All rights reserved.

Pricing

Buying

Merchandise Pricing

Retail

Communication

Mix

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

price

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

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

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)

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?

• 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 Prices

PhotoDisc/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   

Markup Percent

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

Markup percent = retail price – cost of merchandise

Initial markup – retail selling price initially

set for the merchandise minus the cost

of the merchandise.

Maintained markup – the

actual sales realized for the

merchandise minus its costs

Rob Melnychuk/Getty Images

Initial and Maintained Markup

Initial Retail  Price $1.00

Cost of  Merchandise   

Initial 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

• 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

Actual unit sales price ­ Unit variable  cost

Unit Sales Fixed Costs

Contribution/Unit Breakeven 

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?

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

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?

PhotoLink/Getty Images

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

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?

© Digital Vision

The McGraw-Hill Companies, Inc/Ken Karp photographer

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

Retailer’s Income Statement

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

Move To New Location?

Rent Increases to $50,000

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

Digital Vision / Getty Images

If the Retailer Wants to Reduce Prices?

Reduce Prices By 5%

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

Wants to Make a Specific Income?

Make $50,000/Year

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

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

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

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

PhotoLink/Getty Images

– Maximize Profits Price Discrimination

– Problem: Trains People to Buy on Deal

Advantages of EDLP Pricing Strategy

Assures customers of low prices

Reduces advertising and operating expenses

Reduced stockouts and improved inventory management

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

• Wal-Mart, Category Specialists, Dillards,

– Lower Advertising Expense

– Lower Labor Costs

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:

When the level of advertising

communicates the company’s belief in

the brand

The 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

• 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

• 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

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 Competition

The 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!!