CHAP 9: RETAIL PRICING

I. Pricing Strategies
Retailers use two basic retail pricing strategies: high/low pricing and everyday low pricing
1. High/Low Pricing
Retailers using a high/low pricing strategy frequently—often weekly—discount the initial prices for
merchandise through sales promotions.

 Advantages:
o Increases profits through price discrimination
o Sales create excitement
o Sells merchandise
 Disadvantages:
o Train people to buy on deal and wait
o Have an adverse effect on profits

2. Everyday Low Pricing

Many retailers, particularly supermarkets, home improvement centers, and discount stores, have adopted
an everyday low-pricing (EDLP) strategy.
This strategy emphasizes the continuity of retail prices at a level somewhere between the regular nonsale
price and the deep-discount sale price of high/low retailers.
The term everyday low pricing is somewhat misleading, because low doesn’t mean “lowest.”
To reinforce their EDLP strategy, many retailers have adopted a low-price guarantee policy that
guarantees customers the retailer will have the lowest price in a market for products it sells.

 Advantages:
o Assures customers of low prices.
o Reduces advertising and operating expenses.
o Reduces stockouts and improves inventory management.
 Disadvantages:
o Some customers prefer the “thrill” of bargain hunting and don’t feel like they are getting
the best prices with EDLP.

SS HI-LO and EDLP

EDLP

 Assures customers low prices

 Reduces advertising and operating expenses
 Better supply chain management
 Fewer stockouts
 Higher inventory turns
Hi-Lo

 Higher profits
 More excitement
 Build short-term sales and generates traffic

II. Considerations in Setting Retail Prices

Four factors retailers consider in setting retail prices are the price sensitivity of consumers, the cost of the
merchandise, competition, and legal constraints.
1. Customer Price Sensitivity and Cost
The price sensitivity of customers determines how many units will be sold at different price levels.
If customers in the target market are very price-sensitive, sales will decrease significantly when prices
increase.
If customers are not very price-sensitive, sales will not decrease significantly if the prices are increased.
a) Price Elasticity: A commonly used measure of price sensitivity
> -1  insensitivity
< -1  sensitivity

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

2. 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.
3. Pricing Services
Challenges due to:

 The need to match supply and demand => engage yield management
 The difficulties customers have in determining service quality.
a) Matching Supply and Demand
To maximize sales and profits, many services retailers engage in yield management.
Yield management is the practice of adjusting prices up or down in response to demand to control the
sales generated. Ex: Airlines
b) 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:

 Other information available to the customer (Cues > Price)

o When service cues to quality are readily accessible
o When brand names provide evidence of a company’s reputation
o When the level of advertising communicates the company’s belief in the brand
 The risk associated with the service purchase (Price as a surrogate for quality)

III. Setting Retail Prices

1. Setting Prices Based on Costs
Most retailers set price by marking up the item’s cost to yield a profitable gross margin. Then this initial
price is adjusted on the basis of insights about customer price sensitivity and competitive pricing.
a) Retail Price and Markup
The markup is the difference between the retail price and the cost of an item.
The markup percentage is the markup as a percentage of the retail price:
Retail price−Cost of merchandise
Markup percentage =
Retail price
The retail price based on the cost and markup percentage is:

 Retail price = Cost of merchandise + Markup

= Cost of merchandise + (Retail price x Markup percentage)

Cost of merchandise
=
1−Markup percentage (as a fraction)
b) Initial Markup and Maintained Markup
Reductions: factors that reduce the actual selling price from the initial sales price

 Markdowns (Sales)
 Discounts to employees
 Inventory shrinkage due to shoplifting and employee theft
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.
 Thus, the maintained markup is equivalent to the gross margin for the product.
The relationship between the initial and maintained markup percentages is:
2. Pricing Optimization Software
Setting prices by simply marking up the merchandise cost neglects a number of other factors that retailers
need to consider, such as price sensitivities, competition, and the sales of complementary products.
Pricing optimization software: setting prices by simply marking up merchandise cost neglect other
factors 
Merchandising optimization software:

 Utilizes a set of algorithms that analyze past and current merchandise sales and prices,
 Estimate the relationship between prices and sales generated,
 Determine the optimal (most profitable) initial price for the merchandise and the appropriate size
and timing of markdowns.
To set initial prices, the software uses historical sales data from its own and competitors’ stores.

3. Profit Impact of Setting a Retail Price: The Use of Break-Even Analysis

Retailers often want to know the number of units they need sell to begin making a profit. For example, a
retailer might want to know: (the use of break-even analysis)

 Break-even sales to generate a target profit.

 Break-even volume and dollars to justify introducing a new product, product line, or department.
 Break-even sales change needed to cover a price change.
Break-even analysis:

 Determines, on the basis of a consideration of fixed and variable costs, how much merchandise
needs to be sold to achieve a break-even (zero) profit.
 Fixed costs: don’t change with the quantity of product produced and sold.
 Variable costs: vary directly with the quantity of product produced and sold (e.g., direct labor and
materials used in producing a product)
Break-even point quantity: the quantity at which total revenue equals total cost, and then profit occurs
for additional sales.

 The formula for calculating the sales quantity needed to break even is:

¿
Break-even quantity = Total ¿ costs
Actualunit sales price−Unit variable cost
IV. Markdowns
Retailers adjust prices over time (markdowns) and for different customer segments (variable pricing)
1. Reasons for Taking Markdowns
Retailers’ reasons for taking markdowns can be classified as :

 Clearance markdowns - to get rid of slow moving, obsolete merchandise

 Promotional markdowns
o to generate cash to buy additional merchandise
o To increase sales and promote merchandise
o To increase traffic flow and sale of complementary products generate excitement through
a sale

2. Optimizing Markdown Decisions

Retailers have traditionally created a set of arbitrary rules for taking markdowns to dispose of unwanted
merchandise.

 Sell-Through: Identifies markdown items when its weekly sell-through percentages fall below a
certain level.
 Rule-based: Cuts prices on the basis of how long the merchandise has been in the store.
Markdown Optimization: software used to determine when and how much markdowns should be taken
to produce the best results by continually updating pricing forecasts on the basis of actual sales and
factoring in differences price sensitivities 

3. Liquidating Markdown Merchandise

 Sell the merchandise to another retailer

 Consolidate the unsold merchandise
 Place merchandise on Internet auction site
 Donate merchandise to charity
 Carry the merchandise over to the next season

V. Pricing techniques for increasing sales and profits

Reviews several techniques used by retailers to increase sales and profits.
1. Variable Pricing and Price Discrimination
Retailers use a variety of techniques to maximize profits by charging different prices to different
customers.

 Individualized Variable Pricing (first-degree price discrimination)

o Set unique price for each customer equal to customer’s willingness to pay
 o Auctions, Personalized Internet Prices
 Self-Selected Variable Pricing (second-degree price discrimination.) - offer the same
multiple-price schedule to all customers
o Quantity Discounts
o Early Bird Special
o Over Weekend Travel Discount
 Variable Pricing by Market Segment (third-degree price discrimination.) - often charge
different prices to different demographic market segments
o Seniors discounts
o Kids menu
o Zone Pricing (Third Degree of Price Discrimination) – Charge different prices in
different stores, markets, regions
 Pricing discrimination types:
o Promotional Markdowns
o Clearance Markdowns for Fashion Merchandise
o Coupons
o Price Bundling (ex: McDonald’s Value Meal)
o Multiple-Unit Pricing (quantity discounts)

Solution 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

2. Pricing Techniques for Increasing Sales

a) Leader Pricing
Leader pricing is pricing certain items lower than normal to increase customers’ traffic flow or boost sales
of complementary products.
Best items: purchased frequently, primarily by price-sensitive shoppers. Ex: bread, eggs, milk, disposable
diapers
One problem with leader pricing is that it might attract shoppers referred to as cherry pickers, who go
from one store to another, buying only items that are on special. These shoppers are clearly unprofitable
for retailers.
b) Price Lining
Retailers frequently offer a limited number of predetermined price points within a merchandise category
Both customers and retailers can benefit from such a strategy for several reasons:

 Essentially eliminated.
 The merchandising task is simplified.
  Give buyers greater flexibility.
 Can get customers to “trade up”
Ex: $59.99 (good), $89.99 (better), and 129.99 (best)
c) Odd Pricing
Odd pricing refers to the practice of using a price that ends in an odd number, typically (.9)
$2.99:

 Assumption:
 Consumers perceive as $2 without noticing the digits
 9 endings signal low prices
 Retailers believe the practice increases sales, but probably doesn’t
Does delineate:

 Type of store (downscale store might use it.)

 Sale
3. Using the Internet to Make Pricing Decisions
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.

VI. Legal and Ethical Pricing Issues

Some of the legal and ethical pricing issues are predatory pricing, resale price maintenance, horizontal
price fixing, bait-and-switch tactics, scanned versus posted prices, and deceptive reference prices.

1. What types of retailers often use a high/low pricing strategy? What types of retailers generally
use an everyday low-pricing strategy? How would customers likely react if a retailer switched its
pricing strategy from one to the other? Explain your response.
The types of retailers who deal in bullion market selling gold, silver and other precious items often use
high/low pricing strategy. Even the retailers selling fruits and vegetables, gasoline, etc. use high/low
pricing strategy depending upon the season, week, or special events that affects sales of these types of
products. The availability of these products and its demand makes the prices of these products high and
low.
However, the retailers who uses everyday low pricing strategy are the ones who want to bring in major
footfall of customers on a regular manner. The supermarkets, hypermarkets, and grocery stores are the
ones who uses everyday low pricing wherein they offer most products at low prices so as to attract the
customers and to increase the sale of its products.
If a retailer would switch its pricing strategy from one to the other, then the customer would not react in a
welcoming manner, instead the customer would become eager and inquisitive to get informed the reason
for price fluctuation. There is a possibility that the customer might switch to another brand or retailer in
order to avoid paying more for the products that are offered at a higher price by the retailer
2. Why would sewing pattern manufacturers such as Simplicity, Butterick, and McCall’s print a
price of $12.95 (or more) on each pattern and then two times a year offer patterns for sale at $1.99
each? How could this markdown influence demand, sales, and profits?
The organizations might offer their goods at reduced prices at two points in the year because:
1) The demand for their product is low and they want to increase their demand during that period.
2) They want to clear their stocks and prepare for next season so they are offering their products at
reduced prices.
3) The goods being offered at the markdown prices are damaged and the organization is selling them to
cover some of the cost and reduce their losses

3. Why would retailers risk violating any of the legal issues discussed in this chapter, such as
predatory pricing, price fixing, deceptive pricing, bait and switch, or discriminatory pricing?
Explain your answer.
Price Discrimination: Vendors cannot charge different prices to different retailers unless the cost of
manufacture, sale or delivery resulting from different selling methods or quantities sold are different
Resale price maintenance: This issue has had a checkered history. Currently, however, it seems that
vendors can terminate retailers who refuse to maintain suggested retail prices
Horizontal price fixing: It is illegal for competing retailers to conspire to fix prices
Predatory pricing: It is illegal to establish retail prices that are so low that competition is driven from the
marketplace
Price Comparison: It is illegal to promote merchandise that is “on sale” from a “regular” price unless the
retailer usually and recently has sold the merchandise at that price
4. What is the difference between bundled pricing and multiunit pricing?
The difference between bundled pricing and multiple-pricing can be described by stating that bundled
pricing refers to the type of pricing in which the firms sell package of goods or services at a lower price as
compared to the price if those products or services are bought separately. Bundled pricing allows the
sellers to attract customers to buy more which increases the profits earned by the seller.
On the other hand, multiple-unit pricing refers to the pricing strategy wherein the products are sold at low
price if they are bought in more quantities as compared to the price of the product if they are bought
singly.
This way bundled pricing offers different products in a bundle or a package at discounted rate, while in
multiple-unit pricing, the same product is sold in more units at the discounted rate.