Chapter # 14

Retail Pricing
Merchandise Management

Retail Planning
Communication Merchandise
Mix Assortments

Pricing

Buying Buying
Systems Merchandise
 Pricing Issues

• Pricing Strategies
– Everyday Low Pricing (EDLP)
Vs Hi-Lo Pricing
• How Should Prices Be Set?
– Demand Oriented Pricing
• How Do Retailers Set Price?
– Cost Oriented Pricing
• Legal Issues in Pricing
 Pricing Strategies

• Everyday Low Prices (EDLP)

– Charge the same price all the time
– Set prices between regular non-sale price and deep
discount sale prices of a high/low pricing
competitor.
– EDLP retailers typically still have some sales.
• High/Low Pricing
– Regular prices are higher than EDLP competitors,
but merchandise frequently on sale at lower prices.
 Everyday Low Pricing
• Wal-Mart, Category Specialists, Dillards, Food Lion
• Benefits to Consumers
– Assured of Low Price on Every Visit
– Less Stockouts
• Benefits to Retailer
– Lower Advertising Expense
– Lower Labor Costs
 Hi-Lo Pricing
• Most Department Stores, Publix, Kmart
• Benefits to Consumer
– Spend Time to Find Lowest Price
• Benefits to Retailer
– Maximize Profits -- Price Discrimination

Problem: Trains People to Buy on Deal

 Pricing Strategies
Hi-Lo
EDLP
• Higher
Builds loyalty
profits––guarantees
price discrimination
low prices to customers
• More
Lowerexcitement
advertising costs
• Build
Bettershort-term
supply chain
sales
management
and generates traffic
– Fewer stockouts
– Higher inventory turns
Considerations in Setting Retail Price

Price of Merchandise

Demand: Competitors
Cost of What will the How are they
Merchandise customer will pay pricing
for merchandise? merchandise?
Methods for Setting Price
Demand-Oriented – Charge as much a customers are willing to pay
Cost-Oriented – Set price at a fixed percent over cost of merchandise
Competitor-Oriented – Set price in relation to competitor’s prices
 Sample Income Statement
Showing Gross Margin

Net Sales $ 120,000

- Cost of goods sold 58,000
= Maintained markup 62,000

- Alteration costs + cash discounts 3,000

= Gross margin $ 59,000
 Initial and Maintained Markups

• Initial markup = retail selling price

initially placed on the merchandise
- cost of goods sold
• Maintained markup = Actual sales
that you get for the merchandise
- cost of goods sold
 Maintained Markup % and Gross
Margin
Maintained = Net Sales – Cost of Goods Sold
Margin Net Sales

Gross Margin = Maintained Markup – Workroom Costs + Discounts Percen

Net Sales
 Setting Retail Price Based on Costs
Retail Price
$1.00

Margin
$.40
Cost of
Merchandise
$.60
Markup as a Percent of
Retail Price
40% = $.40/$1.00
 Initial and Maintained Markup
Initial Retail
Reductions Price $1.00
$.10
Maintained
Markup $.30 Cost of
Merchandise
$.60
Maintained Markup as a
Percent of Retail Price
30% = $.30/$1.00
 Reductions

• Markdowns (Sales)
• Discounts to employees
• Inventory shrinkage due to
shoplifting and employee theft
 Setting Retail Price Based on Cost
• Determine
– Cost of Goods Sold
– Planned and Forecasted Reductions
– Desired Maintained Markup
• Calculate Initial Markup % Based on Cost of
Goods Sold, Planned and Forecasted
Reductions, and Desired Maintained Markup
• Calculate Initial Retail Price Based on Cost of
Merchandise and Initial Markup Percent
 Determining Initial Markup
from Maintained Markup

Maintained Markup = net sales - invoice costs + cash discounts

Gross Margin = maintained markup - alterations + cash discounts
Initial Markup = ($maintained markup + $ reductions)
($ net sales + $ reductions)
or
Initial Markup = (maintained markup (%) + reductions (%))
100% + reductions (%)
 Example of Markups

Retail = Cost + Markup

100% = 70% + 30%

Retail = $10.00 and markup = 30%

Retail = Cost + Markup
$ 10.00 = $7.00 + $ 3.00
 Example of Setting the
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)

 Pricing Example
A buyer has purchased 200 wallets at $30
each. Some of the handbags will be sold at
$50 retail and others will be sold at $70 retail.
How many handbags should be put at each
price point to realize a maintained markup of
40% assuming no reductions?
Z = percent sold at $50
$50 x + 70 x (1-Z) = 30 x Z /(1-.4)
 Pricing Example
A buyer for women hosiery is planning to
buy for merchandise to be sold during the
summer season that will generate retail
sales of $300,000. The buyer wants to have
a maintained markup of 50% on retail for
summer swim suits sales. Reductions will
be very small and can be ignored. The
buyer has already spent $75,000 for
merchandise that will generate $175,000 at
retail. What markup does the buyer need
to have on the remainder of the planned
 Pricing Example
Planned Sales $300,000 Planned Cost = 150,000
300,000 (1-.50)
Sales Achieved 175,000 Money Spent = 75,000

Remaining Sales 125,000 Remaining Cost 75,000

Markup% Needed on Remaining Sales

Setting Prices Based on Demand –
Price Customer Is Willing to Pay
• Estimate Sales Made at Different Price Levels
• Calculate Profit at Each Price Level
• Set Prices to Maximize Profits
 Demand Curve
Sales at Different Price Levels
Price
Cost = $1 unit

$2

1000
Quantity Sold
 Methods for Estimating Sales at
Different Price Levels
• Analyze Historical Sales and Prices Using
Statistical Methods
• Conduct Price Experiments
• Use Judgment
 A Pricing Experiment

Before After
Store 1 10 units @ $100 21 units @ $80
Gross margin = $500 Gross margin = $630
Store 2 12 units @ $100 13 units @ $100
Gross margin = $600 Gross margin = $650
 Results of Pricing Test

(1) (2) (3) (4) (5)

Total Cost of
Market Units Sold Total
Demand Total ($300,000 fixed Profits
Unit at Price Revenue cost + $5 variable (col 3 x
Market Price (in units) (col 1 x col 2) cost) col 4)
1 $8 200,000 $1,600,000 $1,300,000 $300,000
2 10 150,000 1,500,000 1,050,000 450,000
3 12 100,000 1,200,000 800,000 400,000
4 14 50,000 700,000 550,000 150,000
 Factors That Affect Customer’s
Sensitivity to Price

Customer Income (-)

Need for the Product (-)
Availability of Product from Competitors (+)
Frequency and Amount Spent on Product (+)
Considering Competitor Pricing
 Breakeven Analysis
Understanding the Implication of Fixed and Variable Cost
Contribution/Unit
Breakeven
point
Fixed Costs
Unit Sales

Calculating Breakeven Quantity

Fixed cost
BEP quantity =
Unit price - Unit variable cost
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?
 Cargo Pants
Illustration of Breakeven Analysis
Breakeven Quantity = Fixed Cost
Unit Price – Variable Cost

40,040 units = $400,000

$24.99 - $15.00
 Making a Profit on Cargo Pants
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?
 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
Percent Sales Increase Needed to
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?
 The Gap Considers a
Price Cut of 16.67%

Breakeven % = 100 x (-%price change)

Sales Change % initial margin -%
price change

39.78% = 100 x – (-16.67)

(7/12) + (-16.6)
Using Breakeven Analysis for Other
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 needs if
she:
• Move to a new location with higher rent
• Reduces prices by 5%
• Wants to make a $50,000 profit
 Retailer’s Income Statement

Net Sales $1,000,000

COGS 800,000 80%
Gross Margin 200,000 20%

Operating Expenses
Variable 100,000 10%
Fixed 80,000 8%

Profit 20,000 2%
 Retailer’s Variable and Fixed
Operating Expenses
Variable Fixed
Wages & Salaries
Manager 20,000 20,000
Sales 60,000
Clerical 20,000 10,000
Rent 20,000
Maintenance 10,000
Total 100,000 80,000
 Retailer’s Assets
Current Assets
Inventory $300,000
Accounts Receivable 75,000
Cash 25,000
Fixed Assets 100,000
Total $500,000
 Sales $ Retailer Needs to Break
Even
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
What Is the Breakeven Sales To
Move To New Location?

• Rent Increases to $50,000

Break-even Sales = FC/(GM%-VC%)
 What Is the Breakeven Sales To
If the Retailer Wants to Reduce
Prices?
• Reduce Prices By 5%
Break-even Sales = FC/(GM%-VC%)
What Is the Breakeven Sales If the
Retailer Wants to Make a Specific
Income?
• Make $50,000/Year
Break-even Sales = FC/(GM%-VC%)
 Price Adjustments

• Markdowns
• Coupons
• Rebates
• Price Bundling
• Multiple-Unit Pricing
• Variable Pricing
 Reasons for Taking Markdowns
• Get Rid of Slow-Moving, Obsolete,
Uncompetitively Priced Merchandise
• Increase Sales and Profits through Price
Discrimination
• Generate Cash to Buy Better Selling
Merchandise
• Increase Traffic Flow and Sale of
Complementary Products Generate
Excitement through a Sale
 Markdowns Are a Form of
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.
 Maximize Profits through
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
 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
 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
– Quantity discounts
• Third Degree – Charge different groups different prices
– Markdowns Late in Season
– Early Bird Special
– Seniors Discounts
– Over Weekend Travel Discount
– Coupons
 How To Reduce Markdowns

• Use Markdown Optimization Models

• Improve Sales Forecasts and Merchandise
Budget Plan
• Work with Vendors to Plan Deliveries
 Liquidating Markdown
Merchandise
• Auction merchandise on Internet (eBay or
liquidation exchange)
• Have special clearance location on own
website
• “Job out” the remaining merchandise to
another retailer
• Consolidate the marked-down merchandise
• Give merchandise to charity
• Carry the merchandise over to the next
season
 Clearance Center
Liquidates Markdowns
 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
 Rebates
• Money returned to the customer based on a
portion of the purchase price.
• Retailers’ perspective: more advantageous
than coupons since they increase demand,
but retailer has no handling costs.
• Manufacturers like rebates because:
– Many customers don’t redeem.
– They can offer price cuts to customers directly.
 Price Bundling and
Multiple-unit Pricing

Price Bundling: practice of offering two

or more different products or services
at one price.
Multiple-unit pricing: similar to price
bundling except products or services
are similar rather than different.
 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
 Pricing and the Internet

• Auction pricing more feasible –

easier to form a market of buyers
and sellers (eBay)
• Priceline.com
Using Price to Stimulate Sales

• Leader Pricing
• Price Lining
• Odd Pricing
 Leader 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 price-sensitive shoppers.
• Examples: bread, eggs, milk, disposable
diapers.
 Price Lining
• A limited number of predetermined price points.
• Ex: $59.99 (good), $89.99 (better), and 129.99
(best)
• Benefits:
– Eliminates confusion of many prices.
– Merchandising task is simplified.
– Gives buyers flexibility.
– Can get customers to “trade up.”
 Odd Pricing
• A price that ends in an odd number ($.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
 Legal Issues in Retail Pricing
• Price Discrimination
• Vertical Price Fixing
– Resale Price Maintenance
• Horizontal Price Fixing
• Comparative Price Advertising
• Bait and Switch Tactics
• Scanned Versus Posted Prices
 Vertical Price Fixing
Vertical Price Fixing -- Agreements to fix
prices between parties at different levels of
the same marketing channel.
• Vendors can’t force retailers to sell at
manufacturer suggested retail price (MSRP).
• Retailers can sell above MSRP.
• Often vendors tie selling products are MSRP
with co-op advertising allowance
 Predatory Pricing
• Establishing merchandise prices to drive
competition from the marketplace.
• Illegal!
• Retailers can charge different prices at
different locations if costs are different.
 Comparative Price Advertising
• Compares price of merchandise offered for
sale with a higher “regular” price or MSRP.
• Good because it gives consumers information
about what merchandise should sell for.
• Illegal if used to deceive consumer.
 Potential Deceptions of
Comparative Price Advertising

Comparison price advertising inflates perceptions of savings and value, and

reduces search for lower prices.
Consumers use price to infer quality.
If advertised reference price is fictitious, then customer is deceived.
 Guidelines for Retailers to Avoid
Deception in Comparative Price Advertising

Have reference price in effect about one-third of the time.

Disclose how “sale” prices are set and how long they will be offered.
Offer a “satisfaction guaranteed policy”.
Be careful when using MSLP.
Use objective terms.
Use reference prices that can be easily verified.
 Bait-and-Switch

• Lure customers into store by advertising a

product at a lower than usual price (the
bait) and then induces customer to switch
to higher-priced model (the switch).
• Can occur by
– Retailer out of advertised model.
– Retailer has advertised model, but disparages
it.
 Bait and Switch (cont.)

• Retailers should:
– Have sufficient quantities
– Give a “rain check”
– Don’t disparage merchandise