Keystone Pricing in Retail
What Is It and Why Does It Not Always Make Sense
Keystone is a retail term related to pricing inventory. It is a pricing method whereby merchandise is priced for resale at an amount that is double the wholesale price or cost of the product.
For example, a retailer might say, "The only department in our retail store that allows keystone pricing is our gift department. Because we face a lot of competition with our other product categories, the remainder of our merchandise is priced using a 40 percent markup."
Keystone essentially means that if the cost of the product is $50, then the sale price would be set at $100. This is a 50 percent initial markup (also known as IMU). It is also applying a 50 percent gross margin to the sale of the product. Gross margin can be applied in either a percentage or a dollar amount. So, in this example, the gross margin dollars are $50, and the gross margin percentage is 50. Keep in mind that the gross margin and IMU are always 50 percent when you are setting it at keystone.
Many products in stores today cannot be set at keystone due to the high cost of the item from the vendor versus the price at which the product will sell. For example, computers are notorious for their low margins and competitive prices.
When keystone was first introduced as a term, it actually reflected two markups. The first markup was added by the vendor or manufacturer, and the second markup was added by the retailer. Returning to our example above, the vendor paid $25 to make the product and then sold it to the retailer for $50 and the retailer sold it to the customer for $100. This used to be considered proper business practice in the early days of retail.
In some cases, keystone pricing is not a good strategy. For example, a shoe store owner might price a certain category of shoe at keystone, athletic shoes for example, but that might put the owner at risk of being the most expensive place in town to buy athletic shoes. On the other hand, dress and casual shoes might sell well for that same store owner if set at keystone.
When Not to Use Keystone Pricing
Keystone pricing may not be the best policy for your retail store. There are a few scenarios to consider.
For instance, if the inventory turn of an item is low, then the higher the price and, thus, the higher the gross margin, the harder it will be to sell and the longer it will sit on your shelves or in your stockroom. Remember, in retail, cash is king. So merchandise on shelves costs you more than the price you paid the vendor.
If the product is a limited edition or supply is limited, keystone is too low a policy. Sell your merchandise for what the market will bear.
If you are a discounter, meaning people really only shop with you because of your deals, then a keystone policy will not work for you. People want to see low prices and big deals. Many retailers actually inflate the IMU or MSRP to show a bigger discount to the customer. The customer feels like they are saving 50 percent (especially an older customer who is used to keystone pricing), but the reality is they are only saving 25 percent.
We all have products in our stores that are commodities, meaning they are readily available in lots of places. For example, if you sell gum at the cash register, a retailer cannot logically charge more than the price everyone else in town charges for gum. So keystone pricing would not work.
The bottom line is that the best place to start is at keystone whenever possible. Most of your vendors know this to be true, and they try to control their wholesale prices to accommodate this strategy. However, discounters like Walmart have made this practice hard. As we see retailers like Target and Walmart increase their OEM lines, we will see an easing up of keystone pricing on brand name goods.