Many factors influence a retailer's bottom line, including properly priced products that hit the sweet spot of maximizing unit sales without sacrificing the profit per unit. Understanding your business cost structure and choosing the right pricing strategy are crucial steps toward achieving your profit goals. Many pricing strategies exist, which is why it may be wise to experiment until you find a strategy that is the most effective for your individual business.
Product Cost and Profitability
The cost of goods also includes the cost of any direct labor to produce the item. The expenses related to operating the business, known as operating expenses, include overhead items such as advertising, payroll, marketing, building rent, and office supplies.
Once you have clarity on what your products actually cost, look at how your competition prices their products to establish a benchmark for your price. As a retailer, you also need to examine your channels of distribution, such as online sales through your own website, via brick-and-mortar stores, and through other vendors.
Top Pricing Strategies
Before you can determine which retail pricing strategy to use in determining the right price for your products, you must consider the product's direct costs and other related expenses. These two key elements of overall product cost are termed cost of goods and operating expense.
Markup Pricing: The markup on cost can be calculated by adding a preset, often industry standard, profit margin percentage to the cost of the merchandise. The percentage markup on retail is determined by dividing the dollar markup by the retail price. For example, if your markup is $20 and your product retails for $40, your percentage markup is: $20 / $40 = .50 or 50 percent. Remember to keep your markup high enough to allow price reductions and discounts, cover shrinkage (theft,) and other anticipated expenses, in order to achieve a satisfactory profit. If you retain a varied product selection, you can use different markups for each product line if needed.
Vendor Pricing: Manufacturer suggested retail price (MSRP) is a common strategy used by smaller retail shops to avoid price wars and still maintain a decent profit. For any products you resell, you'll find some suppliers have minimum advertised prices (MAP) and may not let you continue to sell their products if you try to price below their MAP.
Competitive Pricing: Consumers have many choices and are generally willing to shop around to get the best price. Retailers considering a competitive pricing strategy need to provide outstanding customer service to stand above the competition.
- Pricing below competition simply means pricing products lower than the competitor's price. This strategy works well if you as a retailer can negotiate the lowest buying prices from your suppliers, reduce other costs, and develop a marketing strategy to focus on price specials.
- Prestige pricing, or pricing above the competition, may be considered when your location, exclusivity, or unique customer service can justify higher prices. Retailers that stock high-quality merchandise that isn't readily available at other locations may be quite successful in pricing products above their competitors.
Psychological Pricing: Psychological pricing is a technique of setting prices at a certain level where the consumer perceives the price to be fair, a bargain, or a sale price. The most common method is odd-pricing, which uses figures that end in 5, 7 or 9, such as $15.97. It is believed that consumers tend to round down a price of $9.95 to $9, rather than $10.
Keystone Pricing: Keystone pricing involves doubling the cost paid for merchandise to set the retail price. Although this was once the rule of pricing products, more intense competition and the continually changing retail landscape have driven some retailers to use methods other than Keystone. However, stores selling higher-end goods with less sensitivity to price may still use keystone.
Multiple Pricing: This method involves selling more than one product for one price, such as three items for $1. Not only is this strategy great for markdowns or sales events, but retailers have noticed consumers tend to purchase in larger amounts when they use multiple pricing strategies.
Pricing Strategies Based on Discounts
Discount pricing and price reductions are a natural part of retailing. Discounting can include coupons, rebates, seasonal prices, and other promotional markdowns. Typically, price strategies based on discounts are designed to bring in more traffic that might offer the potential of purchasing higher-priced items.
Discount Pricing: This one is self-explanatory. Merchandise priced below cost is referred to as a loss leader. Although retailers make no profit on these discounted items, they hope the loss leader brings more consumers into the store who will purchase other products at higher margins.
Economy Pricing: Used by a wide range of businesses including generic food suppliers and discount retailers, economy pricing aims to attract the most price-conscious of consumers. With this strategy, businesses minimize the costs associated with marketing and production in order to keep product prices down.
Price Skimming: Designed to help businesses maximize sales on new products and services, price skimming involves setting rates high during the introductory phase. One of the benefits of price skimming is that it allows businesses to maximize profits on early adopters before dropping prices to attract more price-sensitive consumers.
Bundle Pricing: With bundle pricing, small businesses sell multiple products for a lower rate than consumers would face if they purchased each item individually. Not only is bundling goods an effective way of moving unsold items that are taking up space in your facility, but it can also increase the value perception in the eyes of your customers.