Chapter 11 Merchandise Pricing In this chapter we will discuss: Price Setting Objectives Price Setting Determinants Pricing Strategies and Practices Methods of Setting Prices Adjustments to the Initial Retail Price Legal Issues in Retail PricingINTRODUCTION ee 1d accomplish three objectives: get the product tain the market share as competition increases; plays an important role in a retail Pricing of merchandise shoul accepted in the market: maint and carn profits. Clearly. the pricing strategy organizations re icing poly offers potential customers important cues regarding the wae peice ee ‘when developing a marketing approach to pricing, rotailere must establish prices that are compatible with what the target customers expect and are willing to pay for their merchandise, Too often, retailers wnderprice their goods and services, in the belief that low prices are necessary for achieving a competitive advantage. They do not realize that convenience, service. and quality give their customers extra value and play a * major role in determining the amount they are willing to pay for the merchandise, An important part of setting appropriate prices is tracking competitors’ prices regularly: however, what the competition is charging is just one variable in the pricing mix. When setting prices, retailers should try to match the competitors prices or even beat them. But retail stores that offer customers extra quality, value, service, or convenience can charge more than the competitors as long as customers recognize the "extras" they are getting, This chapter examines methods for setting prices and its objectives. It also discusses the various pricing strategies used by retailers and examines the legal issues governing the pricing activities of retailers, SETTING THE RETAIL PRICE Price plays a significant role in retailing since it is the only retail mix element that generates income. So when fixing the price of a good or service in a retail store, decision makers should set a price that meets the objectives of the store and the expectations of the customers. AA retailer cannot arbitrarily fix a high or low price for a product. Price is one of the factors that determines the image of a retail store. So a retailer who wants to have constant traffic flow at the store should fix the appropriate price for the merchandise offered in the store. A retail store which prices high will be perceived as an expensive store. And a retail store that prices low will be perceived as a store carrying low quality merchandise. Thus pricing the merchandise plays a major role in conveying the image of a retail store to customers Price Setting Objectives 254 Price plays a major role in attracting and retaining customers. When setting the price of a product, the retailer should meet the needs of customers. Pricing should also be in line with the firm's mission, merchandising policies and other store decisions. So, before establishing pricing policies, the retailer should develop certain objectives that the store should achieve. These objectives can be classified as:# Sales objectives + Profit objectives + Competitive objectives Sales objectives Setting the right price for the products or services offered can inerease the Volume of the merchandise sold by the retailer. The volume sold affects the total revenue and the profit ofthe retail store. The right price for the product is the price that the consumer is willing to pay for the product. Hence, correct pricing decisions are essential for successful retail management. In a retail Store, sales objectives should be considered while formulating the pricing strategy. Sales objectives are expressed in two ways: + Sales volume objectives + Market share objectives Sales volume objectives aim to achieve the future sales target of the retail store as well as to maintain the existing levels of sales of the store. Market share objectives aim to increase and maintain market share of the retailer Market share objectives allow the retailers to judge their performance against that of their competitors and hence is preferred over sales volume objectives Market share growth is justified in new and growing product markets because it allows retailers to compare their performance with that oftheir competitors. Profit objectives ‘Another factor that retailers should take into consideration when setting the retail price is profit. When setting the price, a retailer sets his profit objectives in terms of: profit maximization, target return on investment and net sales. Under the profit maximization objective, the retailer tries to maximize the profit of his retail store though pricing and other merchandise activities. Working to achieve this objective may prove counter productive in the long run as profit maximization may strain the relation between the retailers and the, customers. Retailers at times state their profit objectives as expected target returns on investment i.e. the return the retailer expects on the capital invested in various asses like inventory, store fixtures, inventory etc Competitive objectives A. retailer pursues various competitive price objectives like meeting competitors prices, preventing an increase in competitors, or working towards non price competition Price -Setting Determinants Some retailers set their price by following the pricing of their major competitors or the market leader so that the competitor will not have a price advantage. Some retailers aim at preventing an increase in competition by setting low prices. This makes the market less attractive to the new players planning to enter retailing business, Retailers who want to avoid price ‘competition will compete on the basis of the quality of products, or services offered, the location of the store, the facilities offered to customers, and greater promotional efforts. 255256 nen a ‘When setting the price of the merchandise, retailers should bear in mind certain factors that affect the demand of goods or service: * Demand factor © Competition factor © Cost factor * Product factor * Legal factors Demand factor Customer behavior can always be related to the law of demand. Law of demand refers to the tendency of customers to buy products in a greater quantity when the price is low, and buy less or reduce consumption of the product when the price is high. Retailers should assess the consumer demand for a particular product at different prices. The change in demand of a product on the basis of its price can be better explained with the help of price elasticity of demand. The price clasticity of demand is a measure of the effect a price change has on consumer demand. Price elasticity gives the relationship between the percentage change in quantity demanded and the percentage change in price. ‘The elasticity of demand is higher for stock-up items (non perishable goods) than for perishable goods. The demand for a product is said to be inelastic when a change in its price has no influence on the demand for the product. Similarly, the demand for a product is considered to be clastic when a change in price causes a noticeable change in demand, Therefore, when pricing the merchandise, a retailer should consider the concept of elasticity of demand. Inelastic demand for a product implies that the consumers will not be sensitive to any change in price. Under such conditions the retailer can increase the price without worrying about a fall in demand for the merchandise. But if the demand for the merchandise is elastic, the retailer should be careful when increasing the price of that merchandise. This is because customers are highly sensitive towards an increase in the price of that particular merchandise. A small percentage increase in the price can lead to a huge reduction in the demand for that merchandise. ‘The retailer should also take into consideration the cross-elasticity of demand for a particular merchandise. In some cases, a small rise in the price of a particular product may lead to a fall in the demand for other merchandise. In other words, the cross elasticity of demand signifies that the change in the price of a particular merchandise may reduce the demand for other ‘merchandise. This situation arises in the case of complementary products. Competitive factor The success of a retail pricing strategy depends on its ability to give the retail store an advantage over its competitors. Retailers should monitor the prices of ‘competitors when setting prices for their merchandise. Even though retailers need not copy the same prices set by their competitors, it is wise to set a price which is in line with the competition. Variation in price should reflect thequality of the service provided, the nature of the location, and other retail mix factors. A retailer should think carefully before entering into a price war with competitors, as a continuous price war may lead to losses for both the retailer and its competitors The pricing of the merchandise depends on the competitive position of the retailer in the market. The competitive position in the market is based on the retail mix of the retailer, the loyal customer base, the image of the store ete. The stronger the competitive position in the market, the greater the freedom in deciding the price of the merchandise. If the retailer has a weak competitive position in the market, the freedom for setting the price is limited. The retailer should closely study the prices set by its competitors for high value items because for such items, customers always compare prices. Cost factor Cost has a major influence on the pricing decision of a retailer. The total cost of merchandise includes the actual cost of the merchandise along with the cost incurred in getting the merchandise to the store and preparing it for the sale. Cost forms the basis of pricing for retailers who adopt cost-oriented pricing, which is explained in detail in the latter part of the chapter. Product factor ‘Another major factor that has to be taken into consideration when setting the price is the nature of the product. Product characteristics like perishability, durability and seasonal appeal have an impact on the price that the retailer can quote for a product. For example, woolen clothes move well in winter and raincoats in the rainy season, Similarly, fruits can be priced high when they are fresh, but need to be marked down as time passes. Fashion merchandise is also affected in the same way. Customers are willing to pay high price for new fashion garments, but are reluctant to spend a lot of money on clothes that have gone out of fashion. Thus, retailers should be aware of various product characteristics and their impact on the consumer buying process when pricing merchandise. They should build-in appropriate markups into the initial merchandise price to offset the cost of markdowns when required. In the context of retail goods, there are three types of perishability - physical perishability, style or fashion perishability, and seasonal perishability, Physical perishability of the product: Products deteriorate over time or are damaged during transportation. ‘These products cannot be marketed, and constitute a loss for the retailer. Loss that would be incurred due to the damage or deterioration of the product should be taken into account when pricing physically perishable merchandise. Style or fashion perishability: The marketability of products like apparel depends on the style and fashion of the day. Once a particular style or fashion becomes obsolete, the product becomes difficult to market. When pricing the product, the retailer should take into consideration the perishability cost that can be caused by a change in style or fashion. Seasonal perishability: The demand for some merchandise changes due to ‘changes in season. For example, woolen cloths are in demand only in the winter season. So when pricing a product, the retailer should consider its seasonal perishability 287Product quality is another factor a retailer should consider when pricing a Product. Before pricing a good, the retailer should consider the quality with Tegard to price that he wants to project for a product. Moreover, the retailer should analyze the nature of the product and its availability. If the product is unique in nature, the retailer can charge high a Price. Customers looking for unique products are not price sensitive, and are willing to pay high prices to obtain them. Legal consideration The pricing function of a retail business is greatly influenced by the legal system of a country. Hence, when pricing merchandise, a retailer should consider the laws and regulations of the country and the state. According to the law in most of the countries, pricing activity that aims at restricting or killing the competition is illegal S. PRICING STRATEGIES AND PRACTICES Retailers adopting an everyday low pricing (EDLP) strategy strive to sell goods and services at consistently low prices throughout the year. Such retailers will price their goods between the regular non-sale price and the deep discount price offered by competitors. Retailers following the EDLP strategy do not offer discounts to customers. Such retailers maintain a stable, every day Price. Everyday Low Pricing strategy is popular among grocery retailers and general merchandise retailers. Everyday low pricing Retailers who follow the EDLP strategy simply try to “Keep costs low, sell more merchandise, lower prices further and sell even more”. Retailer leaders like WalMart, Office Depot and Toys "R" Us follow ‘the EDLP pricing strategy. Retail stores that follow the EDLP strategy carry a large number of items but a smaller selection of brands, have a less convenient format and very small fluctuations in prices. Such retailers do not have many promotional activities “Every Day Low Price” formats generally appeal to the cost-conscious buyer. People who shop at EDLP stores often buy a large number of items each trip and shop less frequently. High -Low Pricing 258 Retailers who use a high-low pricing strategy charge higher than EDLP retailers. Such retailers occasionally reduce prices deeply (for a short period), much below the EDLP level. To attract customers, these retailers advertise frequently. Retail stores which follows this strategy provide a high fixed utility to customers with a convenient format, high quality service, and a good assortment of products. Customers visit such stores frequently as they buy inaca) EDLP in Canada ‘The practice of EDLP in Canadian retail stores started in 1994 when Wal-Mart entered the Canadian market. Before 1994, high-low pricing prevailed, with weekly fliers, loss leaders and specials. EDLP created a "market spoiler effect" and changed the shopping preferences of customers in Canada, Now, shoppers in Canada are no longer attracted by periodic sales and promotions, So, to counter Wal-Mart, retailers in Canada have started offering EDLP. The department store leader, Bay, which thrived on scratch-and-save purchase discounts, has come up with "Bay Value" deals. Under this deal, Bay offers 180 moderately priced items of daily consumption at everyday low prices. This pricing system is intended to address the needs of financially constrained customers who would like to avoid the weekend rush for a sale. Zellers in Toronto, however, has moved most of its inventory (96%) to the EDLP system. It emphasizes pricing in its marketing efforts. In Canada, Sears has introduced EDLP on selected products in response to customers’ unwillingness to wait for sales. Though Sears feels that sales have not lost their credibility, it believes that EDLP has an advantage. It feels that it is easier to offer merchandise on EDLP rather than periodic sales, which require advertising and involve the mounting and de-mounting of displays. Retailers in Canada are aware that offering low prices alone will not provide value to customers. They are therefore coming up with ways to enhance customer value, Zellers is doing so by carrying enough stock and broadening its merchandise (to include offerings such as furniture). Bay is redesigning its store layouts to enhance customer service. It is reducing the number of check-outs from 40 to 4 to deploy more staff on the floor. Both retailers claim that they will continue to use sales as a part of their marketing programs. ‘Source: hitp://[Link]/srch/sct/page 17. html ‘small quantities. Since the price often fluctuates in such stores customers defer the purchase of high priced product till the price falls. When the price falls they stock up on the item. High/low price retail stores are suitable for customers looking for shopping convenience, good service and large assortments. ~~ Coupons Coupons are documents that entitle the holder to a percentage price reduction from the actual purchase price of a product or service. The retailer or the manufacturer issues these coupons in newspaper, with the products, at the cash register or through the mail Coupons. induce people (first- time customers) to try particular items of merchandise sold by a store. If the customer likes the product, he becomes a frequent user and increases the sales of the store, Coupons have a mixed impact on retail stores. They generate positive sales in ‘the short run, but in the long run, the net sale increase is negligible if the coupons do not bring in new customers. For example, if a supermarket issues 259 eedRebates cer 1c will be encouraged to buy more and stock tp This oa Tead to aimee in the sales, but this increase is likely to be short -term in nature. ; filers use coupons to lure the customers away from rival retailers. But bis of the Pras coupons are used by the regular customers of retailer to make bulk purchases. Thus coupons do not help retailers to li Sale, Instead, retailers end up paying for the redemption of coupons us ‘use of coupons can lead to an increase in expenditure instead of an increase in sales. In rebates, a portion of the purchase price is returned to the buyer. Alte making a purchase, the customer has to send the proof of purchase to he manufacturer. Upon receipt of the proof of purchase, the manufacturer mail the rebate to the customer, Rebates increase the sales volume of retailers, but not the costs since the retailers do not have to process the rebates. Leader Pricing Leader pricing involves selling a product (leader) at a substantially low price to generate customer traffic and increase the sale of complementary products in the store. Usually, retailers regard these low priced products that are often sold below cost, as loss leaders. But, leader pricing need not always involve Pricing loss leaders below cost price. The products selected for leader pricing should be those that are frequently bought by target customers. Many retailers select items like onions, eggs or sugar as price leaders to attract customers Price Bundling In price bundling, distinct items, generally from different lines of merchandise, are offered together at a special price. This can increase the volume of sales as well as the traffic at the retail store. This kind of offer can also help the retail store remove less desirable merchandise from the store (by offering it as a part ofa package). Price bundling is common in the service retail industry, ¢.g. a complete holiday package is offered to customers, including the cost of air fare, hotel charges and food. Multiple-Unit Pricing 260 Multiple-unit pricing occurs when the price of each unit in a multiple-unit package is less than the price of each unit if it were sold individually. Customers who buy in bulk benefit from such offers. General merchandice and apparel retailers commonly use this multiple pricing strategy. For example, Shoppers’ Stop offers three shirts as a bundle for certain price (Res 1000), which would be less than three such shirts bought separately (399 x 3). Multiple-unit pricing increases the volume of sales of the retailer ae well the profit of the store. This pricing strategy is used to clear out goods as well as end-of-season merchandise.Odd Pricing Price lining involves establishing a specific number of price points for cach merchandise classification. Suppose kids wear is priced at Rs 550, Rs 750, Rs 950. Each price represents a price line or price point. There should be a significant difference between different price points so that the customers can relate the monetary difference with the value difference. If the difference in the price points is sufficiently large, the salesperson can engage the customer in trading up or trading down. ‘The price line helps customers by reducing shopping confusion and making it easy to identify price ranges that suit them. It also helps retailers, by simplifying the purchase and accounting functions; increasing the likelihood of the customer trading up to the next price point; and projecting the depth of the merchandise. Odd pricing refers to the practice of setting retail prices that end in an odd ‘number or just under an even rupee value. For example, Bata showrooms price their merchandise as Rs.99.95, 299.95 etc. Reebok India priced a pair of shoes at Rs 999. Through odd pricing, retailers try to make customers feel that they are paying less for the merchandise. METHODS OF SETTING PRICES. Cost Oriented Pri The pricing of produets/services is a critical decision in any business. In a retail store, price influences the quantities of various items that consumers purchase, which in tum affects total revenue and profit. A good pricing decision is essential for successful retail management. ‘There are three ways of setting prices: © — Cost oriented pricing ‘© Demand oriented pricing and ‘© Competition oriented pricing ing In the cost-oriented pricing approach, a retailer sets the minimum price that is, necessary for the store to achieve a predetermined profit goal. To arrive at this, price, the retailer usually computes merchandise and retail operating costs and adds a profit margin to these figures. When computing cost, the retailer considers not only production costs (materials, labor, overhead) and freight costs, but also a pre-determined gross margin. This approach is commonly followed by retailers who sell many products because it is not possible to determine the demand for each product. Markup Pricing In the cost oriented approach, the retailer uses the markup technique to calculate the retail selling price. The difference between the cost of the 261262 merchandise and the retail selling price is known as the markup. Retailers usually set a markup amount that ensures a specified profit for the store after covering all the selling costs. Markups can be of two types i) Rupee markup and ii) Percentage markup. In Rupee markups a rupee value is added to the cost of the merchandise to cover all the selling expenses and provide a profit, For example, a jewelry retailer may add Rs 1000 as markup to set the retail price of any jewelry item above Rs 10000 (cost price). A grocer may add Rs 5 to the per kilogram cost of the pulses sold in his store, Percentage markups are expressed as a percentage of the merchandise cost added to the unit ‘merchandise cost. For example, a hardware store setting retail prices for all items that have wholesale prices of Rs 100 to 300 may add a markup of 60 percent, resulting in retail prices ranging from Rs 160 to 480. Although the rupee markup method of pricing seems to be simple, it does not permit comparisons between merchandise lines and departments. Hence, many retailers use the percentage markup pricing method to set retail prices. Raiailers calculate the matkup percentage on the basis of the cost price or the retail price Markup percentage (at cost) = (Retail selling price - Merchandise cost) + Merchandise cost Markup percentage (at retail) = (Retail selling price ~ Merchandise cost) + Retail selling price Although retailers can calculate the markup on the basis of the cost price, they generally calculate it in terms of the retail selling price for the following reasons: + Retail expenses, markdowns and profits are expressed as a percentage of sales. Manufacturers quote their selling and discount prices to retailers as percentage reductions from the retail price ist. * Retail selling data is available more easily than cost data. * Profitability statistics appear to be smaller if expressed on the basis of retail price instead of cost; this can be useful when dealing with the government, employees and consumers. Retailers should have a clear understanding of terms like initial markup, maintained markup and gross margin. ° Initial markup can be defined as the initial retail selling price based on the merchandise less the cost of merchandise sold: : Initial markup = Initial retail selling price ~ Cost of the merchandise But, in practice, retailers rarely realize the full initial markup on all the merchandise on display. This is because of various retail reductions that reduce the actual price received by selling the merchandise. These reductions can be due to markdowns, special customer and employee discounts, and inventory shrinkage's because of shoplifting and damages.Se eaten) eon markup can be defined as the actual price received for merchandise sold less merchandise cost. In other words, maintained markup n be stated as the initial markup less all the retail reductions. eel markup = Actual prices received for merchandise sold during a ithe period ~ Merchandise Cost ‘The initial markup and the maintained markup percentage can be calculated using the following equations Initial Markup Percentage = (operating expenses % + operating profit % - cash discounts % + alteration cost % + retail reduction %) ++ (net sales % + retail reductions %) Initial Markup % = (maintained markup % + retail reduction %) + (net sales % + retail reduction %) Maintained Markup % = Initial markup % - {retail reduction % x (100% - Initial markup %)] Gross margin is the difference between net sales and the total cost of goods sold. A retailer can calculate the gross margin as, Gross margin = Net sales ~ Total cost of goods The relationship between gross margin and maintained markup is given in the following equation Gross margin = maintained markup ~ alteration costs + cash discounts Maintained markup = gross margin + alteration cost ~ cash discounts Demand Oriented Pricing In demand oriented pricing, a retailer fixes the price on the basis of customer demand, Retailers try to work backwards starting from the products' perceived value to the buyer, rather than starting from the costs. Retailers adopting demand oriented pricing consider a range of prices that are acceptable to target customers and try to determine a price which maximizes profits. This pricing approach is used by retail organizations which strive to gain sales volumes and market share. It allows retailers to estimate the quantity of goods that customers demand of various products at different levels of price, thereby enabling them to fix the price that would help them achieve the stated sales goals, Retailers who rely on cost-oriented pricing fix the price of the merchandise on the basis of the cost of the retail store, whereas, retailers who use demand oriented pricing fix the price on the basis of customer demand. Retailers using the demand oriented pricing approach should understand the Psychological implications of the retail price on customers. Psychological pricing takes into consideration: + Price-quality association «Prestige pricing Customers who make price-quality associations may perceive a high pri iced product as a high quality product and a low priced product as low quality product. Price becomes a major decision variable when a customer funds difficult to distinguish between similar merchandise offered by different retailers, 263264 Prestige pricing is based on the assumptions underlying the price-quality association. Retailers using this pricing approach target customers who do not shop in stores offering low value goods and services. These retailers will not keep low priced merchandise in the store, as their customers may perceive the store to be of a low quality and low status. Before adopting a prestige pricing strategy, retailers should carefully study their target market. This is because many customers are economizers and they tend to look for discounts. Prices based on price-quality associations or prestige pricing do not appeal to such customers. Factors that affect customer's sensitivity to price Before setting the initial retail price of a product retailers should understand their customers’ sensitivity towards the price of the merchandise. They must determine whether the customers are price sensitive or not. Some of the factors that influences the sensitivity of customers towards price are: Awareness about substitutes Customers become very price sensitive when a large number of substitutes are available for a particular product in a given trade area. In some cases, within a particular area different stores with different formats sell the same product. In such a market, itis very difficult to differentiate the product through price. Retailers therefore try to differentiate on the basis of fashion, color and design of the products, Volume of expenditure Customers become price sensitive, when expenditure is high in terms of rupee value or as a percentage of income, Therefore, customers will be price sensitive when buying high priced goods like furniture, consumer durables, automobiles ete, Retailers dealing in such items should set prices in line with the competition Difficulty in Comparison Customers are more price sensitive when they can easily compare the merchandise offered by the competing retailers. To avoid such comparisons, retailers should stock unique merchandise. But sourcing unique/exclusive merchandise is not an easy proposition, To tackle this problem, retail stores like Shoppers Stop, Pantaloons and FoodWorld stock store/proprietary brands in many product categories Benefit/price relationship Customers’ sensitivity to price is determined by their expectations of a product with regard to its price. For example, a customer who wants to acquire a specific image or unique benefit through a product will be less sensitive to the price. Such customer will pay far more for a designer watch at a Titan showroom than for a watch offering similar performance elsewhere. Situation ‘The store atmosphere or the buying situation also determines the price sensitivity of customers. Depending on the situation, the price of the sameMeenas product can vary, In certain situations people are willing to pay a premium price for a particular product, even though the same product is available at a lower price in some other store/location. For example, customers are willing to pay more for a soft drink at an amusement park than at a department store. Competition-Oriented Pricing DX ADJUSTME! Markdown In competition- oriented pricing, retailers fix the price on the basis of their competitor's price, They do not consider cost and demand for the merchandise as criteria for fixing the price, And they do not alter the price even though there is a change in demand or an increase in the cost of the merchandise. Competition- oriented retailers can fix the price below the market price, at the market price or above the market price. Retailers can charge higher than the market price, only when the location of their stores is convenient for customers, and their stores offer good customer service, wide assortments, a favorable image and an exclusive brand. Retail stores with an inconvenient location and self-service formats should charge less than the market price. Competition-oriented pricing is easy and simple in nature, It does not require calculations based on the demand curve or the price elasticity. Moreover, competition-oriented pricing does not lead to retaliation as prices are based on those already existing in the market. TO THE INITIAL RETAIL PRICE In a competitive marketplace, retailers make price adjustments to adapt to changing intemal and external factors like competition, seasonality, demand patterns, merchandise costs and pilferage. Retailers adjust the initial merchandise prices upward or downward to sell their goods and services and achieve the required profit margins. These adjustments can be classified into: * Markdown Markdown cancellation © Additional markup © Additional markup cancellation ‘A markdown is a reduction from the original retail price of an item to match the lower price offered by competing retailers, to adapt to inventory overstocking, to clear out shopworn merchandise, to reduce assortments of odds and ends, or increase customer traffic. Retailers often mark down the ‘merchandise price to achieve two objectives: i, reduce the merchandise (old) in the retail store (clearance sale) and ii, attract more traffic flow and generate sales (promotion sale). Ata clearance sale, retailers offer substantial markdowns on the initial retail selling prices. Such sales are aimed at pushing slow moving and obsolete (fashion goods) merchandise and end of season goods. Hence, clearance sales 265