5th Edition

PPT 15-1

Chapter 15

Pricing

McGraw-Hill/Irwin PPT 15-2 Retailing Management, 5/e Levy/Weitz:

Copyright 2004 by The McGraw-Hill Companies, Inc. All rights reserved.

Merchandise Management

Retail Communication Mix

Planning Merchandise Assortments

Pricing
Buying Systems Buying Merchandise

PPT 15-3

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
PPT 15-4

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.

PPT 15-5

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

PPT 15-6

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

PPT 15-7

Pricing Strategies
EDLP Builds loyalty guarantees low prices to customers Lower advertising costs Better supply chain management
Fewer stockouts

Hi-Lo Higher profits price discrimination More excitement Build short-term sales and generates traffic

Higher inventory turns

PPT 15-8

Considerations in Setting Retail Price

Price of Merchandise

Cost of Merchandise

Demand:

What will the customer will pay for merchandise?

Competitors
How are they pricing merchandise?

PPT 15-9

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 competitors prices

PPT 15-10

Sample Income Statement Showing Gross Margin

Net Sales = Cost of goods sold Maintained markup

$ 120,000 58,000 62,000

Alteration costs + cash discounts Gross margin

3,000 $ 59,000

PPT 15-11

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

PPT 15-12

Maintained Markup % and Gross Margin

Maintained = Sold Margin Net Sales Cost of Goods Net Sales

Gross Margin = Maintained Markup Workroom Costs + Discounts Percent Net Sales

PPT 15-13

Setting Retail Price Based on Costs

Retail Price $1.00 Margin $.40

Markup as a Percent of Retail Price 40% = $.40/$1.00

Cost of Merchandise $.60

PPT 15-14

Initial and Maintained Markup

Reductions $.10
Maintained Markup $.30 Maintained Markup as a Percent of Retail Price 30% = $.30/$1.00 Initial Retail Price $1.00

Cost of Merchandise $.60

PPT 15-15

Reductions

Markdowns (Sales)
Discounts to employees

Inventory shrinkage due to shoplifting and employee theft

PPT 15-16

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
PPT 15-17

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 (%)

PPT 15-18

Example of Markups

Retail = Cost + Markup

100% = 70% + 30%

Retail = $10.00 and markup = 30% Retail = Cost + Markup $ 10.00 = $7.00 + $ 3.00
PPT 15-19

Example of Setting the Initial Retail Price

Cost = $100 Planned Initial Markup = 56.85%
+ (56.85% x Retail Price)

Retail Price = $100

Solve for Retail Price

.4315 x retail price = 100

Retail Price = $100/.4315 = 231.75

Initial Retail Price = Cost of Merchandise (1-markup percentage)

PPT 15-20

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)

PPT 15-21

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 purchases to realize the overall markup of 50%?
PPT 15-22

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

PPT 15-23

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

PPT 15-24

Demand Curve Sales at Different Price Levels

Price Cost = $1 unit

$2

1000
PPT 15-25

Quantity Sold

Methods for Estimating Sales at Different Price Levels

Analyze Historical Sales and Prices Using Statistical Methods
Conduct Price Experiments

Use Judgment

PPT 15-26

A Pricing Experiment

Before Store 1 10 units @ $100 Gross margin = $500 Store 2 12 units @ $100

After 21 units @ $80 Gross margin = $630 13 units @ $100

Gross margin = $600

Gross margin = $650

PPT 15-27

Results of Pricing Test

(1) (2) Market Demand at Price (in units) (3) (4) Total Cost of Units Sold Total ($300,000 fixed Revenue cost + $5 variable (col 1 x col 2) cost) (5) Total Profits (col 3 x col 4)

Market

Unit Price

1
2 3

$8
10 12

200,000
150,000 100,000

$1,600,000
1,500,000 1,200,000

$1,300,000
1,050,000 800,000

$300,000
450,000 400,000

14

50,000

700,000

550,000

150,000

PPT 15-28

Factors That Affect Customers Sensitivity to Price

Customer Income (-)
Need for the Product (-) Availability of Product from Competitors (+) Frequency and Amount Spent on Product (+)

PPT 15-29

Considering Competitor Pricing

PPT 15-30

Breakeven Analysis
Understanding the Implication of Fixed and Variable Cost Breakeven point

Contribution/Unit
Fixed Costs Unit Sales

Calculating Breakeven Quantity BEP quantity

PPT 15-31

Fixed cost
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?
PPT 15-32

Cargo Pants Illustration of Breakeven Analysis

Breakeven Quantity = Fixed Cost

Unit Price Variable Cost

40,040 units =

$400,000
$24.99 - $15.00

PPT 15-33

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?

PPT 15-34

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

PPT 15-35

Percent Sales Increase Needed to Breakeven on a Price Decrease

The Gap has bought 60,000 womens 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?

PPT 15-36

The Gap Considers a Price Cut of 16.67%

Breakeven % = 100 x (-%price change) Sales Change % initial margin -% price change
100 x (-16.67) (7/12) + (-16.6)

39.78%

PPT 15-37

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

PPT 15-38

Retailers Income Statement

Net Sales COGS Gross Margin $1,000,000 800,000 200,000 80% 20%

Operating Expenses Variable Fixed Profit

PPT 15-39

100,000 80,000 20,000

10% 8% 2%

Retailers Variable and Fixed Operating Expenses

Variable Fixed 20,000 10,000 20,000 10,000 100,000 80,000 Total

Wages & Salaries

Manager Sales Clerical Rent Maintenance 20,000 60,000 20,000

PPT 15-40

Retailers Assets
Current Assets

Inventory
Accounts Receivable

$300,000
75,000

Cash
Fixed Assets Total

25,000
100,000 $500,000

PPT 15-41

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
PPT 15-42

What Is the Breakeven Sales To Move To New Location?

Rent Increases to $50,000
Break-even Sales = FC/(GM%-VC%)

PPT 15-43

What Is the Breakeven Sales To If the Retailer Wants to Reduce Prices?

Reduce Prices By 5%
Break-even Sales = FC/(GM%-VC%)

PPT 15-44

What Is the Breakeven Sales If the Retailer Wants to Make a Specific Income?
Make $50,000/Year
Break-even Sales = FC/(GM%-VC%)

PPT 15-45

Price Adjustments
Markdowns
Coupons Rebates

Price Bundling
Multiple-Unit Pricing

Variable Pricing

PPT 15-46

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
PPT 15-47

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.
PPT 15-48

Maximize Profits through Price Discrimination

Want Charge Every Customer the Maximum They Are Willing to Pay Problem
Dont know willingness to pay

With list prices, cant prevent high willingness to pay customers from buying at low price

PPT 15-49

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
PPT 15-50

Types of Price Discrimination

First Degree Set unique price for each customer equal to customers 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
PPT 15-51

How To Reduce Markdowns

Use Markdown Optimization Models Improve Sales Forecasts and Merchandise Budget Plan Work with Vendors to Plan Deliveries

PPT 15-52

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
PPT 15-53

Clearance Center Liquidates Markdowns

PPT 15-54

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
PPT 15-55

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 dont redeem.

They can offer price cuts to customers directly.

PPT 15-56

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.

PPT 15-57

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
PPT 15-58

Pricing and the Internet

Auction pricing more feasible

easier to form a market of buyers and sellers (eBay) Priceline.com

PPT 15-59

Using Price to Stimulate Sales

Leader Pricing Price Lining

Odd Pricing

PPT 15-60

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.

PPT 15-61

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.

PPT 15-62

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 doesnt. Does delineate:
Type of store (downscale store might use it.)

Sale

PPT 15-63

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
PPT 15-64

Vertical Price Fixing

Vertical Price Fixing -- Agreements to fix prices between parties at different levels of the same marketing channel. Vendors cant 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
PPT 15-65

Predatory Pricing
Establishing merchandise prices to drive competition from the marketplace. Illegal! Retailers can charge different prices at different locations if costs are different.

PPT 15-66

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.

PPT 15-67

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.

PPT 15-68

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.

PPT 15-69

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.
PPT 15-70

Bait and Switch (cont.)

Retailers should:
Have sufficient quantities Give a rain check

Dont disparage merchandise

PPT 15-71