RETAIL

PRICING
NGUYEN THI MY HANH
Industrial and Systems Engineering
International University

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LEARNING GOALS OF THE LESSON

- Understand pricing strategies

- Have knowledge about considerations in setting retail prices

- Understand how retailers set retail prices

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CONTENT
1. Pricing strategies:
+ High/Low Pricing
+ Everyday Low Pricing
2. Consideration in setting retail prices:
+ Price sensitivity
+ Competition
+ Cost
+ Legal constraint
3. How do retailers set retail prices?
+ Based on cost
+ Based on retail price 3
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PURPOSE OF PRICING STRATEGY

Why is it important to charge “the right price”?

• Pricing decision is important because customers have alternatives to choose

from and are more informed than ever before.

• Customers seek for good value.

Value = perceived benefits

price
-> Retailers can increase value and stimulate sales by increasing benefits or
reducing price. 4
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PRICING STRATEGIES

High/Low Pricing Everyday Low Pricing (EDLP)

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PRICING STRATEGIES: HIGH/LOW PRICING

• Discount the initial prices through frequent sales promotions

• Advantages
• Increases profits through price discrimination
• Creates excitement
• Sells merchandise

• Disadvantages
• Train people to buy on deal and wait
• Have an adverse effect on profits
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PRICING STRATEGIES: EDLP

- Emphasizes the continuity of retail prices at a level somewhere between the regular
non-sale price and the deep-discount sale price of high/low retailers.

- Doesn’t mean lowest price

- Advantages: + Assures customers of low prices

+ Reduces advertising and operating expenses
+ Reduces stockouts and improves inventory management

- Disadvantages: + Perception of quality

+ Reduce profit margins 7
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CONSIDERATION IN SETTING RETAIL

PRICES

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CUSTOMER PRICE SENSITIVITY AND COST

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PRICE SENSITIVITY OF CUSTOMERS

(DEMAND CURVE)

Quantity Sold at If customers are very

Different Prices price sensitive, sales
decrease significantly
with price increases

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PROFIT AT DIFFERENT PRICES

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PRICE ELASTICITY
A commonly used measure of price sensitivity:
Elasticity = percent change in quantity sold
percent change in price

- Elasticity > -1: The target market for a product is generally viewed to be
price – insensitive (inelastic)

- Elasticity < -1: The target market for a product is price-sensitive (elastic)

𝑃𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 ∗ 𝐶𝑜𝑠𝑡

Profit – maximizing price = 12
𝑃𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦+1
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PRICE ELASTICITY
Price – elastic (Sensitive) Price – inelastic (Insensitive)
More substitute Almost no substitute

Airline tickets Necessities

for a vacation

Expensive products
relative to
a consumer’s income
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PRICE ELASTICITY

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PRICE ELASTICITY (EXAMPLE)

A retailer originally priced a private-label DVD player at $90 and then raised the
price to $100. Before raising the price, the retailer was selling 1,500 units a week.
When the price increased, sales dropped to 1,100 units per week. What is the price
elasticity? What target customer should the retailer focus on? What is the price
that maximizes the profit of the retailer knowing the cost of a private – label DVD
is $50?
(1,100 − 1,500)/1,500
= −2.67
(100 − 90)/100

 Price – sensitive

−2.67 ∗50 15
Profit – maximizing price = = $79.94
−2.67+1
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COMPETITION
- Retailers need to consider competitors’ prices when setting their own.
- The chosen pricing policy must be consistent with the retailer’s overall strategy and its
relative market position.

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COMPETITION
Customer Utility fuction:
𝑢𝑖 = 𝑣𝑖 − 𝑝𝑖 − 𝑡𝑖

Customers will buy the products from the retailers where give them higher
utility.

Competitive price data are typically collected using store personnel, but
pricing data also are available from business service providers such as
ACNielsen and IRI.

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HOW CAN RETAILERS REDUCE PRICE

COMPETITION?

• DEVELOP LINES OF PRIVATE LABEL MERCHANDISE.

• NEGOTIATE WITH NATIONAL BRANDS MANUFACTURERS FOR
EXCLUSIVE DISTRIBUTION RIGHTS.
• HAVE VENDORS MAKE UNIQUE PRODUCTS FOR THE RETAILER.

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PRICING FOR SERVICES

Challenges due to :
- The need to match supply and demand. Services are intangible and thus
cannot be inventoried + mostly have limited capacity.

-> To maximize sales and profits, many services retailers engage in yield
management. i.e. Using sophisticated computer programs, they monitor the
reservations and ticket sales for each flight and adjust prices according to capacity
utilization.

- The difficulties customers have in determining service quality.

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DETERMINE SERVICE QUALITY

Customers are likely to use price as an indicator of both service costs and service
quality when consumers are unfamiliar with a service or service provider or when
the risk associated with the service purchase.

Customers will less depend on price to indicate the service quality:

• When service cues to quality are readily accessible
• When brand names provide evidence of a company’s reputation
• When the level of advertising communicates the company’s belief in the brand

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SETTING RETAIL PRICES

How Do Retailers Set Retail Prices?
Theoretically, retailers maximize their profits by setting prices on the basis of
the price sensitivity of customers and the cost of merchandise.

In reality, retailers need to set price for over 50,000 SKUs many times during
year.

• Set prices based on pre-determined markup and merchandise cost

• Make adjustments to markup price based on customer price sensitivity and

competition
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RETAIL PRICES AND MARKUP (MU)

Retail Price
$405
Markup
$105
Cost of Merchandise
$300

Markup is the
𝑅𝑒𝑡𝑎𝑖𝑙 𝑃𝑟𝑖𝑐𝑒 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒
difference between MU % =
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒
the retail price and
the cost of an item 𝑅𝑒𝑡𝑎𝑖𝑙 𝑃𝑟𝑖𝑐𝑒 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒
MU % =
𝑅𝑒𝑡𝑎𝑖𝑙 𝑝𝑟𝑖𝑐𝑒
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RETAIL PRICES: BASED ON COST

𝑅𝑒𝑡𝑎𝑖𝑙 𝑃𝑟𝑖𝑐𝑒 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒

MU % = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒

Retail price = Cost of merchandise + Markup

= Cost of merchandise + MU% * Cost of merchandise

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RETAIL PRICES: BASED ON RETAIL PRICE

𝑅𝑒𝑡𝑎𝑖𝑙 𝑃𝑟𝑖𝑐𝑒 − 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒

MU % = 𝑅𝑒𝑡𝑎𝑖𝑙 𝑝𝑟𝑖𝑐𝑒

• Retail price = Cost of merchandise + Retail price * Markup %

• Retail price = Cost of merchandise

1 – Markup %
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EXAMPLE OF SETTING RETAIL PRICE

• Cost of merchandise = $300
• Markup percentage = 35%
• Retail price = ?

Based on cost: Based on selling price:

Retail price = Cost of merchandise + 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒

Retail price =
Markup 1−𝑀𝑎𝑟𝑘𝑢𝑝 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒

= 300 + 300 * 35% 300

= = 461.5$
= 405$ 1−35%
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INITIAL MARKUP & MAINTAINED MARKUP

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INITIAL MARKUP & MAINTAINED MARKUP

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INITIAL MARKUP & MAINTAINED MARKUP

The item illustrated costs $0.60. The average actual sale price for the item is
$0.90. If the reductions are $0.10, so the maintained markup is $0.30. What is
the initial markup and price?

0.3 0.1
∗100% + ∗100%
0.9 0.9
Initial markup percentage = 0.1 = 40%
100%+ ∗100%
0.9

0.6
Initial price = = $1 28
1−0.4
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Profit Impact of Setting a Retail Price:

The Use of Break-Even Analysis
A retailer might want to know
 Break-even sales to generate a target profit.
 Break-even volume and dollars to justify introducing a new product,
product line, or department.
 Break-even sales change needed to cover a price change.
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Profit Impact of Setting a Retail Price:

The Use of Break-Even Analysis
• Break-even analysis:
• Determines, on the basis of a consideration of fixed and variable costs, how
much merchandise needs to be sold to achieve a break-even (zero) profit

• Fixed costs: don’t change with the quantity of product produced and sold.

• Variable costs: vary directly with the quantity of product produced and sold
(e.g., direct labor and materials used in producing a product)
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Breakeven Analysis
Break-even point quantity is
the quantity at which total
revenue equals total cost, and
then profit occurs for
additional sales.
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Breakeven Analysis Example

PetSmart is considering an introduction of a new private-label, dry dog food targeting
owners of older dogs. The cost of developing this dog food is $700,000, including
salaries for the design team and costs of testing the product. PetSmart plans to sell the
dog food for $12 a bag. PetSmart will be purchasing the product from a privatelabel
manufacturer, thus I have to pay for a variable cost $5/bag. How many dog food bags
does PetSmart have to sell to start earn profit? How many dog food bags does PetSmart
have to sell to start earn $200,000 profit? How many units must it sell to break even
if it lowers its selling price by 16.67 percent, to $10?
700,000
𝐵𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = = 100,000 𝑏𝑎𝑔𝑠
12 − 5
700,000 + 200,000
𝐵𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 = = 128,572 𝑏𝑎𝑔𝑠
12 − 5
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Price Adjustments
Retailers adjust prices over time (markdowns) and for different customer
segments (variable pricing)

 Why do retailers take markdowns?

 How do they optimize markdown decisions?
 How do they reduce the amount of markdowns by working with
vendors?
 How do they liquidate markdown merchandise?
 What are the mechanics of taking markdowns?
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Reasons for Taking Markdowns

 Clearance Markdowns to get rid of slow-moving,
obsolete merchandise

 Promotional Markdowns
 To increase sales and promote merchandise
 To increase traffic flow and sale of
complementary products generate
excitement through a sale

=> To generate cash to buy additional merchandise

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Optimizing Markdown Decisions

Traditional Approach- Use a set of arbitrary rules

 Sell-Through: Identifies markdown items when its weekly sell-
through percentages fall below a certain level.
 Rule-based: Cuts prices on the basis of how long the merchandise
has been in the store.

Optimization software is used to determine when and how much

markdowns should be taken to produce the best results by continually
updating pricing forecasts on the basis of actual sales and factoring in
differences in price sensitivities
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Liquidating Markdown Merchandise

 Sell the merchandise to another retailer

 Consolidate the unsold merchandise
 Place merchandise on Internet auction site
 Donate merchandise to charity
 Carry the merchandise over to the next season

PhotoLink/Getty Images
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Pricing techniques for increasing sales and profits

Variable Pricing and
Price Discrimination
Retailers use a variety of techniques to maximize profits by charging different
prices to different customers

Individualized Variable Pricing (First Degree of Price Discrimination)

 Set unique price for each customer equal to customer’s willingness to pay
 Auctions, Personalized Internet Prices
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Pricing techniques for increasing sales and profits

Variable Pricing and
Price Discrimination

Self-Selected Variable Pricing (Second Degree of Price Discrimination) – Offer the

same price schedule to all customers
 Quantity Discounts
 Early Bird Special
 Over Weekend Travel Discount
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Pricing techniques for increasing sales and profits

Variable Pricing and Price Discrimination

 Clearance markdowns for fashion merchandise

 Coupons
 Price bundling
 McDonald’s Value Meal
 Multiple-unit pricing or quantity discount
 Variable pricing by market segments (Third degree of price discrimination) – Charge
different groups different prices
 Seniors discounts
 Kids menu
 Zone Pricing (Third Degree of Price Discrimination) – Charge different prices in
different stores, markets, regions
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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

 Customization
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Pricing Techniques for Increasing Sales

 Leader Pricing
 Price Lining
 Odd Pricing
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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
 Might attract cherry pickers
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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”
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Odd Pricing
 A price that ends in an odd number (.9) . i.e. $2.99

- Reduce losses due to employee theft

- Keep track of how many times an item had been marked down. i.e. $17.99,
$15.98, etc.

- Assumption that:
 Consumers perceive as $2 without noticing the digits
 9 endings signal low prices
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Internet and Price Competition

 The Internet offers unlimited shopping experience.

 Seeking lowest price? Use shopping bots or search engines.

 These programs search for and provide lists of sites selling what
interests the consumer.

 Retailers using the electronic channel can reduce customer emphasis on

price by providing services and better information.
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Legal and Ethical Pricing Issues

 Price Discrimination
 Predatory Pricing
 Resale Price Maintenance
 Horizontal Keywords Price fixing
 Bait Keywords and Switch tactics
 Scanned vs. Posted Prices

PhotoDisc/Getty Images
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