PPT 15-1

5th Edition5th Edition

PPT 15-2

Chapter 15

PricingPricing

McGraw-Hill/IrwinLevy/Weitz: Retailing Management, 5/e Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved.

PPT 15-3

Merchandise Management

BuyingSystems

PlanningMerchandiseAssortments

BuyingMerchandise

Pricing

RetailCommunication

Mix

PPT 15-4

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 15-5

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 15-6

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 15-7

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 15-8

Pricing Strategies

EDLP

• Builds loyalty – guarantees low prices to customers

• Lower advertising costs

• Better supply chain management

– Fewer stockouts

– Higher inventory turns

Hi-Lo

• Higher profits – price discrimination

• More excitement

• Build short-term sales and generates traffic

PPT 15-9

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 15-10

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 competitor’s prices

PPT 15-11

Sample Income Statement Showing Gross Margin

Net Sales $ 120,000

- Cost of goods sold 58,000

= Maintained markup 62,000

- Alteration costs + cash discounts 3,000

= Gross margin $ 59,000

PPT 15-12

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 15-13

Maintained Markup % and Gross Margin

Maintained = Net Sales – Cost of Goods Sold Margin Net Sales

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

PPT 15-14

Setting Retail Price Based on Costs

Retail Price $1.00

Cost of Merchandise $.60

Margin $.40

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

PPT 15-15

Initial and Maintained Markup

Initial Retail Price $1.00

Cost of Merchandise $.60

Maintained Markup $.30

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

Reductions $.10

PPT 15-16

Reductions

• Markdowns (Sales)

• Discounts to employees

• Inventory shrinkage due to shoplifting and employee theft

PPT 15-17

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 15-18

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 15-19

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 15-20

Example of Setting theInitial Retail Price

Cost = $100 Planned Initial Markup = 56.85%

Retail Price = $100 + (56.85% x Retail Price)

Solve for Retail Price

.4315 x retail price = 100

Retail Price = $100/.4315 = 231.75

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

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

PPT 15-21

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 15-22

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 15-23

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 15-24

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 15-25

Demand CurveSales at Different Price Levels

Quantity Sold

Cost = $1 unit

1000

Price

$2

PPT 15-26

Methods for Estimating Sales at Different Price Levels

• Analyze Historical Sales and Prices Using Statistical Methods

• Conduct Price Experiments

• Use Judgment

PPT 15-27

A Pricing Experiment

Before After

Store 1 10 units @ $100 21 units @ $80

Gross margin = $500 Gross margin = $630

Store 2 12 units @ $100 13 units @ $100

Gross margin = $600 Gross margin = $650

PPT 15-28

Results of Pricing Test

(1) (2) (3) (4) (5)Total Cost of

Market Units Sold TotalDemand Total ($300,000 fixed Profits

Unit at Price Revenue cost + $5 variable (col 3 xMarket Price (in units) (col 1 x col 2) cost) col 4)

1 $8 200,000 $1,600,000 $1,300,000 $300,000

2 10 150,000 1,500,000 1,050,000 450,000

3 12 100,000 1,200,000 800,000 400,000

4 14 50,000 700,000 550,000 150,000

PPT 15-29

Factors That Affect Customer’s Sensitivity to Price

Customer Income (-)

Need for the Product (-)

Availability of Product from Competitors (+)

Frequency and Amount Spent on Product (+)

PPT 15-30

Considering Competitor Pricing

PPT 15-31

Breakeven Analysis

Understanding the Implication of Fixed and Variable Cost

BEP quantity

Fixed cost =

Unit price - Unit variable cost

Calculating Breakeven Quantity

Unit Sales

Fixed Costs

Contribution/UnitBreakeven point

PPT 15-32

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 15-33

Cargo Pants Illustration of Breakeven Analysis

Breakeven Quantity = Fixed Cost

Unit Price – Variable Cost

40,040 units = $400,000

$24.99 - $15.00

PPT 15-34

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 15-35

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 15-36

Percent Sales Increase Needed to Breakeven on a Price Decrease

The Gap has bought 60,000 women’s 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 15-37

The Gap Considers a Price Cut of 16.67%

Breakeven % = 100 x (-%price change) Sales Change % initial margin -% price change

39.78% = 100 x – (-16.67) (7/12) + (-16.6)

PPT 15-38

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 15-39

Retailer’s Income Statement

Net Sales $1,000,000

COGS 800,000 80%

Gross Margin 200,000 20%

Operating Expenses

Variable 100,000 10%

Fixed 80,000 8%

Profit 20,000 2%

PPT 15-40

Retailer’s Variable and Fixed Operating Expenses

Variable Fixed

Wages & Salaries

Manager 20,000 20,000

Sales 60,000

Clerical 20,000 10,000

Rent 20,000

Maintenance 10,000

Total 100,000 80,000

PPT 15-41

Retailer’s Assets

Current Assets

Inventory $300,000

Accounts Receivable 75,000

Cash 25,000

Fixed Assets 100,000

Total $500,000

PPT 15-42

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 15-43

What Is the Breakeven Sales To Move To New Location?

• Rent Increases to $50,000

Break-even Sales = FC/(GM%-VC%)

PPT 15-44

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

• Reduce Prices By 5%

Break-even Sales = FC/(GM%-VC%)

PPT 15-45

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 15-46

Price Adjustments

• Markdowns

• Coupons

• Rebates

• Price Bundling

• Multiple-Unit Pricing

• Variable Pricing

PPT 15-47

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 15-48

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 15-49

Maximize Profits through Price Discrimination

• Want Charge Every Customer the Maximum They Are Willing to Pay

• Problem

– Don’t know willingness to pay

– With list prices, can’t prevent high willingness to pay customers from buying at low price

PPT 15-50

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 15-51

Types of Price Discrimination

• First Degree – Set unique price for each customer equal to customer’s 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 15-52

How To Reduce Markdowns

• Use Markdown Optimization Models

• Improve Sales Forecasts and Merchandise Budget Plan

• Work with Vendors to Plan Deliveries

PPT 15-53

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 15-54

Clearance Center Liquidates Markdowns

PPT 15-55

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 15-56

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 don’t redeem.

– They can offer price cuts to customers directly.

PPT 15-57

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 15-58

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 15-59

Pricing and the Internet

• Auction pricing more feasible –

easier to form a market of buyers

and sellers (eBay)

• Priceline.com

PPT 15-60

Using Price to Stimulate Sales

• Leader Pricing

• Price Lining

• Odd Pricing

PPT 15-61

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 15-62

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 15-63

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 doesn’t.

• Does delineate:

– Type of store (downscale store might use it.)

– Sale

PPT 15-64

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 15-65

Vertical Price Fixing

Vertical Price Fixing -- Agreements to fix prices between parties at different levels of the same marketing channel.

• Vendors can’t 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 15-66

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 15-67

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 15-68

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 15-69

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 15-70

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 15-71

Bait and Switch (cont.)

• Retailers should:

– Have sufficient quantities

– Give a “rain check”

– Don’t disparage merchandise