Pricing Objectives

What you’ll learn to do: Explain how retailers determine pricing objectives

We will examine the connection between retail pricing strategies and retailer’s business models/objectives in this section. In addition to thinking like retailers, we will take a step back to examine some general economic principles that retail businesses must understand and contend with.

External Factors and Retail Pricing

There are three major external factors that impact retail pricing. They are

• Competition
• Channel
• Geography

Competition is what comes to mind first when considering how to run almost any business. For retailers, they will do extensive research to understand who is their competition and how they operate in a given market. They will physically “shop” the competition to obtain information about assortments of merchandise, the depth of the assortments, pricing of items carried (especially those that are in common), in-store promotion and presentation, online activities, and how the competition may change over time. Retailers will also speak to vendors in common to glean tidbits of what competitors may be planning to do in the future.

Channel refers to the various means that customers use to shop for merchandise. The most common are retail stores, catalogs, online, direct sales, and home shopping television networks. Today, many retailers have adopted multi-channel strategies to protect and grow their share of market. This adds several layers of complexity to pricing policies. Although somewhat of a new term, multi-channel retailing has been in place for over a century. Sears started doing business as a catalog only, then added retail stores and finally joined in the online shopping channel. There are many examples of retailers starting in one channel and pushing out into others.

Geography refers to specific market locations. It can defined as broadly or narrowly as appropriate for the retailer’s target. Examples of retail geographies would be: the Los Angeles area, the Midwest, Mexico, online, South America, Mid-town Manhattan, the EU, etc. As you can see from these examples, geographies can be city blocks, cities, states, countries, continents, and world-wide on the Internet. Retailers are interested in geographies, primarily looking for commonalities in factors such as buying preferences, price elasticity, government regulation, and overall economic condition.

There are other considerations as well, but most retailers will develop pricing strategies specifically for competition, channels and geographies in order to be competitive in all areas.

Pricing Strategies

Our discussion of retail pricing strategies has so far covered some important high-level concepts. We started with the basic principles of value and markup. We then explored some common methods of pricing a retailer can employ: keystone, premium, discount, psychological, bundle, and tiered. That was followed with a discussion of how pricing is part of the overall retail mix and the 6 P’s. Finally, we touched on some external factors that affect retail pricing: competition, channel and geography. Clearly being a retailer is not for the faint of heart!

Given all of these considerations, the one most important factor underlying a retailers’ pricing strategy is the high-level business objective being supported.

A common business objective for a retailer would be to grow revenue. To accomplish this objective, a retail business would create a comprehensive strategy across all dimensions of the company. Such an overarching strategy would include a review of current competition strength and weakness, current channel performance, sales results by geography, product mix performance, promotion history, review of results of current pricing methods, and much more. As the retail business looks for improvement across all of the various areas, the pricing strategy would play a large role in attaining a goal of increasing revenue.

Certainly to grow revenue you would expect that the retailer would become more aggressive in their overall pricing, perhaps through promotion or establishing everyday value, bundled or tiered pricing on important categories (Key Value Categories or KVCs) and items (Key Value Items or KVIs) in the assortment. We will talk about KVCs and KVIs later in this module.

Pricing strategy would be an important component to support the retail business objective of increasing profit. As the retailer develops their overall strategy to achieve this goal, you can imagine that the pricing strategy would focus on raising margins through premium pricing and less aggressive promotion. This is not as simple as this brief discussion would imply–a retailer cannot simply raise prices across the board arbitrarily and expect good results. Product assortments would have to be modified by adding more high-value or exclusive merchandise. Assortments of the high-value categories would have to be deepened so that the retailer could feel confident that their assortment dominance earns the right to higher markups.

Another common retail business objective would be penetration into a new market area. There are several possible pricing strategies that could be employed to support this business objective. For one, a retailer could distribute their existing product assortment into the new market and promote it heavily- taking a temporary hit on margins in order to establish their business in the new geography. Another pricing strategy that has been used in this situation is the adding of “loss leaders” temporarily to the product mix and pricing them at discount levels. In this scenario it would not be uncommon to expect vendors to assist the retailer with special buys on select products in order for both retailer and vendor to expand their presence in a new geography.

These are just a few examples of how various retail pricing strategies could support overall retail business objectives. Given all of the principles, methods, and factors of retail pricing we have discussed so far, the bottom line is there must be congruence between pricing strategy and the needs of the business for the retailer to succeed.

Price Elasticity

Elasticity is a classic economic principle that helps us understand how much a change in price will affect market behaviors. If we make a change in price, how will that impact the demand for the product? Price elasticity is the measure of the market’s response to price changes.

Elasticity is important to pricing decisions because it helps us understand whether raising prices or lowering prices will enable us to achieve our business objectives. How much will a lower price increase sales? Will a price increase cause us to lose many customers or just a few? Price elasticity is another factor to consider in order to select the most effective pricing strategy.

Elasticity in price denotes a large impact on demand due to changes in price. Raising the price causes decreased demand, while lowering the price stimulates increased demand. Inelasticity refers to the situation where there is insensitivity to price–demand will not increase or decrease despite changes in price.

Case study from a mass-merchant retailer illustrating price elasticity

In the 1980’s there was a certain men’s denim jean manufacturer who had the dominant brand in the market. Their brand was so popular that they could not physically produce enough product to satisfy all of their retail customers. In order to be fair to all of their customers, the company devised an “allocation” system that gave all retailers the same percentage of their desired orders. For example, if a retailer wanted to buy 100,000 pairs of denim jeans for the season, and the allocation was 80%, the retail customer could expect to receive 80,000 pairs.

On the retail side, an annual event called “Back to School” was the most popular time to sell denim jeans. All of the major retailers targeted the middle of August to advertise their big sale of the popular jean brand. These were days well before “big data” analytics, but the mass merchant in question had been running this promotion at the same time for many years and so knew exactly how many pairs of the denim jean product it would sell by month, week and day given the price.

The retailer in this case study knew that it would sell 50,000 pairs a week at a sale price of $24.99, 75,000 pairs at $22.99, and 120,000 pairs at $19.99 sale prices. So it become a matter of the supply (how much did the retailer have in stock) versus the projected sales at the various sale price options. If the mass-merchant could procure 85,000 units of the denim jean product, then they had to set their big sale price no lower than $22.99 or risk selling out.

This is a classic example of price elasticity. You have the situation of limited supply and highly sensitive market reaction to the price of the goods in question.