MKTG 1058: DISTRIBUTION

CHANNELS

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Distribution Channels MKTG 1058LECTURE EIGHT

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Merchandise Pricing(Dunne Chapter Ten)

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Learning Objectives1. Discuss the factors a retailer should

consider when establishing pricing objectives and policies.

2. Describe the differences between the various pricing strategies available to the retailer.

3. Describe how retailers calculate the various markups

4. Discuss why markdown management is so important in retailing and describe some of the errors that cause markdowns.

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Pricing Objectives & Policies

Interactive Pricing DecisionsLegal ConstraintsPricing ObjectivesPricing Policies

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Why is Pricing Important?Pricing decisions is important because

customers have alternatives to choose from and are better informed

Customers are in a position to seek good value

Value = perceived benefitsprice

So, retailers can increase value and stimulate sales by increasing benefits or reducing price

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Pricing in the marketing/retailing mixPrice is the only variable that generates revenues; all other aspects of the retail marketing mix generate costs

The key issue to examine is the extent to which the retailer has control over pricing being the final link in the distribution channel

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Some quotes about pricing…

Source: Kotler, Armstrong and da Silva

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Pricing problems faced by retailers How to manage price Specifically markups and markdowns Often incorrect and/ outdated Pricing decisions should be linked to strategic

operations of the retailer But in reality many pricing decisions are ad

hoc or reactively (to price competition) Too many retailers believe the only to

attract customers is to run a sale

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How does a retailer know when, how long and how frequently sales should be run?What is the purpose of the sale? What is the customer responses to such sales?

How price sensitive are our customers and what is the impact of “Sales?”

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Recent pricing strategy used by Courts

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Considerations in Setting Retail Prices

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Three Approaches to Setting Prices

Source: Kotler, Armstrong and da Silva

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Interaction: A Retailer’s Pricing Objectives & Other Decisions

Exhibit 10.1

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1. Merchandise attributes, which depends on the market the retailer is serving.

2. Location, specifically the store's distance from competitors and customers.

3. Promotion, which is crucial in generating demand, is not independent of price.

4. Credit and/or Check Cashing availability can also generate demand and affect pricing levels.

Key factors considered by the Retailer when setting Prices

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5. Customer Service levels affect expenses, which in turn affect price.

6. Store Image is affected by the way a retailer chooses to price its products.

7. Legal Constraints, both state and federal, must be considered when determining prices.

Key factors considered by the Retailer when setting Prices

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Pricing objectives and policies Pricing Objectives - A retailer's pricing

objectives should be in agreement with its mission statement and merchandising policies. These include:Profit oriented objectivesSales oriented objectivesStatus quo objectives

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Pricing Objectives & Policies EDLP (everyday low prices):

Is when a retailer charges the same low price every day throughout the year and seldom runs the product on sale.

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Profit oriented pricing objectives Target return objective:

Is a pricing objective that states a specific level of profit, such as percentage of sales or return on capital invested, as an objective.

Profit maximization:Is a pricing objective that seeks to obtain as much profit as possible.

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Profit oriented pricing objectives Skimming:

Is a pricing objective in which price is initially set high on merchandise to skim the cream of demand before selling at more competitive prices

Penetration:Is a pricing objective in which price is set at a low level in order to penetrate the market and establish a loyal customer base.

8-20Source: Kotler, Armstrong and da Silva

The concept of Skimming versus Penetration Pricing

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Other types of pricing objectives Sales-Oriented Objectives - Seek some level

of unit sales, dollar sales, or market share. The achievement of such objectives does not necessarily guarantee that profits will also increase.

Status Quo Objectives - Seek to maintain the retailer's current market share position or level of profits or to compete on grounds other than price.

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Examples of Pricing Objectives (Berman & Evans)

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Pricing policies Pricing Policies - Pricing policies are

rules of action that ensure uniformity of pricing decisions within a retail operation. A retailer's pricing policies should reflect the expectations of its target market

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Pricing Policies

Pricingbelow the

market

Pricing atmarket levels

Pricing abovethe market

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Pricing policies Pricing Below the Market – Retailers with such a

policy rely on a high volume, generated by low prices, to produce satisfactory profits.

Pricing at Market Levels - Most merchants want to be competitive with one another. Competitive pricing is based on:

a. Pricing zones, a range of prices for a certain merchandise line that appeals to customers in a particular demographic group.

b. The size of a retail store affects its ability to compete on a price basis.

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3. Pricing Above the Market - Certain market sectors are receptive to high prices because non-price factors are more important to them than price.

Merchandise Offerings - Some consumers are willing to pay higher prices for specialty items, an exclusive line, or unusual merchandise.

Services Provided - Service-oriented merchants may be able to develop a loyal group of customers by providing anything from wardrobe counseling to delivery.

Convenient Locations - The convenient location of some retailers allows them to charge higher prices since consumers’ value time.

Extended Hours of Operation - By remaining open while competitors are closed, some merchants are able to charge above-average prices

Note: this is how retailers are able to compete on a non-price basis through differentiation

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Price and Non-Price Competition

Source: Kotler, Armstrong and da Silva

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Interactive Pricing Decisions LV has set its prices to be consistent

with its store image and design and promotion, which all communicate prestige and exclusivity.

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Interactive Pricing Decisions Factory outlets are known for their low

prices. However, the typical consumer will incur high travel costs to reach these outlets.

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Interactive Pricing DecisionsWhen retailers offer free delivery, the

cost of providing this service must be factored into the prices the retailer charges.

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Specific Pricing Strategies Customary

Pricing Variable Pricing Flexible PricingOne-Price Policy Price LiningOdd Pricing

Multiple-Unit Pricing

Bundle Pricing Leader Pricing Bait-and-Switch

Pricing Private Label

Brand Pricing

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Specific Pricing Strategies Customary pricing:

Is a policy in which the retailer sets prices for goods and services and seeks to maintain those prices over an extended period of time.

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Specific Pricing Strategies Variable pricing:

Is a policy that recognizes that differences in demand and cost necessitate that the retailer change prices in a fairly predictable manner.

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Specific Pricing Strategies Flexible pricing:

Is a policy that encourages offering the same products and quantities to different customers at different prices.

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Specific Pricing StrategiesOne-price policy:

Is a policy that establishes that the retailer will charge all customers the same price for an item.

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Specific Pricing Strategies Price lining:

Is a pricing policy that is established to help customers make merchandise comparisons and involves establishing a specified number of price points for each merchandise classification.

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Specific Pricing Strategies Trading up:

Occurs when a retailer uses price lining and a salesperson moves a customer from a lower-priced line to a higher one.

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Specific Pricing Strategies Trading down:

Occurs when a retailer uses price lining, and a customer initially exposed to higher-priced lines expresses the desire to purchase a lower-priced line.

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Specific Pricing StrategiesOdd pricing:

Is the practice of setting retail prices that end in the digits 5, 8, 9 – such as $29.95, $49.98, or $9.99.

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Specific Pricing StrategiesMultiple-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.

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Specific Pricing Strategies Bundling:

Occurs when distinct multiple items, generally from different merchandise lines, are offered at a special price.

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Specific Pricing Strategies Leader pricing:

Is when a high-demand item is priced low and is heavily advertised in order to attract customers into the store.

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Specific Pricing Strategies Loss leader:

Is an extreme form of leader pricing where an item is sold below a retailer’s cost.

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Specific Pricing StrategiesHigh-low pricing:

Involves the use of high everyday prices and low leader “specials” on items typically featured in weekly ads.

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ELDP• EDLP (everyday

low prices)is when a retailer charges the same low price everyday throughout the year and seldom runs the product on sale.

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ELDP and Hi-Lo Pricing Strategies Compared:

EDLP Builds loyalty –

guarantees low prices to customers

Lower advertising costs

Better supply chain management Fewer stock-outs Higher inventory turns

Hi-Lo Higher profits – price

discrimination More excitement Build short-term sales

and generates traffic

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Specific Pricing Strategies (cont’d)• Bait-and-Switch Pricing is a practice where a

low-priced model of a shopping good, such as an automobile or refrigerator, is used to lure shoppers into a store and then the salesperson attempts to persuade them to purchase a higher-priced model.

• Private Label Brand Pricing occurs when a retailer can purchase an item at a cheaper price, have a higher markup percentage, and still be priced lower than a comparable national brand.

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Determining Mark-Ups/ Markdowns

Note: this is a fairly technical part of the chapter. You will need practice of the

questions to understand this topic well.

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Using MarkupsCalculating MarkupMarkup MethodsUsing Markup Formulas When Purchasing Merchandise

Initial Versus Maintained MarkupPlanning Initial Markups

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Calculating Markups• Markup is the selling price of the

merchandise less its cost, which is equivalent to gross margin.

• To calculate the selling price (or retail price), the retailer should begin with the following basic markup equation:

SP = C + Mwhere C is the dollar cost of merchandise per unit, M is the dollar markup per unit and SP is the selling price per unit.

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Markup Conversion Table

Exhibit 10.2

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Relationship of Markups Expressed on Selling Price and Cost

Exhibit 10.3

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Basic Markup FormulasExhibit 10.4

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Basic Markup Formulas

• The equation for expressing markup as a percentage of selling price is:Percentage of Markup on Selling Price =

(SP – C)/SP = M/SP• When expressing markup as a percentage of

cost the equation is:Percentage of Markup on Cost =

(SP – C)/C = M/C

Exhibit 10.4

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• The equation to find markup on selling when we know markup on cost is:Percentage of Markup on Selling Price = Percentage of Markup on Cost/ (100% + Percentage of Markup on Cost)

• When we know markup on selling price we can easily find markup on cost:Percentage of Markup on Cost = Percentage of Markup on Selling Price/ (100% -Percentage of Markup on Selling Price)

Basic Markup Formulas Exhibit 10.4

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Basic Markup Formulas

• Finding the Selling Price when Cost and Percentage of Markup on Cost are known:

Selling Price =Cost + % Markup on Cost (Cost)

• Finding Selling Price when Cost and Percentage Markup on Selling Price is known:

Selling Price = Cost/(1 - % Markup on Selling Price)

Exhibit 10.4

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Using Markup Formulas when Purchasing Merchandise

• If you know that a particular item could be sold for $8 per unit and that you need a 40% markup on selling price to meet your profit objective, how much would you be willing to pay for the item?% of Markup on selling price =

(SP – C)/SP40% = ($8 –C)/$8

C= $4.80

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Using Markup Formulas when Purchasing Merchandise• If a retailer purchases an item for $12 and wants a

40% markup on selling price, how would a retailer determine the selling price?(SP = C + M), we know that SP = C + .40P since markup is 40% of selling price. If markup is 40% of selling price, cost must be 60% since cost and markup rate complement each other and must total 100%. Thus, if

60% SP = $12 (divide both sides by 60%) thenSP = $20

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Initial versus Maintained Markups It is not always possible for retailers to sell

all their merchandise at the price initially set by the retailer.1. Initial Markup - The markup placed on the merchandise when the store received it. Initial markup = (Original selling price -Cost)/Original selling price.2. Maintained markup = (Actual retail price - Cost)/Actual retail price. Maintained markup, or achieved markup, is usually lowerthan the initial markup by the amount of reductions realized.

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Initial Versus Maintained Markup•Maintained markup differs from initial

markup by the amount of reductions:Initial markup = (Original retail price –Cost)/Original retail price

Maintained markup = (Actual retail price – Cost)/Actual retail price

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Differences Between Initial and Maintained Markups

•The need to balance demand with supply.

•Stock shortages•Employee and customer discounts•Cost of alterations•Cash discounts

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Initial versus Maintained MarkupA retailer wants a profit for the period of $10,000. Expected sales are to be $200,000; operating costs are $30,000 and reductions are $4,000. Therefore, the retailer’s initial markup must be 21.6% [IM% = (Profit + Operating Expenses + Reductions) / (Sale + Reductions)]

A retailer wants a profit for the period of $10,000. Expected sales are to be $200,000; operating costs are $30,000 and reductions are $4,000. Therefore, the retailer’s initial markup must be 21.6% [IM% = (Profit + Operating Expenses + Reductions) / (Sale + Reductions)]

Cost of Goods Sold $160,000

Operating Expenses $30,000 Profit $10,000 Reduction $4,000

Original Retail Selling Price $204,000

78.4% Initial Cost %

21.6% Initial Markup %

21.6%= (204,000-160,000) / 204,000

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Initial versus Maintained MarkupAfter taking the $4,000 in reductions, the retailer had a maintained markup % of 20%. [MM% = IM% - ((Reduction %) x (100% - IM%))] [21.6% - (.2% x 78.4%)] = 20%

After taking the $4,000 in reductions, the retailer had a maintained markup % of 20%. [MM% = IM% - ((Reduction %) x (100% - IM%))] [21.6% - (.2% x 78.4%)] = 20%

Cost of Goods Sold $160,000

Operating Expenses $30,000 Profit $10,000

Reduction $4,000

Actual Retail Selling Price $200,000

80% Maintained Cost %

20% Maintained Markup %

20%= (200,000-160,000) / 200,000

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Planning Initial Markups To determine the Initial Markup, use

the following formula:Initial markup percentage = (operating expenses + Net Profit + Markdowns + Stock shortages + Employee and customer discounts + Alteration costs – Cash discounts)/(Net sales + Markdowns + Stock shortages + Employee and customer discounts)

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Planning Initial Markups To simplify the equation, remember that

markdowns. Stock shortages, and employee and customer discounts are all retail reductions from stock levels. Likewise, gross margin is the sum of operating expenses and net profit. A simpler formula:Initial markup percentage = (Gross margin +

Alteration costs – Cash discounts + Reductions)/(Net sales + Reductions)

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Planning Initial Markups Some retailers record cash discounts as

other income and not as a cost reduction in determining the initial markup, the formula can be simplified one more time:Initial markup percentage = (Gross

margin + Alteration costs + Reductions)/(Net sales + Reductions)

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Markup Determinants As goods are sold through more retail outlets,

the markup percentage decreases. The higher the handling and storage costs of

the goods, the higher the markup should be. The greater risk of a price reduction due to

the seasonality of the goods, the greater the magnitude of the markup percentage early in the season.

The higher the demand in elasticity of price for the goods, the greater the markup percentage.

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Markdown Management

Markdown is any reduction in the price of an item from its initially established price.Markdown percentage:Markdown percentage = Amount of reduction/Original selling price

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Reasons for Taking Markdowns

Get rid of slow-moving, obsolete, uncompetitive priced merchandise

Increase sales and promote merchandiseGenerate cash to buy additional

merchandise Increase traffic flow and sale of

complementary products generate excitement through a sale

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Markdown Management

Buying ErrorsPricing ErrorsMerchandising ErrorsPromotion Errors

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Merchandising errors resulting in markdowns

1. Buying errors, which include buying the wrong merchandise, quantities, sizes, styles, colors, patterns, or price ranges.2. Pricing errors occur when the price of the item is too high to move the product at the speed and quantity desired.

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Merchandising errors resulting in markdowns3. Merchandising errors include failure on the

buyer's part to: relate new merchandise to old or tie it to the store's image; inform the sales staff on how the new merchandise meets the store's target market needs; excite the sales force about new merchandise; or improper handling of merchandise by the sales staff

4. Promotion errors occur when the consumer has not been properly informed or prompted to purchase the merchandise.

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Markdown policies Markdown Policy - Retailers will find it advantageous

to develop a markdown timing policy to guide two crucial decisions: when and how much of a markdown to take. In theory, there are two extremes to a markdown timing policy:

1. Early markdown policy is used to speed the movement of merchandise and enable the retailer to take less of a markdown per unit.

2. Late markdown policy is used to avoid disrupting the sale of regular merchandise by too frequently marking goods down.

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Markdown policy Amount of markdown: Another issue to

be considered is the amount of the markdown, which is tied to the timing.

a. Early markdowns should be smaller - just enough to stimulate sales.

b. Late markdowns should be larger to move the remaining merchandise

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Markdown policyOne rule of thumb for markdowns is

that "prices should be marked down at least 25% in order for the consumer to notice." However, the markdown percentage should vary with the type of good, time of season, and competition.

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Markdown PolicyAdvantages of Early Markdown Policy: Secure a more rapid or higher rate of inventory

turnover Speed the movement of merchandise by making

it more attractive; therefore, markdown percent will be lower

Improve cash flow position by providing money for new merchandise and outstanding buys

Provide space for merchandise

Disadvantages of Early Markdown Policy: Possible damage to store image Possible loss in customer confidence in store

(the customer could begin to think, if I wait a week, the merchandise will cost less)

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Markdown PolicyAdvantages of Late Markdown Policy: Avoids disrupting sales of regular merchandise

(bargain hunters are in store only twice a year) Gives store a longer time to secure a higher

markup Customers look forward to “BIG SALES” Customer confidence is retained

Disadvantages of Late Markdown Policy: The retailer may need the space or money that

a quicker markdown policy could provide It could make inventory turnover too low

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Maintained Markup PercentageThe following formula can also be used to determine the maintained markup percentage:Maintained markup percentage =

Initial markup percentage - [(Reduction percentage)(100% - Initial markup

percentage)]Where

Reduction percentage = Amount of reductions/Net sales

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Exercises on Merchandise Pricing

Dunne Chapter 10

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Question 8:

• Compute the markup on selling price for an item that retails for $59.95 and costs $36.20.

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Question 8: Answer:

Percentage of markup on selling price = (SP - C)/SP

= ($59.95-36.20)/$59.95

= $23.75/$59.95 = 39.6%

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Question 9:

Complete the following: Dress Shirt Sport Shirt Belt Selling Price $45.00 $49.99 $25.00 Cost $24.00 $27.35 $13.50 Markup in Dollars Markup Percentage on Cost Markup Percentage on Selling Price

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Question 9: Solution:

Dress Shirt Sport Shirt Belt Selling Price $45.00 $49.99 $25.00 Cost $24.00 $27.35 $13.50 Markup in Dollars $21.00 $22.64 $11.50 Markup Percentage on Cost 87.5% 82.8% 85.2% Markup Percentage on Selling Price 46.7% 45.3% 46.0%

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Question 10:

• A buyer tells you that he realized a markup of $60 on a set of tires. You know that his markup is 25 percent based on the retail price. What did he pay for that set of tires?

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Question 10 Solution:• First, solve for the selling price. % Markup on Selling Price = (Selling Price

– Cost) / Selling Price = 25% = 60/ Selling Price. Selling Price = $240. • Second, solve for the cost. 25% = ($240 –

Cost)/$240. Cost = $180. • The set of tires cost the buyer $180.

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Question 14:Intimate Apparel wants to produce a 9 percent operating profit this year on sales of $1,200,000. Based on past experiences the owner made the following estimates:Net Alteration Expenses $ 8,100 Employee Discount $ 15,400Markdowns $141,000 Operating Expense $375,000Stock Shortages $43,200 Cash Discounts Earned $ 4,500

Given these estimates, what average initial markupshould be asked for the upcoming year?

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Question 14 Solution:• Initial Markup Percentage = (Operating Expense

+ Profit + Markdowns + Employee Discounts Alteration Expense + Stock Shortages-Cash Discounts) / (Sales + Markdowns + Stock Shortages + Employee Discounts)

= ($375,000 + $108,000 + $141,000 + $15,400 + $8,100 + $43,200-$4,500) / ($1,200,000 + $141,000 + $43,200 + $15,400)

= $686,200/$1,399,600 = 49.03 percent

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QUESTIONS FROM THE CASE STUDY IN CHAPTER 10

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PART A: The buyer for the women’s sweater department has purchased wool sweaters for $47.69. She uses an odd

pricing policy and wants to sell them at 47 percent markup on

selling price. At what price should each sweater be sold?

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Answer to Part A:

Sales Price = Cost/(1 - % Markup) = $47.69/(1-.47) =

$89.98[Sales Price = $89.98]

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PART B: The buyer for men’s shirts has a price point of $45 and requires a markup of 40 percent. What would be the

highest price he should pay for a shirt to sell at this price point?

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Suggested Answer: % Markup = (Sales price – Cost)/ Sales

Price.40 = (45 – C)/ 45;

[Cost = $27.00]

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PART C: The Men’s Department buyer hopes to achieve net sales of

$1,500,000 for the upcoming season. Operating expenses are expected to be

$560,000 and retail reductions are $180,000. Management has set a

profit goal of $110,000. What should the initial markup percentage be?

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Suggested Answer: Initial Markup Percentage =

(Operating Expenses + Net Profit + Retail Reductions)/(Net Sales + Retail

Reductions)=

($560,000 + $180,000 + $110,000)/($1,500,000 + $180,000)

= $850,000 / $1,680,000 = 50.6%; [Initial Markup Percentage = 50.6%]

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PART D: A buyer submits the following plans to his general merchandise

managers: Planned sales = $85,000; planned initial markup = 40%; planned reductions = $31,000. Based on these

projections, what is the planned maintained markup percentage?

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Suggested Answer:

Maintained markup percentage = Initial markup percentage – [(Reduction percentage)(100% - Initial markup

percentage)]

= 0.40 – [($31,000/$85,000)(1-.40)] = 18.1%