Pricing Strategies for Profits - Part 1
Retail pricing is the foundation for every business that sells its products to customers, whether from a brick-and-mortar facility or online. Your customers come to you with a number of factors they care about before they make a purchase decision. However, what they are willing to pay for an item or service will definitely be close to the top of their list.
When you set prices for the products you offer, you can take one of several approaches, depending on your overall business goals for the short- and long-term. The traditional approach includes setting the retail price for any given item or service includes the cost you pay for that item (by wholesale purchase or making it from components) and any markups you add so you make a profit from selling that item.
Here’s a basic formula for this pricing approach:
Retail Price = [(Item’s cost) / (100-markup percentage)] x 100
In words, if an item costs you $0.50 to acquire/manufacture, and you want a 50% profit, your retail price would be:
[(0.50) / (100-50)] x 100 = $1.00 Retail Price
What are your retail pricing objectives?
It’s obvious that every merchant wants to make the most of profits and keep profit margins as high as possible in a competitive market.
Unfortunately, the retail market is notoriously unstable and your business objectives may shift over time as local, regional or even national events affect your business (like a pandemic…). Depending on your particular type of retail or the time of year, your biggest goal could be simply staying afloat for the slow months until you attract more customers during the prime months.
As you decide your retail pricing objectives, consider these important factors that affect your business beyond just profit margins and markups.
What is your overall business mission?
What do you plan to do to expand as a retailer?
Who are your target customers?
Your answers to these questions give you starting sense of what matters for your business in the short and long term. For example, a retailer hoping to leverage large short-term profit margins to underwrite new stores longer term must adopt quite a different pricing strategy than a luxury retailer wanting to keep its pricey products desired by consumers.
Factors affecting your retail pricing
While retail pricing is undeniably complex, you can start by categorizing the factors affecting your pricing as internal or external.
Internal factors are generally elements of your business that you control, such as your manufacturing/acquisition costs and processes, or what funds you have available to invest in seasonal promotions and marketing campaigns. Internal factors give you an important view of your baseline or roughly what you need to earn from sales to keep your business in the black.
External factors, as you might expect, are almost always out of your control. These factors include your competitors’ location(s) and pricing as well as your target customers’ overall purchasing power. Look at the “big picture” trends in the world such as the national, regional and global economy. These will impact customer purchasing behaviors as we are witnessing currently.
Common pricing strategies 1 through 6
Each of these pricing strategies means there will be a different outcome for short and long term profits including different business strategies and objectives.
1. Manufacturer Suggested Retail Price (MSRP)
This type of pricing is most familiar for retailers and customers. Manufacturer Suggested Retail Price (MSRP) standardizes prices for the same product sold in numerous locations. You will often see this used for mass-produced items like vehicles, consumer electronics and small household appliances.
MSRP is also called cost-based pricing and includes the cost of manufacturing, a profit margin for the manufacturer and the retailer. Typically the item’s manufacturer sells their products to the retailer at roughly half the MSRP, allowing the retailer to realize a profit from the sale to the customer.
Pros: This approach takes any calculations out of setting the item’s price, saving time and energy.
Cons: Working from the MSRP on certain products could erode your competitive edge on those products. If you offer the same item at the same price as your competitors, you eliminate a major way to differentiate yourself.
2. Keystone pricing
Keystone pricing means doubling the wholesale or production cost of an item to determine its retail price. This practice is derived from the MSRP method.
Pros: As we mentioned with the MSRP, the Keystone approach saves time and energy for its retailers, as few calculations are needed to determine the product’s retail price.
Cons: Although Keystone pricing works well for some products, it does not work for all items. For higher-value items, you may be setting your price too low, and therefore you won’t achieve the profit margins you could potentially on that item. For lower-value items, Keystone pricing may be too high for customers to purchase, hurting sales. Be especially careful of this if you have a competitor nearby selling the same item at a lower price.
3. Bundle pricing
Bundle pricing is the scenario where you sell a group of products for a single unit price—such as a five-pack of underwear or a six-pack of athletic socks or five-pack underwear. Bundle pricing is also called multiple pricing,
Pros: Bundle pricing can lead to larger purchases of certain products or product groups. For example, if you have older or stale inventory to sell, this could be a smart way to move the items quickly. Merchants prefer bundle pricing to streamline their marketing promotions, promoting a single price point rather than several. Customers perceive that bundle deals give them more quantity for a good price.
Cons: Once you set a precedent of selling items in a bundle package at a low cost, it can be more difficult to again sell them individually at their previous price.
4. Discount pricing
As you might guess, discount pricing is selling items at a discount, whether with sales codes or coupons mailed or emailed directly to the customer or with store discounts or markdowns. While discounting can eat into your calculated profit margin, selling items occasionally at a sale price can help drive customers into your store/sight and gaining awareness from new target groups of customers who are searching for a deal.
Pros: Use discount pricing to get rid of slow-moving, clearance or out-of-season products quickly.
Cons: If you offer too many discounts too often, it lowers your value in your customers’ perception, making them less willing to ever pay full price again for your products or services.
5. Penetration pricing
Penetration pricing is often employed by newer brands that are being introduced to the market. This practice is initially keeping the new product prices low to attract a wide group of customers to purchase the brand and its variety of associated products.
Pros: Offering lower prices on a newer but comparable brand than the established competition helps marketers and companies appeal positively with shoppers and building a loyal customer base early in the product’s lifecycle.
Cons: Switching from the initial introductory low prices to more stable regular pricing too abruptly or too soon after introduction can boomerang and make your new customers unhappy.
6. Loss-leader pricing
Loss-leader pricing attracts customers by offering a discount on one much-wanted high-demand product, then encouraging them to purchase other products once they’re in your store or site.
Merchants use loss-leader pricing to mitigate their potential profit loss on the high-demand product by selling other products (at a higher profit) the customer purchased by impulse once they were in the store/site.
Pros: Loss-leader pricing provides increases the average transaction value (ATV), or the amount a customer spends during a single visit.
Cons: It’s important with loss-leader pricing to carefully monitor customer service and customer care. Your customers should not feel forced to purchase items they don’t want or come in to buy. At the same time, you don’t want to jeopardize sales by only selling the high-demand discounted product.
Questions or comments? Want to add to the conversation? Contact Mike Krause at (305) 723-1234, mike@SalesSensePayments or please visit SalesSensePayments.com.
Stay tuned for Part 2 on retail pricing strategies.
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