Retail Book Chap15

CHAPTER 15 PRICING ONLINE LEARNING CENTER

Pricing The pricing module contains four sections that complement this chapter. 1.

Markup Percentage Calculate markup as a percentage of retail, given retail and cost; or calculate retail, given markup as a percentage of retail and cost. Use with Discussion Questions 7 & 8.

2.

Maintain Markup and Initial Markup Calculate initial markup, given maintain markup, planned reductions, and planned sales. Use with Discussion Questions 5 & 6.

3.

Breakeven Analysis Calculate breakeven units and dollars, given fixed cost, unit variable cost, and the unit selling price. Use with Discussion Question 9.

4.

Markdown Simulation (Max Margin’s Markdown Challenge) The Max Margin’s Markdown Challenge was developed by Oracle. This section of the Online Learning Center sets up the scenario that the student has been hired as a markdown manager in a department store. The student receives detailed instructions, along with tips to keep in mind. The section explains that the student’s responsibility is to markdown 5 items in one store over a 15-week selling period. The challenge is that the student will be competing against the superstar buyer, Max Margin, which is really the Oracle markdown simulation. Students learn what it might be like to be a buyer facing weekly markdown decisions. Although the simulation is accessed through the Online Learning Center, the simulation is housed on Oracle’s server. As a result, each game has different products. Thus, students can improve their scores, and therefore their skill level by playing the game multiple times. We have found that it is good to provide students with an additional incentive to prepare for this class assignment. If not, we find that some don’t really receive much benefit. We suggest that instructors give some extra credit points to the team that gets the highest score (i.e., percentage gross margin they achieved divided by percentage by Max Margin.) This exercise, when used in the classroom, is best done in groups because of the group learning that takes place. Groups of two to three seems to work best. Have each group bring their computer to class. The room must be Internet accessible.

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The game has two modes of operation. In the “regular mode,” students have five minutes to make the first decision, and one minute to make each subsequent decision. We find one minute is not enough time to enable the students to make an informed choice. Using the “classroom” mode, the students can have as much time as they need or as the instructor wishes them to take. We find that two minutes for subsequent decisions is sufficient. Students will play two rounds. In the first round, they play against Max Margin. In the second round, they have a chance to see how they could have improved their score. Plan on taking about an hour for this exercise in class. The following instructions were prepared by Professor Jennifer Ashman at University of Michigan. It is very useful to provide these instructions prior to the class.

Max Margin’s Markdown Challenge The purpose of this game is to introduce you to the benefits of using a power tool to make markdown decisions. The power tool employs merchandise markdown analysis and optimization to generate higher gross margin, better sell-thru, and a bigger bonus from your markdown decisions. You will have two rounds to beat buyer superstar Max Margin. Round 1: You will be presented with 5 items, for which you will make markdown decisions over a 15-week selling season. Round 2: You will adjust all 15-weeks of markdown decisions, one item at a time, to improve your gross margin percentage. First page: Enter any name Choose a Name:

vs.

Congratulations, You Have Just Been Promoted to Markdown Manager! Your goal is to maximize your Gross Margin Dollars, and sell-thru (inventory clearance), for the following items, over the course of a 15-week selling period. Item Name

Cost

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Initial Retail

Salvage Cost

Receipt Units

Women's Leather Jacket

$208.0 0

$520.00

$104.00

6,850

Fashion Purse

$900.0 0

$1,800.00

$0.00

630

Flower Vase

$8.00

$19.99

$4.00

1,450

Deluxe Propane Grill

$175.0 0

$500.00

$50.00

9,000

Fancy Dinner Set

$160.0 0

$400.00

$4.00

1,300

Scenario: It is Saturday, January 14, 2006. You have just received last weeks' "Weekly Selling Report". You have 14 weeks to maximize the profitability of these items. Directions: To take a markdown this week, choose either 25% or 50% from the MD Action column on the left. Once you select a markdown, you can't go back. When you're ready, click "Submit MD for this Week" below.

Week: 1

MD Action (For This Week)

Time Left For This Week:

4:43

Weekly Selling Report (for last week's sales) Item# Item Name

Orig Price Cur Price

NOMD 25% 50% 1

Women's Leather Jacket

2

Fashion Purse

3

Flower Vase

4

5

$520.00

$520.00

$1,800.00 $1,800.00

Cum Sales

Cum ST%

LW Sales

LW ST%

WOS Inv

6.7%

456

6.7%

14.0

24

3.8%

24

3.8%

25.3 606

$19.99

8

0.6%

8

0.6% 180.3

Deluxe Propane Grill

$500.00

$500.00

5

0.1%

5

0.1%

Fancy Dinner Set

$400.00

$400.00

49

3.8%

49

3.8%

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6394 $3,324,880

456

$19.99

Inv $'s

1442

$1,090,800

$28,826

1799.0 8995 $4,497,500

25.5

1251

$500,400

Bonus: Bonus over gross margin dollar plan. Cum Sales: Total sales from beginning of period to date. Cum ST: (Cumulative Sell Through) Total sales percent from beginning of selling season until today. Cur Price: Current retail price, after markdown. EOW Inv End of week inventory units. Units: Inv $'s: End of week inventory dollars. GM$: (Gross Margin Dollars) Net Sales - (cost of goods sold + salvage costs). GM%: (Gross Margin Percent)Ratio of Gross Margin vs Net Sales. Inventory: End of week inventory units. Inv $'s: End of week inventory dollars. Item Cost: Cost per item. LW Sales: (Last Week Sales) Sales units for last selling week. LW ST%: (Cumulative Sell Through Percent) Last week's percent sales units vs. the beginning of week inventory. NOMD: (No Markdown) Optimal MD: Markdown taken to maximize gross margin. Receipt Units: Units of an item received for a selling season. Round 1 MD: Your markdown decisions in first round. Round 2 MD: Your markdown decisions in second round. Sales Dollars: Net Sales. Sales Units: Units Sold. Salvage Cost: How much you'll make on an item if you just get rid of it (i.e., sell to discount store). Sell-Thru: Percent of inventory sold. WOS: (Weeks of Supply) inventory / average sales units. Number of weeks of inventory remaining, assuming continuing selling rate.

You will play 15 rounds with Max Margin, and after all 15 weeks are complete, you will get a final score. See below. Item# Item Name

Ending Inv GM% GM$ Your GM Dollars / Max's GM Dollars $1,256,32 1 Women's Leather Jacket 0 46.9% 88.7% 0 2 Fashion Purse

0 39.2% $365,850

73.9%

3 Flower Vase

0 53.9%

$13,587

78.2%

4 Deluxe Propane Grill

0 30.4% $687,500

35.5%

5 Fancy Dinner Set

0 44.6% $167,300 $2,490,55 0 43.0% 7

67.1%

Your Score for All Items (Percent of Max's Gross Margin Dollars)

You have potential!

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60.6%

Round 2: You can go back in and look by item at what happens each week based on the changes you make/do not make to your pricing strategy. If you hit the Power Button at the bottom, the computer will automatically adjust pricing.

Round 2: Item 1, Women's Leather Jacket

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INSTRUCTOR NOTES

ANNOTATED OUTLINE •

See PPT 15-3

The importance of pricing decisions is growing because today's customers have more alternatives to choose from and are better informed about the alternatives available in the marketplace.

Query students on what is a good value for them when buying a specific product, such as jeans or sneakers. Different conceptions of value would emerge, including the lowest price, good quality for the money paid, etc. Note that students willing to pay different prices would still consider their own choices as being good value.

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Value is the ratio of what customers receive (the perceived benefit of the products and services offered by the retailer) to what they have to pay for it.

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Value = Perceived Benefits/Price

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Retailers can increase value and stimulate more sales by either increasing the perceived benefits offered or reducing the price.

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If retailers set prices higher than the benefits they offer, sales and profits will decrease.

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If retailers set prices too low, their sales might increase, but profits might decrease due to the lower profit margin.

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In addition, retailers need to consider the value proposition offered by their competitors and legal restrictions related to pricing.

I. Considerations in Setting Retail Prices •

These considerations are illustrated in PPT 154 and 15-5.

Retailers consider four factors when setting retail prices.

A. Customer Price Sensitivity and Cost •

As the price of a product increases, the sales for the product will decrease because fewer and fewer customers feel the product is a good value.

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The price sensitivity of customers determines how many units will be sold at different price levels.

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Ask students to list products or services they would estimate to be price elastic and others they would estimate to be price inelastic.

1. Price Elasticity •

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A commonly used measure of price sensitivity is price elasticity. Price elasticity is the percentage change in quantity sold divided by the percentage change in price.

See PPT 15-6 and 15-7 for discussion of price elasticity.

Elasticity =

% change in quantity sold/% change in price •

The target market for a product is considered price insensitive (inelastic) when its price elasticity is greater than -1.

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The target market for a product is considered price sensitive (elastic) when its price elasticity is less than -1.

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A number of factors affect the price sensitivity for a product.

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The more substitutes a product or service has, the more likely it is to be price elastic.

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Products and services that are necessities are price inelastic.

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Products that are expensive relative to a consumer’s income are price elastic.

PPT 15-9 through 15-14 illustrate calculations used to determine price elasticity.

B. Competition •

Retailers can price above, below, or at parity with the competition. The chosen pricing policy must be consistent with the retailer’s overall strategy and its relative market position.

See PPT 15-15 for an example.

1. Collecting and Using Competitive Price Data •

Ask students for examples of retailers using each of these pricing strategies relative to competing retailers.

Most retailers routinely collect price data about their competitors to see if they need to adjust their prices to remain competitive.

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2. Reducing Price Competition •

See PPT 15-16

Retailers attempt to reduce price competition by utilizing some of the branding strategies described in Chapter 14 to offer unique merchandise, such as developing line of private-label merchandise, negotiating with national brand manufacturers for exclusive distribution rights, or having vendors make unique products for them.

These issues are summarized in PPT 15-17.

C. Legal and Ethical Pricing Issues •

In addition to customer price sensitivity, cost and competition, retailers need to consider legal and ethical issues when setting prices. For a description of the three degrees of price discrimination, see PPT 15-8.

1. Price Discrimination •

Price discrimination by retailers occurs when a retailer charges different prices for the identical products and/or services sold to different customers. Price discrimination between retailers and their customers is generally legal.

2. Predatory Pricing •

Predatory pricing is a particular form of price discrimination where a marketdominating firm charges below-cost prices for some goods or in some areas in order to drive out or discipline one or more rival firms. Eventually, the predator hopes to raise prices and earn back enough profits to compensate for the losses during the period of predation.

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The firm challenging prices as being predatory bears the burden of proving three things: (1) the predator has significant market power; (2) the predator prices some goods at least below its total cost, including an allocation for overhead costs for a significant period; and, (3) there is reasonable likelihood that the predator will be able to recoup its

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predatory losses. •

A retailer generally may sell the same merchandise at any price so long as the motive isn't to destroy competition.

3. Resale Price Maintenance •

Vendors often encourage retailers to sell their merchandise at a specific price, the manufacturer’s suggested retail price (MSRP) in order to reduce price competition among retailers, eliminate free riding, and stimulate retailers to provide complementary services.

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Although not historically, these practices are currently legal.

4. Horizontal Price Fixing Retailers can, however, offer different prices to different customers as long as the pricing policies aren’t discriminatory.

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Horizontal price fixing involves agreements between retailers that are in direct competition with each other to have the same prices.

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As a general rule of thumb, retailers should refrain from discussing prices or terms or conditions of sale with competitors.

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The only exception to this rule is when a geographically oriented merchant’s association is planning a special coordinated event.

5. Bait-and-Switch Tactics •

Bait-and-switch is an unlawful deceptive practice that lures customers into a store by advertising a product at a lower than usual price (the bait) and then induces the customers to switch to a higher-priced model (the switch).

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To avoid disappointed customers and problems with the FTC, retailers should have sufficient quantities of advertised items, or if they run out of stock, should offer customers a rain check.

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Ask students if they have ever experienced baitand-switch.

6. Scanned Versus Posted Prices •

Many states and localities have specific laws regarding accurate pricing. FTC-led studies of the accuracy of price scanning versus posted or advertised prices have generally found a high level of accuracy, but mistakes are made in one out of 30 scans. Generally, retailers lose money because the scanned price is below the recommended price.

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Experts recommend that retailers adopt specific practices to ensure accurate pricing. These include, on-going training of employees, designating one person as the pricing coordinator, and random price audits done on a daily basis.

II. Setting Retail Prices •

Many retailers have to set prices for over 50,000 SKUs and make thousands of pricing decisions each month. From a practical perspective, they cannot conduct experiments nor do statistical analyses to determine the price sensitivity for every item.

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Retailers typically set prices by marking up the item’s cost to yield a profitable gross margin. Then these cost-based prices are adjusted on the basis of insights about customer price sensitivity and competitive pricing.

A. Retail Price and Markup •

When setting prices based on merchandise cost, retailers start with the following equation:

Retail price = Cost of merchandise + Markup •

The markup is the difference between the retail price and the cost of an item.

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The appropriate markup is determined to cover all of the retailer’s operating expenses needed to sell the merchandise

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Setting prices is primarily dependent on the margin management component of the strategic profit model. Although, if prices are lowered, the velocity of sales in terms of inventory turnover should also increase.

and produce a profit for the retailer. •

The markup percentage is the markup as a percentage of the retail price:

See PPT 15-18, 15-19, and 15-20 for an example.

Markup percent = Retail price – Cost of merchandise/Retail price •

The retail price based on the cost and markup percentage is:

Retail price = Cost of merchandise/ 1 – Markup percentage (as a fraction) •

Traditionally, apparel retailers used a 50 percent markup, referred to as keystoning that set the retail price by simply doubling the cost. 1. Initial Markup and Maintained Markup

See PPT 15-21 and 15-22

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Retailers rarely sell all items at the initial price. They frequently reduce the price of items for special promotions or to get rid of excess inventory at the end of a season.

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Initial markup is the difference between the retail selling price originally placed on the merchandise and the cost of the merchandise, whereas maintained markup is the actual sales you get for the merchandise less its cost.

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The difference is due to various reductions, such as markdowns, discounts to employees and customers, and inventory shrinkages (due to shoplifting, breakage or loss).

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Initial markup must be high enough so that after reductions are taken out, the maintained markup is left.

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The relationship between initial markup and maintained markup is:

Instructors may wish to stress the difference between maintain markup and gross margin. We find it more important, however, to stress that they are almost the same thing. Even those students going into retailing are more likely to remember the similarity.

See PPT 15-23

Initial markup % =

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(Maintained markup % + % Reductions) ___________________________ 100% + % Reductions

B. Profit Impact of Setting a Retail Price: The Use of Break-Even Analysis •

Break-even analysis determines how much merchandise is required to be sold to achieve a break-even (zero) profit at various sales levels.

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Break-even quantity =

See PPT 15-26

Total fixed costs/(Actual unit sales price – Unit variable cost) See PPT 15-27 through 15-31 for an illustration of Break-Even Analysis.

1. Calculating Break-Even for a New Product •

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The break-even point (BEP) is the quantity at which total revenues are equal to total cost, and beyond which profit occurs. BEP quantity= Fixed costs/(Actual unit sales price - Unit variable cost)

Assume you have a lemonade stand that rents for $5.00. Lemonade costs $.30 and sells for $.50/cup. BEPquantity would be: $5.00 ÷ $.20 = 25 cups. Assume an ad costs $10,000, shirts cost $30 and sell for $50. How many shirts do you need to sell to breakeven?

The retailer can choose the profit they wish to make, and calculate quantity by adding profit to the numerator, i.e. BEP quantity = (Fixed costs +profit) ÷ (Unit price - Unit variable costs)

$10,000 ÷ $20 = 500 shirts What if the vendor splits the cost of the ad? $5,000 ÷ $20 = 250 shirts

To convert the break-even quantity to break-even sales dollars, multiply the BEP quantity by the selling price. 2. Calculating Break-Even Sales

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The retailer can calculate how much sales would have to increase to profit from a price cut.

III. Price Adjustments •

Retailers adjust prices over time

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See PPT 15-32 to 15-40 for various applications of Break-Even Analysis.

(markdowns) and for different customer segments (variable pricing). A. Markdowns •

Markdowns are a reduction in the initial retail price. Markdowns are a type of second-degree price discrimination because the lower price induces pricesensitive customers to buy more merchandise. 1. Reasons for Taking Markdowns

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See PPT 15-24 and 15-25 Markdowns can be classified as either clearance (to get rid of merchandise) or promotional (to generate sales).

Ask students why retailers take markdowns.

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When merchandise is slow-moving, obsolete, at the end of its selling season, or priced higher than competition, it generally gets marked down.

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Markdowns are part of the cost of doing business. Retailers set their initial markup high enough so that after markdowns and other reductions are taken, the planned maintained markup is achieved.

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Retailers employ markdowns to promote merchandise to increase sales. Markdown sales generate cash flow to pay for new merchandise.

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Markdowns are also taken to increase customers' traffic flow.

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Markdowns may also increase the sale of complementary products. 2. Optimizing Markdown Decisions

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Instead of depending on arbitrary rules for taking markdowns, retailers can benefit significantly from merchandising optimization software.

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Merchandising optimization software is a set of algorithms that monitors merchandise sales, promotions,

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Ask students how retailers can reduce the amount of markdowns. Ask students under what

competitors’' actions, and other factors to determine the optimal (most profitable) price and timing for merchandising activities, especially markdowns. •

The optimization software works by constantly refining its pricing forecasts on the basis of actual sales throughout the season.

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Retailers must also work closely with their vendor partners to coordinate deliveries and help share the financial burden of taking markdowns. 3. Reducing the Amount of Markdowns by Working with Vendors

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Retailers can reduce the amount of markdowns by working closely with their vendors to time deliveries with demand.

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Retail buyers can often obtain markdown money - funds a vendor gives the retailer to cover lost gross margin dollars that result from markdowns and other merchandising issues.

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As discussed in Chapter 10, collaborative supply chain management systems reduce the lead time for receiving merchandise so that retailers can monitor changes in trends and customer demand more closely, thus reducing markdowns. 4. Liquidating Markdown Merchandise

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Retailers can use one of five strategies to liquidate merchandise:

a. Sell the remaining merchandise to another retailer. b. Consolidate the unsold merchandise. c. Place the remaining merchandise on an Internet auction site, like eBay or have a special clearance location on its own webpage.

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circumstances markdown money would be legal. Under the Robinson Patman Act, it would only be legal if it were offered to all retailers on a proportionately equal basis.

d. Give the merchandise to charity. e. Carry the merchandise over to the next season. •

Marked-down merchandise can be consolidated in a number of ways.

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First, the consolidation can be made into one or a few of the retailer's regular locations.

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Second, marked-down merchandise can be consolidated into another retail chain or an outlet store under the same ownership.

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Finally, marked-down merchandise can be shipped to a distribution center or a rented space such as a convention center for final sale.

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The Internet is increasingly useful for liquidating marked-down merchandise.

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Giving clearance merchandise to charities is an increasingly popular practice. Charitable giving is always a good corporate practice.

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The final liquidation strategy – to carry merchandise over to the next season – is used with relatively high priced nonfashion merchandise, such as traditional men's clothing and furniture. 5. Markdowns and Price Discrimination

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Ideally, retailers would like to have the opportunity to charge customers as much as they would be willing to pay. This practice is called first-degree price discrimination.

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Markdowns and other widely used retail adjustment practices are known as second-degree price discrimination – charging different prices to different people on the basis of the nature of the

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See PPT 15-45

offering. See PPT 15-42 and 15-43

B. Variable Pricing and Price Discrimination 1. Individualized Variable Pricing •

Ideally, retailers would maximize their profits if they charged each customer as much as the customer was willing to pay.

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Charging each customer a different price based on their willingness to pay is called first-degree price discrimination.

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Pricing merchandise through auction bidding is an example of first-degree price discrimination.

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Although first-degree price discrimination is legal and widely used in some retail sectors, it is not practical in most retail stores. It is difficult to assess each customer’s willingness to pay, trying to do may cause ill-will on the part of customers, and posted prices can’t be changed as each customer walks in the door.

Ask students to identify retail categories that frequently implement first-degree price discrimination.

2. Self-Selected Variable Pricing •

Markdowns and other widely used retail adjustment practices are known as second-degree price discrimination – charging different prices to different people on the basis of the nature of the offering.

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Clearance markdowns result in higher prices being charged at the beginning of the season than at the end of the season. Some customers will have a high willingness to pay because they want the fashion items early in the season. More price-sensitive customers will wait until the items are marked down at the end of the season.

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Coupons offer a discount on the price of specific items when they're purchased at a

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See PPT 15-44 Ask students if they, or anyone they know, use

store.

coupons regularly. Why or why not? This is a way of getting to the advantages and disadvantages.

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Coupons are used because they induce customers to try products for the first time, convert those first-time users to regular users, encourage large purchases, increase usage, and protect market share against competition.

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Price bundling is the practice of offering two or more different products or services for sale at one price.

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Price bundling is used to increase both unit and dollar sales by bringing traffic into the store.

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Multiple-unit pricing is similar to price bundling in that the lower total merchandise price increases sales, but the products or services are similar, rather than different.

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This strategy is used to increase sales volume.

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Depending on the type of product, customers may stockpile for use at a later time, resulting in no long-term effect on sales.

Ask students to identify retailers that use price bundling, and what products they use. (It is used a lot with travel -- cruises, tours)

See PPT 15-52

C. Variable Pricing by Market Segment •

Retailers often charge different prices to different demographic market segments, a practice referred to as third-degree price discrimination.

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Another example of third-degree price discrimination is zone pricing. Zone pricing refers to the practice of charging different prices in different stores, markets, regions, or zones. This practice is generally used by retailers to address different competitive situations in their various markets.

IV. Pricing Strategies •

Retailers use two basic retail pricing strategies: high-low pricing and everyday

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low pricing (EDLP).

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Ask students to name retailers using a High/Low Pricing strategy from the following: women’s shoes, men’s suits, home electronics, and home furniture.

A. High/Low Pricing •

With this strategy, retailers offer prices that are sometimes above their competitors EDLP but they use advertising to promote frequent sales.

See PPT 15-46 and 15-47

B. Everyday Low Pricing See PPT 15-48 and 15-49

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This strategy stresses continuity of retail prices at a level somewhere between the regular nonsale price and the deep discount sale price of the retailer’s competitors.

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EDLP does not necessarily mean the lowest price in the market.

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A more accurate description of this strategy is everyday same prices because the prices don’t have significant fluctuations.

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Some retailers have adopted a low price guarantee policy in which they guarantee that they will have the lowest possible price for a product or group of products. The guarantee usually promises to match or better any lower price found the local market, and includes a provision to refund the difference between the seller’s offer price and the lower price.

Name retailers using EDLP strategies from the following: grocery store chain, and building supplies.

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See PPT 15-50

C. Advantages of the Pricing Strategies •

Advantages of High/Low Pricing:

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Increases profits through price discrimination

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Sales create excitement

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Allows retailers to get rid of slow moving merchandise

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Advantages of EDLP:

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Assures customers of low prices

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Reduces advertising and operating expenses

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Reduced stockouts and improved inventory management

A chain of supermarkets that has strong national buying power wants to open several stores in a competitive area. Which strategy is best for them and why? How would the situation be different for a jewelry store chain?

V. Pricing Services Ask students for examples of services retailers utilizing yield management.

A. Matching Supply and Demand •

As services are intangible, they cannot be inventoried. When a services retailer’s capacity is unused, its revenue is lost forever. On the other hand, due to capacity limitations, services retailers might encounter situations when they cannot realize as many sales as consumers are willing to make.

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Yield management is the practice of adjusting prices up or down in response to demand to control the sales generated.

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Other services retailers use less sophisticated approaches for matching supply and demand, such as “early bird specials” and matinees at the movies.

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See PPT 15-51

B. Determining Service Quality •

Due to the intangibility of services, it is often difficult for customers to assess the quality of services. Customers are likely to use price as an indicator of service quality. Especially in high-risk purchase situations (medial or dental services), customers may look to price as a surrogate for quality.

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Thus, in addition to being chosen to manage capacity, service prices must be set to convey the appropriate quality signal.

VI. Pricing Techniques for Increasing Sales •

See PPT 15-53

There are three strategies that could be used to increase retail sales without resorting to price discrimination.

A. Leader Pricing •

See PPT 15-40 In leader pricing, certain items are priced lower than normal to increase customers' traffic flow or to boost sales of complementary products.

Ask students what retailers typically use a leader pricing strategy, and what products they use.

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Reasons for using leader pricing are similar to those for coupons. The difference is that with leader pricing, the merchandise has a low price to begin with, so customers, retailers, and vendors don’t have to handle coupons.

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Some retailers call these products loss leaders.

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The best items for leader pricing are frequently purchased products. The retailer hopes consumers will also purchase other products while buying loss leaders.

B. Price Lining •

See PPT 15-55 and 15-56 In price lining, retailers offer a limited number of predetermined price points

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within a classification. Ask students to identify retailers that use price lining. Then ask if a price lining strategy helps them in making their shopping decisions.

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Both customers and retailers can benefit from such a strategy in the following ways:

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Confusion that often arises from multiple price choices is essentially eliminated.

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Merchandising task is simplified for the retailer.

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Price lining can also give buyers greater flexibility.

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Customers may “trade up” to more expensive offerings.

C. Odd Pricing • •

See PPT 15-57 and 15-58 Odd pricing refers to a price ending in an odd number, typically a nine. While odd pricing originally had loss prevention and accounting functions, some retailers believe odd pricing can increase profits.

Ask students if they think an odd pricing strategy works. For example, if they bought a pair of jeans for $29.99, what price would they tell a friend when asked later - $29 or $30?

PPT 15-59

VII. The Internet and Price Competition •

Retailers are concerned that the growth of electronic retailing will intensify price competition. Using the Internet, consumers can search for merchandise across the globe to find the lowest prices.

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Shopping bots or search engines are computer programs that search for and provide a list of all Internet sites selling a product category or price of a specific brand offered.

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Retailers using an electronic channel can reduce the emphasis on price by providing better services and information. Because of these services, customers might be willing to pay higher prices for the merchandise.

VIII. Summary

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ANSWERS TO DISCUSSION QUESTIONS AND PROBLEMS 1.

How does merchandising optimization software help buyers make better markdown decisions? The importance of some technological aids in making markdown decisions can be illustrated by considering the example of a mom-and-pop owned neighborhood convenience store. If the store carries about 10,000 SKUs, the owner would, through experience and trial-and-error develop some plan for taking markdowns. Essentially, the owner would develop some set of rules for taking markdowns. One rule could be the level of sales, such that if weekly sales of products or product categories fall below the average expected figure, markdowns could be taken. Another way would be consider how long the merchandise has been in the store and markdown percentages could be varied based on the amount of weeks the merchandise has been in the store. Any rule so developed can only be imperfect – it is conceptually and physically impossible for an individual to monitor so many items in a store and make perfect markdown decisions. On the other hand, technology can be used as an aid by selecting and developing some appropriate set of rules for markdown decisions – be it sales, or inventory, or a combination of these and other factors. Markdown optimization software is a set of algorithms that monitors merchandise sales, promotions, competitors' actions, and other factors, to determine the optimal (most profitable) price and time for markdowns. Using the software, the retailer can monitor pricing forecasts based on actual sales and compute several sales scenarios for each item. The software can then be used to identify different outcomes based on expected profits and other factors and select the markdown percentage and timing to produce the best results.

2.

A simple examination of markdowns could lead us to believe that they should be taken only when a retailer wants to get rid of merchandise that’s not selling. What other reasons could a retailer have to take markdowns?

While markdowns are commonly taken to move merchandise that is not selling well, there are several other reasons (creating opportunities) to take them. Sometimes retailers take markdowns to create sales. By selling merchandise faster because of the markdown, the retailer can not only sell the merchandise it marks down, but can also sell new merchandise that is replacing the discounted merchandise. Markdowns are also taken to generate and increase customer traffic flow. The hope is that customers will purchase other products at regular prices while in the store.

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3.

Do you know any retailers that have violated any of the legal issues discussed in this chapter? Explain your answer. The student should mention stores that have violated the following legal issues: • • • • •

4.

Price Discrimination: Vendors cannot charge different prices to different retailers unless the cost of manufacture, sale or delivery resulting from different selling methods or quantities sold are different. Resale price maintenance: This issue has had a checkered history. Currently, however, it seems that vendors can terminate retailers who refuse to maintain suggested retail prices. Horizontal price fixing: It is illegal for competing retailers to conspire to fix prices. Predatory pricing: It is illegal to establish retail prices that are so low that competition is driven from the marketplace. Price Comparison: It is illegal to promote merchandise that is “on sale” from a “regular” price unless the retailer usually and recently has sold the merchandise at that price.

What is the difference in the pricing strategies of e-Bay.com, priceline.com, and staples.com? Which firm do you think will be the strongest in 10 years? Why? e-Bay.com is an online auction, where consumers put in a bid, and the highest bid wins. At Priceline.com the customer puts in the price they are willing to pay, and Priceline will try to find the product they are looking for at that price. Staples.com is the electronic channel used by office supply category killer, Staples. Online auctions like e-Bay and Priceline are becoming more and more popular. Customers not only enjoy the great price points, but also enjoy the entertainment and excitement of the “pricing game.” It is possible that all or none of these firms will be strong in ten years. From a consumer’s perspective, Priceline looks very promising. Priceline allows customers to get a product at the price they set. The customer does not depend on others to set the price. Staples.com utilizes a High/Low pricing strategy with frequent sales promotions and price breaks on selected items advertised on the retailer’s website. Staples.com’s disadvantage compared to the other two retailers here is the intense level of competition they face from other office supply retailers using the electronic channel, like Office Max and Office Depot. With multiple alternatives in the marketplace, staples.com will have a difficult time creating sustainable advantage based on a pricing strategy. From a basic business model perspective, however, e-Bay may be the winner. First, it already has a very strong brand. Second, it has been successful expanding in a multitude of product categories. Finally, it is successfully partnering with other large and well-known Internet firms.

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NOTE: For questions 5-9, students may use the student side of the Online Learning Center by clicking on Pricing. 5.

A department’s maintained markup is 38 percent, reductions are $560, and net sales are $28,000. What’s the initial markup percentage? You can use your Student CD to answer this question. MMU$ = 10,640.00 Initial markup (IMO) % = (MMU$ + Reductions) ÷ (Net sales + Reductions) IMO% = 11,200 ÷ 28,560 IMO% = .392 or 39.2%

6.

Maintained markup is 39 percent, net sales are $52,000, and reductions are $2,500. What are gross margin in dollars and the initial markup as a percentage? Explain why initial markup is greater than maintained markup. Gross margin (GM) = Maintained markup - Reductions GM = (52,000 x .39) - 2,500 GM = 20,280 – 2,500 GM = $17,780.00 Initial markup (IM) = (Maintained markup + Reductions) ÷ (Net sales + Reductions) IM = (20,280 + 2500) ÷ (52,000 + 2,500) IM = 22,780 ÷ 54,500 IM = .418 or 41.8% The initial markup is greater than the maintained markup because the retailer must initially markup merchandise high enough to achieve the planned maintained markup after the reductions are taken.

7.

The cost of a product is $150, markup is 50 percent, and markdown is 30 percent. What’s the final selling price? Retail Price = Cost + Markup R = 150 + .5 R R = 300 Markdown (MD) = R x (1 - Markdown) MD = 300 x .70 MD = 210

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8.

Manny Perez bought a tie for $9 and priced it to sell for $15. What was his markup on the tie? The basic formula applies: Markup = Retail - Cost Since we are calculating markup at retail, we know that the retail price equals 100%. The problem asks what part of retail price (100%) is represented by markup. Therefore: Dollar markup = Retail price - Cost price Dollar markup = $15.00 - $9.00 Dollar markup = $6.00 Dollar markup Markup = Dollar markup/Retail price Markup = $6.00/$15.00 Markup = 40% Markup

9.

Answer the following: (a) The Limited is planning a new line of leather jean jackets for fall. It plans to retail the jackets for $100. It is having the jackets produced in the Dominican Republic. Although The Limited does not own the factory, its product development and design costs are $400,000. The total cost of the jacket, including transportation to the stores, is $45. For this line to be successful, The Limited needs to make $900,000 profit. What is its break-even point in units and dollars? (b) The buyer has just found out that The GAP, one of The Limited's major competitors, is bringing out a similar jacket that will retail for $90. If The Limited wishes to match The GAP's price, how many units will it have to sell? (a) In the example of The Limited, Product development and design costs could be taken as fixed costs. Unit price is $100, and unit variable costs are $45. Therefore, the contribution margin (= Unit Price minus Unit Variable Cost) = $55. Fixed Costs + Profit Breakeven Quantity = __________________ = Unit Price – Unit Variable Cost

$400,000 + $900,000 _________________ $100 - $ 45

Breakeven Quantity = 23, 636 units. At the unit price of $100, the breakeven point in dollars is 23,636 X $100 = 2,363,600.

(b) If Limited wishes to match The GAP's price, its unit price will be reduced by 10%. The contribution margin percentage (%CM) was (Selling price – Variable costs) $100 - $ 45 _________________________ X 100 = ____________ X 100 = 55% Selling price $100

- % price change

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% Breakeven Sales Change = ___________________________ X 100 % CM + % price change -(-10) ______________ X 100 = 22.22% 55 + (-10) Therefore, unit breakeven sales change will be: 23,636 unit x X 22.22% = 5,252 units. Thus, The Limited would have to sell an additional 5,252 units or a total of 28,888 units. Another way to calculate this would be to simply insert the new unit price of $90 in the breakeven formula used earlier and re-calculate the breakeven quantity. The resulting number would only differ by 1 unit, due to rounding of the numbers past the decimal.

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ADDITIONAL ASSIGNMENTS AND EXERCISES Exercise 15-1 Talbot’s – Reading Assignment

Read the following article. After answering the questions below, be prepared to discuss in class. Branch, Shelly. “Tough Sale: Long Used to Getting Full Price, A Retailer Faces New Pressures; Despite Recent Stumbles, Talbot’s Vows to Keep Holding Line on Discounts.” Wall Street Journal, February 3, 2004. 1. What are the advantages and disadvantages of Talbot’s using a High/Low pricing strategy? Advantages

Disadvantages

2. Other than sales, how is Talbot’s offering its customers value? Product

Promotion

Placement

3. Should Talbot’s continue to limit its sales to four per year? Explain your response.

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Exercise 15-1 with Answers Talbot’s – Reading Assignment Read the following article. After answering the questions below, be prepared to discuss in class. Branch, Shelly. “Tough Sale: Long Used to Getting Full Price, A Retailer Faces New Pressures; Despite Recent Stumbles, Talbot’s Vows to Keep Holding Line on Discounts.” Wall Street Journal, February 3, 2004. 1. What are the advantages and disadvantages of Talbot’s using a High/Low pricing strategy? Advantages - The same merchandise appeals to multiple markets, some customers are willing to pay full-price and price sensitive customers will wait for sales - Sales create excitement and draw crowds - Sales move merchandise - Original high price denotes quality merchandise Disadvantages - Customer will be “programmed” to wait and buy only when there is a sale - Long-term sales, profitability, and earnings are suffering - The competition for women’s apparel is having more frequent sales 2. Other than sales, how is Talbot’s offering its customers value? Product - Offering private label classic and career fashions that can’t be found at other retail locations Promotion - Placing advertising in USA Today to remind customers that Talbot’s offers great gifts for the holidays - Holding and open house with a drawing for $100 gift certificates - Courting their best customers with a Christmas gift from the CEO - Offering charge card customers appreciation dividends - Sending birthday cards with a 10% savings Placement - Locating stores in small shopping or strip centers - Shifting merchandise to match store demand 3. Should Talbot’s continue to limit its sales to four per year? Explain your response. - Even though they are able to sell a larger percentage of merchandise at the original price vs. other apparel stores (70% vs. 46%) this retailer is paying the price with inconsistent financial performance. - The seasonal nature of apparel requires that merchandise be marked down in a timely manner - Competitors that offer woman’s career apparel offer more frequent sales - Even customers who can afford the full-price are trained to wait for sales

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Exercise 15-2 Wal-Mart – Reading Assignment After reading the following article complete the table below and be prepared to discuss in class. “Is Wal-Mart Too Powerful?” BusinessWeek, October 6, 2003. 1. Wal-Mart’s pricing strategy is to offer customers the lowest prices possible. Perform a SWOT analysis on the world’s largest retailer. Strengths

Weaknesses

Opportunities

Threats

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Exercise 15-2 with Answers Wal-Mart – Reading Assignment After reading the following article complete the table below and be prepared to discuss in class. “Is Wal-Mart Too Powerful?” BusinessWeek, October 6, 2003. (LexisNexis Academic) 1. Wal-Mart’s pricing strategy is to offer customers the lowest prices possible. Perform a SWOT analysis on the world’s largest retailer. Strengths -

#1 global retailer, #1 US grocer, #3 US pharmacy EDLP strategy, up to 14% savings offered $245 B in revenue in 2002 Low-cost, effective supply chain Clout (dominance) with vendors High market share of household staples 15% growth rate

Weaknesses -

Opportunities -

Price sensitive customers Admired company “Family-friendly” merchandising Market development, new locations in the US and foreign markets Urban store locations Hypermarket format Food and drug sales

High employee turnover Low wages, $ 8.23/hour Poor morale Not staying with their “Made in America” supplier strategy (Sam Walton), in 1995 imports = 6% of products and in 2003 imports = 50 to 60% of merchandise

Threats -

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Unions entering an anti-union company 40+ lawsuits, forced overtime and sex discrimination Hated company Grassroots opposition to building new stores, example – VT Not all suppliers can meet Wal-Mart’s requirements To obtain lowest-cost merchandise using global suppliers