Starting a Business

Make Sure the Pricing Is Right With These Tips

Make Sure the Pricing Is Right With These Tips
Image credit: Ruiwen Chua | Flickr

In Start Your Own Retail Business and More, the staff of Entrepreneur Media, Inc. and writer Ciree Linsenman explain how you can get started in the retail industry, whether you want to start your own specialty food shop, gift shop, clothing store or kiosk. In this edited excerpt, the authors offer tips on pricing your products to ensure your retail success.

Your pricing strategy is important for two reasons. For one thing, the difference between what you pay for products or services and what you charge customers determines your margin, which has an immediate effect on your business’s profitability. Also, price directly affects the demand for what you have to offer—if they're right, prices have the power to attract customers.

In making your pricing decisions, answer these questions:

  • What prices are shoppers willing to pay for the merchandise?
  • Where do you want to be in comparison with your competitors’ pricing: equal, above, or below?
  • What's the suggested retail price proposed by the supplier?
  • What are the qualities or characteristics of the merchandise that influence a shopper’s perception of quality and value—style, whether it's perishable, scarcity, richness, commodity, or other?

Narrowing the decision-making process even further, give careful consideration to your specific pricing objectives:

  • Return on investment. Establish prices that will yield a specific return-of-profit percentage on your investment.
  • Maximum profit. Set prices designed to produce the highest possible profit percentage you can expect to earn on the goods you sell.
  • Sales increase. Prices should produce a specified percentage increase in overall store sales. Usually this involves reducing prices to sell more merchandise.
  • Improved cash flow. Establish short-term prices to bring more sales dollars into your business.

If you stock mostly branded goods, then your pricing will be largely determined by the competition, either locally or nationally, because there aren't usually large variations in the prices charged by the major brands to small retailers. After all, a pair of Levi’s 501 jeans is the same product wherever it is purchased, and it's readily identifiable, so the only comparison a customer needs to make is on the price. On the other hand, if you have products made especially for you or if your products are mostly unbranded, then careful price planning can provide profit opportunities.

Pricing strategies

The most commonly used pricing strategy retailers can employ is cost pricing. Simply stated, you calculate all your expenses—direct and indirect—then add a profit. The second strategy is competitive pricing. This involves meeting the going price for similar products in your local market. The cost you paid isn't taken into account here. Finally, market-value pricing looks at what the market will bear. This pricing is generally used for unique products or services that have few or no competing products on the market. You can take higher markups here.

Price points are the specific prices you choose within your price line. They're important because research indicates that more people will buy an item at one price than at another—even if the difference between the two is only a few cents. Suppliers can often help you select the best price points. For example, should you sell an item for $12.95 or $13.50? Stay with the lower price as long as a sufficient gross profit and store image can be maintained.

Applying these three pricing principles can help you achieve your business goals:

1. Divide your price lines into three zones: prestige, popular, and competitive. The prestige price zone is the one at the top of the line that will improve the image of your store and enhance the rest of the line, but not chase customers away. The popular zone is in the middle, where most purchases are made. The competitive zone is at the bottom, where you might price an item simply to compete with another store located nearby. All prices in a line can fall into any of these zones.

2. Try to find merchandise that will fit into your predetermined price lines and points. Savvy buyers are specific with their vendors. (“Do you have a silk sweater set that I can retail at $39.95 and get my regular markup?”) Such a buyer knows what will attract customers under current market conditions. Price predetermination is a self-disciplinary skill you’ll want to acquire. Setting specific price points before going to vendors can keep a new entrepreneur from starting out with the wrong inventory.

3. Be careful not to lock yourself into fixed lines and price points. There are many reasons price lines must be adjusted upward and downward and price points changed. Stay abreast of economic conditions, consumer buying habits, and your competition in all channels.

Concepts of retail price

The difference between the invoice cost and the original retail price is the initial markup. Maintained markup is the difference between the invoice cost and retail sale. Maintained markup differs from initial markup by the amount of any reductions.

Most astute retailers rely on the retail markup approach because it's a quick and useful way to see if an item is profitable for you to carry. However, retail enterprises that sell custom-made items or have direct labor may be better off calculating their markups on the cost basis. If an item costs $9.75 wholesale, and you keystone it (double the cost of goods), you'll sell it for $19.50. Your markup percentage, based on cost, is 100 percent ($9.75 divided by $9.75 times 100). Your markup percentage, based on retail selling price, is 50 percent ($9.75 divided by $19.50 times 100). Bakeries, computer consultants, appliance repair shops, embroidery businesses, and the like usually use the cost approach.

There are many practices retailers follow when it comes to markup. The approaches introduced here will provide some insight into the problems and possibilities you will encounter.

If you buy something for $5 and sell it for $10, you've taken a keystone markup. Small, less sophisticated merchants use this simple method. However, this approach doesn't allow for individual markup selection and often ignores what competitors are doing with identical merchandise. This method also doesn't account for the realities of retailing that reduce your margins, such as selling articles marked down to lower-than-retail prices, damaged merchandise, employee discounts, and shoplifting.

Particular markup percentages are usual and customary in a number of trade areas. For example, the traditional markup for hardware is 40 percent of the retail price. For jewelry, the markup range may be 400 to 800 percent. Those who follow the principle of trade acceptance want to be competitive with others in the trade and don't analyze individual items in determining markup.

Still other retailers believe you should always go for the highest price for any item as long as you don’t drive customers away. Advocates of this theory usually specialize in items that are unfamiliar to customers and not handled by competitors. They're guided by the law of supply and demand, keeping prices high as long as demand is high. Many of these retailers would rather sell less at higher prices than more at lower prices. Does your business concept fit into this model, or would another markup approach be better?

The good-buy theory is a popular one because it rewards good buying and can enhance the store’s reputation if used well. You can increase the markup on an unusually good buy and still offer your customers a great deal when you've scooped the competition.

Still another approach is the high-start/quick-drop-back position. Retailers using this approach are looking for an immediate reaction from the market and are willing to drop back to a lower price to get mass distribution. They can legally advertise that an item that was offered at a higher price is now offered at a much lower price. First-of-a-kind or first-in-the-market opportunities can be leveraged to skim buyers off the top and quickly capture the secondary market by capitalizing quickly on consumer reaction.

Edition: October 2016

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