4 Pricing errors that will break your business

Retail pricing can make or break your business. Coming up with RRP is 50% science and 50% art. The following symptoms and common strategies is evidence of poor pricing practices:

Price-point proliferation

This happens usually in multi-category stores. Stand in front of any merchandise category, say the pen department in a newsagent, and observe how many price points there are. Often you find six to eight price points ranging from below $1 to $10.

Can a customer really tell the difference between a $2.95 pen and $3.95 pen? If not, why are you selling pens at $2.95?

Rationalising price points makes buying a pen a more pleasant experience, and if managed correctly, will improve your margins.

In most categories/sub-categories, three price points (value, mid, premium) will do and in larger categories with a wider range of prices no more than five price points.

Pricing to achieve a margin

Many retailers follow a standard approach to pricing to achieve a certain margin. A standard mark-up is applied to every item purchased. In time, as wholesale prices increase, it results in the proliferation mentioned above.

A further problem is that is that while costs may increase, the value of the item does not necessarily increase. Often costs go up because volume is declining and the worst thing you can do is to increase the price. Simply applying a standard mark-up is counter-productive and it is often better to either accept a reduced margin to maintain volume or to de-stock.

Your mark-up is irrelevant; the only thing that is relevant is what a customer is willing to pay.

Of course ultimately you must achieve a certain margin (your ‘maintained margin’ after markdowns, returns etc) but on a product by product basis, the price is determined by a range of qualitative factors (see below), and the financial outcome is considered afterwards.

If you under-achieve your margin, you can’t simply up the prices to do so without considering these other factors – you have to reconsider your range. Of course there is no such thing as over-achieving your margin.

Following Manufacturers advice

The laws that govern resale price maintenance allow a maximum RRP but no minimum. (For a quick rundown of what can and can’t be done, this page by the ACCC sums it up nicely.)

On the one hand larger manufacturers are likely to have arrived at their pricing recommendation based on some pricing analytics, but that still does not mean that it is right for your business. Make your decision on the range of qualitative (the art) and quantitative (the science) factors, where manufacturer’s recommendation is one consideration. (Of course if you are an agent for a manufacturer, it is different.)

Ignoring qualitative pricing factors

People use price as a heuristic. That is they use it as an indicator (mental shortcut) of something else, and our case usually it is used to indicate ‘value’. Generally one must be an expert to fairly judge value. Say you are buying a car, can you unequivocally tell the difference between a Mazda and a Lexus? Most people use the brand and the price associated with that brand as an indicator of what a good car and what they then expect from that car given the price. It is no different when thy buy shoes or anything else.

The following qualitative factors need to be considered:

  • Brand

As the retailer it is therefore your job to manage how your pricing strategies over time communicate an important aspect of your brand. By setting your price, you are creating (or breaking) your brand.

  • Consistency

You should apply your pricing consistently - if you are selling coffee for $5 and slice of cake for $10, you shouldn’t sell a Coke for $2.  And if you are selling $2 coffees, you shouldn’t sell $5 cokes.

  • Value

People don't buy stuff because it is cheap, but they never want to pay more than it is worth. (Price's Golden Rule of Pricing). This is possibly the most important consideration: what is a customer prepared to pay, given the economic-, social- and competitive context of your store and your product?

  • Strategy

What are you trying to achieve? Market share vs profitability? Growing a business or defending territory? USP or competitive advantage? What is happing online?

  • Timeframe

How important is the product in the long run?

  • Marketing & Operations

How does the product sit in your offer? Is it needed to stimulate sales for another category? Is it a loss-leader?

The key point I want to make, especially for smaller independents, is that the worst thing you can do is to have set and forget approach to pricing. I can’t tell you how often I come across a retailer who simply says they multiply by 2.2 (to achieve 100% mark-up plus GST) and that is how they price everything.

That may the easy approach, but it is also the easy way to go broke quickly.