CHAPTER 14 RETAIL PRICING ANNOTATED OUTLINE INSTRUCTOR NOTES • 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. • 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. • Value = Perceived Benefits/Price • Retailers can increase value and stimulate more sales by either increasing the perceived benefits offered or reducing the price. • If retailers set prices higher than the benefits they offer, sales and profits will decrease. • If retailers set prices too low, their sales might increase, but profits might decrease due to the lower profit margin. • In addition, retailers need to consider the value proposition offered by their competitors and legal restrictions related to pricing. See PPT 14-3 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. IV. Pricing Strategies • Retailers use two basic retail pricing strategies: high-low pricing and everyday low pricing (EDLP). See PPT 14-6 A. High/Low Pricing • With this strategy, retailers frequently – often weekly – discount the initial 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. prices for merchandise through sales promotions. • This strategy is in response to competitive moves and to the positive response from value-conscious consumers. See PPT 14-4 B. Everyday Low Pricing • This strategy stresses continuity of retail prices at a level somewhere between the regular non-sale price and the deep discount sale price of the retailer’s competitors. • EDLP does not necessarily mean the lowest price in the market. • A more accurate description of this strategy is everyday same prices because the prices don’t have significant fluctuations. • 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. See PPT 14-5 Name retailers using EDLP strategies from the following: grocery store chain, and building supplies. Customers comparison shop now more than ever before. It is becoming increasingly difficult for retailers to offer a true EDLP strategy. C. Advantages of the Pricing Strategies • Advantages of High/Low Pricing: • Increases profits through price discrimination • Sales create excitement • Allows retailers to get rid of slow moving merchandise • Advantages of EDLP: See PPT 14-6 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? • Assures customers of low prices • Reduces advertising and operating expenses • Reduced stockouts and improved inventory management I. Considerations in Setting Retail Prices * Retailers consider four factors when setting retail prices. See PPT 14-7 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. • The price sensitivity of customers determines how many units will be sold at different price levels. See PPT 14-08, 14-9 1. Price Elasticity • 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. • 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. • The target market for a product is considered price sensitive (elastic) when its price elasticity is less than -1. • A number of factors affect the price sensitivity for a product. Ask students to list products or services they would estimate to be price elastic and others they would estimate to be price inelastic. See PPT 14-11 • The more substitutes a product or service has, the more likely it is to be price elastic. • Products and services that are necessities are price inelastic. • Products that are expensive relative to a consumer’s income are price elastic. 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. Ask students for examples of retailers using each of these pricing strategies relative to competing retailers. 1. Collecting and Using Competitive Price Data • Most retailers routinely collect price data about their competitors to see if they need to adjust their prices to remain competitive. 2. Reducing Price Competition • 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. See PPT 14-12 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 See PPT 14-15 do statistical analyses to determine the price sensitivity for every item. * 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. Setting Prices Based on Costs • Most retailers either use the MSRP (manufacturer’s suggested retail price) or 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. 1. 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. * The appropriate markup is determined to cover all of the retailer’s operating expenses needed to sell the 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. See PPT 14-16, 14-17, and 14-18 merchandise and produce a profit for the retailer. * The markup percentage is the markup as a percentage of the retail price: 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. 2. Initial Markup and Maintained Markup * 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. * 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. * The difference is due to various reductions, such as markdowns, discounts to employees and See PPT 14-19 and 14-20 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 14-22 customers, and inventory shrinkages (due to shoplifting, breakage or loss). * Initial markup must be high enough so that after reductions are taken out, the maintained markup is left. * The relationship between initial markup and maintained markup is: Initial markup % = (Maintained markup % + % Reductions) ___________________________ 100% + % Reductions See PPT 14-20 B. Merchandising Optimization Software • A relatively new approach to setting retail prices takes a more comprehensive approach using merchandising optimization software. These software programs use a set of algorithms that analyze past and current merchandise sales and prices, estimate the relationship between prices and sales generated , and then determine the optimal (most profitable) initial price for the merchandise and the appropriate size and timing of markdowns. • Given its cost, however, (more than $1 million) the software is only used currently by a small set of the largest retail firms. PPT 14-31 C. 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. * Break-even quantity = Total fixed costs/(Actual unit sales price – Unit variable cost) See PPT 14-27, 14-28, and 14-29 1. Calculating Break-Even for a New Product * 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) * 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) * To convert the break-even quantity to break-even sales dollars, multiply the BEP quantity by the selling price. 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? $10,000 ÷ $20 = 500 shirts What if the vendor splits the cost of the ad? $5,000 ÷ $20 = 250 shirts 2. Calculating Break-Even Sales * 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 (markdowns) and for different customer segments (variable pricing). See PPT 14-30 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 price-sensitive customers to buy more merchandise. 1. Reasons for Taking Markdowns * Markdowns can be classified as either clearance (to get rid of merchandise) or promotional (to generate sales). * When merchandise is slow-moving, obsolete, at the end of its selling season, or priced higher than See PPT 14-31 Ask students why retailers take markdowns. competition, it generally gets marked down. * 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. * Retailers employ markdowns to promote merchandise to increase sales. Markdown sales generate cash flow to pay for new merchandise. * Markdowns are also taken to increase customers' traffic flow. * Markdowns may also increase the sale of complementary products. 2. Optimizing Markdown Decisions * Instead of depending on arbitrary rules for taking markdowns, retailers can benefit significantly from merchandising optimization software. * Merchandising 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 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. * Retailers must also work closely with their vendor partners to coordinate deliveries and help share the financial burden of taking markdowns. See PPT 14-32 and 14-33 Ask students how retailers can reduce the amount of markdowns. Ask students under what 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. 3. Reducing the Amount of Markdowns by Working with Vendors * Retailers can reduce the amount of markdowns by working closely with their vendors to time deliveries with demand. * 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. * 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 * 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. 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. • First, the consolidation can be made into one or a few of the retailer's regular locations. • Second, marked-down merchandise can be consolidated into another retail chain or an outlet store under the same ownership. • Finally, marked-down merchandise can be shipped to a distribution center See PPT 14-34 or a rented space such as a convention center for final sale. • The Internet is increasingly useful for liquidating marked-down merchandise. • Giving clearance merchandise to charities is an increasingly popular practice. Charitable giving is always a good corporate practice. • 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. B. Variable Pricing and Price Discrimination See PPT 14-35, 14-36, 14-37 1. Individualized Variable Pricing • Ideally, retailers would maximize their profits if they charged each customer as much as the customer was willing to pay. • Charging each customer a different price based on their willingness to pay is called first-degree price discrimination. • Pricing merchandise through auction bidding is an example of first-degree price discrimination. • 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. 3. Clearance Markdowns for Fashion Merchandise • 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. 4. Coupons • Coupons offer a discount on the price of specific items when they're purchased at a store. • 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. • Coupons are also considered a form of second-degree price discrimination because price-sensitive consumers are more likely to expend the extra effort to collect and redeem coupons whereas price- insensitive consumers will not. • Some risks to the retailer are associated with the use of coupons. Like all temporary promotions, coupon promotions may be stealing sales from a future period without any net increase in sales. Also coupons may alienate, annoy or confuse Ask students if they, or anyone they know, use coupons regularly. Why or why not? This is a way of getting to the advantages and disadvantages. consumers and therefore do little to increase store loyalty. 5. Rebates • Rebates provide another form of discounts for consumers off the final selling price. In this case, the manufacturer issues the refund as a portion of the purchase price returned to the buyer in the form of cash. • Rebates can be even more frustrating for consumers than coupons, as they are required to carefully follow a set of steps to apply. • Manufacturers like rebates because as many as 90% of consumers for an eligible item don’t bother to redeem them. Retailers like rebates because they increase demand in the same way coupons may, but the retailer has no handling costs. 6. Price Bundling * Price bundling is the practice of offering two or more different products or services for sale at one price. • Price bundling is used to increase both unit and dollar sales by bringing traffic into the store. Ask students to identify retailers that use price bundling, and what products they use. (It is used a lot with travel -- cruises, tours) 7. Multiple-unit Pricing * 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. * This strategy is used to increase sales volume. * Depending on the type of product, customers may stockpile for use at a later time, resulting in no long-term effect on sales. 8. Variable Pricing by Market Segment • Retailers often charge different prices to different demographic market segments, a practice referred to as third-degree price discrimination. • 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. V. Pricing Services 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. • Yield management is the practice of adjusting prices up or down in response to demand to control the sales generated. • Other services retailers use less sophisticated approaches for matching supply and demand, such as “early bird specials” and matinees at the movies. Ask students for examples of services retailers utilizing yield management. 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 (medical or dental services), customers may look to price as a surrogate for quality. • 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 * There are three strategies that could be used to increase retail sales without resorting to price discrimination. See PPT 14-39 A. Leader Pricing * In leader pricing, certain items are priced lower than normal to increase customers' traffic flow or to boost sales of complementary products. * 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. * Some retailers call these products loss leaders. * The best items for leader pricing are frequently purchased products. The retailer hopes consumers will also purchase other products while buying loss leaders. See PPT 14-40 Ask students what retailers typically use a leader pricing strategy, and what products they use. B. Price Lining See PPT 14-41 * In price lining, retailers offer a limited number of predetermined price points within a classification. * Both customers and retailers can benefit from such a strategy in the following ways: * Confusion that often arises from multiple price choices is essentially eliminated. * Merchandising task is simplified for the retailer. * Price lining can also give buyers greater flexibility. * Customers may “trade up” to more expensive offerings. Ask students to identify retailers that use price lining. Then ask if a price lining strategy helps them in making their shopping decisions. C. Odd Pricing * 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. See PPT 14-42 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? 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. • Although consumers shopping electronically can collect price information with little effort, they can also get a lot of information about the quality performance of products at a low cost. This additional information about product quality might lead customers to pay more for high- quality products, thus decreasing the importance of price. PPT 14-43 • 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. 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. These issues are summarized in PPT 14-44. 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 market-dominating 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. • 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 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. • The U.S. Supreme Court recently ruled that the ability of a vendor to require retailers to sell merchandise at MSRP should be decided on a case by case basis, depending on the individual circumstances. 4. Horizontal Price Fixing * Horizontal price fixing involves agreements between retailers that are in direct competition with each other to have the same prices. * As a general rule of thumb, retailers should refrain from discussing prices or terms or conditions of sale with competitors. * The only exception to this rule is when a geographically oriented merchants association is planning a special coordinated event. Retailers can, however, offer different prices to different customers as long as the pricing policies aren’t discriminatory. 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 Ask students if they have ever experienced bait- and-switch. then induces the customers to switch to a higher-priced model (the switch). • 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. 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. • 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. VIII. Summary • Setting prices is a critical decision in implementing a retail strategy, because price is a critical component in customers’ perceived value. • Retailers consider the price sensitivity of consumers in their target market, the cost of the merchandise and services offered, competitive prices, and legal restrictions. ANSWERS TO “GET OUT AND DO ITS” 2. Go to the Web page for Overstock.com and look at its top selling merchandise. Select a few key items and compare the price of each product at other online retail sites, such as Target.com, Amazon.com, Sears.com and Macys.com. How do the prices compare for this Internet outlet to a discount store, online retailer, and department stores? Are the results what you expected or were you surprised? Explain your reaction. Results here will vary depending on the merchandise selected. Answers could be discussed in class to see the findings. 3. Go to the Web site for Sandals (www.sandals.com) and see what you can get for an all- inclusive price. Describe how bundling services and products provide vacationers with value? Find another example in the travel and tourism industry of price bundling that successfully increases sales. The Sandals website highlights what is included in the all-inclusive packaging. Bundling services is convenient for some travelers who wish for a one-stop, no-hassle vacation. Other examples of bundling include travel sites like Expedia.com that bundle airfare and hotel together. 4. Go to your favorite food store and your local Walmart to find their prices for the market basket of goods listed in the accompanying table. What was the total cost of the market basket at each store? Did Walmart live up to its slogan of “Always lower prices”? One of Walmart’s current advertising strategies is to encourage customers to compare the prices of frequently shopped items to Walmart’s prices. However, some critics suggest that Walmart isn’t always comparing the prices of the exact same merchandise. For this exercise, students should shop the products listed in the table and see if there is a true price difference between a local grocery store and Walmart. ANSWERS TO DISCUSSION QUESTIONS AND PROBLEMS 1. What types of retailers often have high/low pricing? What types of retailers generally use an everyday low pricing strategy? How would customers likely react if a retailer switched its pricing strategy? Explain your response. High/Low Pricing - Retailers using a high/low pricing strategy frequently—often weekly— discount the initial prices for merchandise through sales promotions. Examples: Department stores and specialty stores. Some customers learn to expect frequent sales and simply wait until the merchandise they want goes on sale and then stock up at the lower prices. Everyday Low Pricing - Many retailers, particularly supermarkets, home improvement centers, and discount stores, have adopted an everyday low pricing (EDLP) strategy. This strategy emphasizes the continuity of retail prices at a level somewhere between the regular nonsale price and the deep-discount sale price of high/low retailers. Although EDLP retailers embrace their consistent pricing strategy, they occasionally have sales, just not as frequently as their high/low competitors. Changing the pricing strategy may delight some customers and confuse others. Consider the recent confusion around JC Penney’s. In 2012, JC Penney’s tried to switch from a high/low pricing strategy to an EDLP strategy. Customers were confused and JC Penney’s lost a tremendous amount of market share. 2. Why would sewing pattern manufacturers such as Simplicity, Butterick and McCall’s print a price of $12.95 (or more) on each pattern and then two times a year offer patterns for sale at $1.99 each? How could this markdown influence demand, sales and profits? Sewing patters are marked down twice a year to move inventory and make space for new designs. The seasonal nature of patterns can impact demand. Some consumes will wait for a sale and the stock up. Others will be excited to see what’s new and purchase patters at full price. 3. Reread Retailing View 14/1. Will an EDLP strategy work for JCPenney? Explain your answer? JCPenney traditionally used a high/low pricing strategy. Historically, JCPenney would offer over 600 sales a year with thousands of coupons. JCPenney was losing market share though, and wondered if following the Walmart model of EDLP would benefit the company. However, the target audience of JCPenney liked the sales and coupons and enjoyed the thrill of the hunt. The switch to EDLP did not translate well for JCPenney shoppers and alienated loyal customers without attracting new ones. Most consumers don’t have a lot of faith in a traditional EDLP strategy and believe that eventually, something will go on sale. Plus, with EDLP, customers can no longer brag about the great deals they got on their merchandise.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. 4. Re-read Retailing View 14.5. What are your thoughts about extreme couponing? Should retailers take steps to restrict it? Extreme couponing occurs when customers use multiple coupons or buy in large quantities to receive discounts. Extreme couponing is challenging because 1) it delays check-out time causing problems for other customers, 2) it causes inventory management issues by increasing the number of stock-outs, and 3) it erodes retailer margins. Stores like Rite Aid, Kroger, and Walmart are implementing practices to reduce the frequency of extreme couponing. Students should discuss their thoughts about extreme couponing. If someone is going to go through all the work to find the coupons, is it fair to punish them or restrict their usage? Should retailers restrict extreme couponing or embrace it as some online retailers have? 5. What is the difference between bundled pricing and multi-unit pricing? Price bundling is the practice of offering two or more different products or services for sale at one price. Multiple-unit pricing or quantity discounts refer to the practice of offering two or more similar products or services for sale at one lower total price. NOTE: For questions 6-10, you may use the Online Learning Center. Click on “pricing.” 6. A department store’s maintained markup is 38 percent, reductions are $560, and net sales are $28,000. What’s the initial markup percentage? MMU$ = 10,640.00 Initial markup (IMO) % = (MMU$ + Reductions) ÷ (Net sales + Reductions) IMO% = 11,200 ÷ 28,560 IMO% = .392 or 39.2% 7. 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. 8. 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 9. Men’s Wearhouse purchased black leather belts for $15.99 each and priced them to sell for $29.99 each. What was the markup on the belts? 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 = $29.99 - $15.99 Dollar markup = $14.00 Dollar markup Markup = Dollar markup/Retail price Markup = $14.00/$29.99 Markup = 47% Markup 10. 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 $400,000 + $900,000 Breakeven Quantity = __________________ = _________________ Unit Price – Unit Variable Cost $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 % 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. ADDITIONAL RETAIL MATH/PRICING PROBLEMS 1. A store sold the following items for the day: 2 sweaters at $39, 16 pairs of jeans at $59, 2 purses at $29 and 2 suits at $169. What are the gross sales for the day? 2 x 39=$78 16 x $59=$944 2 x $29=$58 2 x $169=$338 Add the total number of goods sold to get gross sales for the day: $1,468 2. Using the problem above, besides the gross sales, the store had customer returns and allowances: 1 jean returned at $59, 2 skirts at $39. They also had to give a discount of 10% on a $169 suit because it was soiled. What were the customer returns and allowances for the day? 1@$59 =$59 2@$39=$78 $169x10%=$16.90 Add cost of all returns and allowances $153.90 in customer returns and allowances for the day. 3. The store wants to calculate the customer returns and allowances as a percentage of sales. What is this percent? 153.90/1468= 10.49% 4. Using the store above, what were the gross sales for the day? $1468-$153.90=$1314.10 5. The buyer wants to know her cost of inventory sold. She purchased the jeans at $19, sweaters at $9, jeans at $27 and suits at $67. What was her cost of inventory sold on this day? 2x$19= 38 2x$9=$18 16x$27 =$432 2x$67=134 Add cost of all goods sold that day =$622 6. What is the gross margin, using the number calculated above? $1468-$622 = $846 7. The direct expenses for the month included the following: $200 for advertising, $500 for salaries, and $200 in rent expenses for the month. What were the direct expenses for the month? What were the direct expenses for the day, assuming a 31 day month? $200+$500 +$200 = $900 900/31 days = 29.03 per day 8. Indirect expenses during the month included: $75 for water, $89 for electricity, $60 for insurance. What were the indirect expenses for the month? For the day, assuming a 31 day month? $75 + $89 + $60 = $224 224/31 = $7.23 per day 9. What would be the total operating costs in this problem for the day? $29.03 + $7.23 = $36.26 10. What is the profit for this store on this particular day? Gross margin = $846 (calculated in number 6) Operating expenses =$36.26 $846-$36.26 = $809.74 11. A buyer wants to calculate her profit for the month. She knows the following information: The store sold $34,600 worth of merchandise Cost of merchandise sold (cost of inventory) was $15,890 The store had $600 in customer returns and allowances Her operating expenses were $6,000 Calculate her profit (or loss) for the month $34,000 -$15890 - $600 -$6000 = $12110 12. What is the gross margin if the store had net sales of $3,267 and cost of inventory sold of $1346? $3276-$1346= $1921 13. A store had indirect expenses for the month of $500 for advertising, $30 for security monitoring, and $75 for insurance. What would the direct expenses be for a day (when there are 30 days in the month?) $500 + $30 + $75 = $605 $605/30 = $20.17 14. A buyer wants to know her mark-up on a purchase. She purchased 25 sweaters at $9 and will sell them for $25. She also purchased 45 pairs of jeans at $21 and will sell them for $45. What is her total dollar markup in dollar and percent for this purchase? Cost: 25@$9=$225 45@$21=$945 Total cost: $1170 Retail: 25@$25=$625 45@$45=$2025 Total retail: $2650 total retail $2625-$1170=$1480 is the total dollar markup. 1480/2650 = 44% percent mark-up Another way to do this problem: $25-$9=$16 x 25 = $400 $45-$21=$24 x 45=$1080 $1080+400 = $1480 total dollar markup 15. A buyer realized several sweaters were not selling well. As a result, she marked them down from $58 to $38. There were 30 sweaters she marked down. What is the total dollar markdown? What is the total dollar markdown in percent? $58 - $38 = $20 x 30 = $500 Total dollar markup $58 x 30 = $1740 total retail 500/1740 = 29% 16. A store had average markdowns last year of 21%. The projected sales are $230,000. Assuming she is calculating based on a seven month season, what is her planned markdowns? 21% x $230,000= $48300 17. A store had sales of $203,562 for the year. Their average stock was $57,640. What was their turnover for the year? $203,562/$57640 = 3.53 18. A buyer decides to use the weeks of supply method to develop her buying plan. Her planned sales are $460,000 and her desired turnover is 4. What should her weeks of supply be for the coming year? 52/4 = 13 x $460,000 = $5,980,000 of inventory should be ordered for the year. 19. A buyer has determined he desired level of stock per month is $12,800. she plans to have sales of $5,600 for that month. What would her basic stock requirements be for the month? $5600 + $12800 =$18400 20. A buyer has planned purchases (or desired inventory) of $241,571. She has already ordered $46,798. She has received $87,623 worth of merchandise. What is her current open to buy? $241571-$46798-$87623 = $107,150 21. The cost of a new CD album is $8.75. The buyer plans to make an initial markup up of 25% on the retail price. What should the retail price be? 8.75/(1.25) = 11.67 22. The initial selling price for a blouse is $25. The cost was $14. What was the initial markup on retail? (25-14)/25 = 44% 23. A belt was originally priced a $17 and put on sale for $12. What was the markdown percentage on retail? (17-12)/17 = 29.4% 24. The cost of bicycle is $200. The initial markup on retail is 40%. After offering the bicycle at the initial selling price, the bicycle was markdown by 20% and it sold at that price? (a) What was the eventual selling price for the bicycle? Initial price = 200/(1 - .40) = $333.33 Selling price after markdown = 333.33 x (1. - .2) = 266.67 (b) (1) What was the maintained markup? (266.67 – 200)/266.67 = 25% 25. A woman’s dress suit was originally priced at $250. The first markdown was 20% on retail and the second markdown was an addition 30%. What is the selling price of the suit after the second markdown? 250 x .8 x .7 = $140 26. (a) A buyer for men’s ties wants to have a maintained markup of 40%. The buyer forecasts that the reduction as a percent of sales will be 13%. What should the initial markup be? (.4 + .13)/(1+ .13) = 46.9% see page 421 in seventh edition (b) In the above example, if the cost of the ties is $12, what would be the initial selling price? 12/(1-.469) = 22.60 27. A buyer orders 500 cotton sweaters at a cost of $20 per sweater. (a) What is the cost for all of sweater when they are sold? 500 x 20 = $10,000 (b) If the buyers wants to have a maintain markup of 50%, what is the total sales dollars that must be generated by the sale of all 500 sweaters? 20/1-.5) x 500 = 20,000 (c) The buyer sets the initial selling price for the sweaters at $45. 200 sweaters are sold at that price. How many sales dollars were generated by the sales of the initial 200 sweaters? 200 x 45 = 9,000 (d) How many sales dollars must be generated by the remaining 300 sales to achieve a maintained markup of 50%? 20,000 – 9, 000 = 11,000 (e) Sales of the sweaters are slowing and thus the buyer is going to mark them down. What does he need to sell each of the remaining 300 sweaters at realize a 50% maintained markup? 11,000/300 = $36.67 (f) How much of a markdown on retail can the buyer take to realize a 50% maintained markup on the sales of all 500 sweaters? (45.00 – 36.67)/45.00 = 18.5 28. A buyer for women hosiery is planning to buy for merchandise to be sold during the summer season that will generate retail sales of $150,000. The buyer wants to have a maintained markup of 34% on retail for summer hosiery sales. Reductions will be very small and can be ignored. The buyer has already spent $53,250 for merchandise that will generate $75,450 at retail. What markup does the buyer need to have on the remainder of the planned purchases to realize the overall markup of 34%? Sales needed at end of season = $150,000 COGS at season end = (1-.34) x 150,000 = 99,000 Sales generated = 75,450 cost for sales generated = 53,250 Additional sales needed = 150,000 – 75,450 = 74,550 Cost that can be spent for additional merchandise = 99,000 – 53,350 = 45,650 Markup needed on remaining merchandise = (74,550 – 45,650)/74,550 = 63.3% 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 seem to work best. Have each group bring their computer to class. The room must be Internet accessible. 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 Initial Retail Salvage Cost Receipt Units Women's Leather Jacket $208.00 $520.00 $104.00 6,850 Fashion Purse $900.00 $1,800.00 $0.00 630 Flower Vase $8.00 $19.99 $4.00 1,450 Deluxe Propane Grill $175.00 $500.00 $50.00 9,000 Fancy Dinner Set $160.00 $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 Time Left For This Week: 4:43 Weekly Selling Report (for last week's sales) MD Action (For This Week) Item # Item Name Orig Price Cur Price Cum Sale s Cum ST% LW Sale s LW ST% WOS Inv Inv $'s NOM D 25 % 50 % 1 Women' s Leather Jacket $520.00 $520.00 456 6.7% 456 6.7% 14.0 6394 $3,324,88 0 2 Fashion Purse $1,800.0 0 $1,800.0 0 24 3.8% 24 3.8% 25.3 606 $1,090,80 0 3 Flower Vase $19.99 $19.99 8 0.6% 8 0.6% 180.3 1442 $28,826 4 Deluxe Propane Grill $500.00 $500.00 5 0.1% 5 0.1% 1799.0 8995 $4,497,50 0 5 Fancy Dinner Set $400.00 $400.00 49 3.8% 49 3.8% 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 Units: End of week inventory 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 Women's Leather Jacket 0 46.9% $1,256,320 88.7% 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 67.1% 0 43.0% $2,490,557 60.6% You have potential! Your Score for All Items (Percent of Max's Gross Margin Dollars) 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 Solution Manual for Retailing Management Michael Levy, Barton A. Weitz, Dhruv Grewal 9780078028991
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