When setting prices, retailers have two very basic models to choose from: keystone markup and industry benchmarks. Keystone markup is simply doubling the costs of goods or a 100% markup. Some stores will price their products at 110% above costs, while others may choose to be more competitive. Keystone markup is easy to do, but the downside is that there are no analytics or other factors guiding it.
The second model follows industry benchmarks that help retailers understand the standards set in their chosen niche. These benchmarks are based on average gross profit margins in 55 retail segments. Interesting thing about benchmarks is that the percentage for gross margin is very close to keystone markup.
Benchmarking is helpful when looking at how the competition does their pricing, but it may be too general for every retailer. And keystones lack metrics that guide profitability higher. Are these pricing models still useful? Yes, they are a good starting point, but full of mistakes that can take away from your profits.
5 Pricing Mistakes
We see it every day when we go to the grocery store. Some products are priced much higher than others, yet they are practically the same thing. The difference is that the higher priced item may have a greater value than the others in its category. Value is the key to better pricing decisions.
There are five pricing mistakes that don’t account for value. Every retailer should understand how to avoid them in order to stay on target.
1. Cost-Based Pricing:
The keystone model is solely based on product costs, and neglects customer-perceived value. The customer’s willingness to pay is a major factor in gaining profitability. Understanding this requires knowledge of what your competition is doing and the use of point of sales metrics.
2. Small Changes in Prices:
Even small discounts in your pricing can have an impact on your profits. These discounts take away from revenue and cash flow, two very important things for retailers. Fighting for the pennies may seem like a waste of energy, but in the end it will pay off.
3. Forgetting to Manage Prices:
This is different than #2 because it’s about setting the right price the first time. Making improvements to inventory and purchasing strategies will require price management. When your business changes, so should your prices to communicate a better value, while you can capitalize on lower costs.
4. Price Sensitivity:
Consumers are willing to pay for value, because of excellent customer service or superior products. Apple is an great example of avoiding price sensitivity. Their premium pricing strategy focuses on quality and the giving the best user experience. And their profitability comes from lower costs of production.
5. Similar Products, Similar Pricing:
Similar is not the same, which means there are subtle differences between the products. These differences can have greater value to the customer, so you can price them at a higher amount. Organic produce and dairy tend to have this advantage in the grocery store.
Principles of Pricing
Pricing decisions takes a lot of time and effort. Understanding what the right prices are for your products can help you become more profitable. Just remember to avoid those five mistakes and stay on top of your point of sale reports, so you can adjust your prices when the time is right.