The primary goal of most businesses is to make a profit. There are many factors that affect the profitability of a business, such as management, location, cost of labor, quality of product or service, market demand and competition. In our free enterprise system the right to establish a price is yours. Market demand controls the response to your product or services.
You must understand the market for your product or service, the channels of distribution and the competition before you establish prices. You must know all costs and carefully analyze them. The marketplace responds rapidly to technological advances, international competition and a knowledgeable buying public. You must constantly keep abreast of all factors that will affect pricing and be ready to make necessary changes.
Markup on cost is accomplished by adding some percentage of cost to the cost of goods (merchandise shipping).
Annie's Purse Shop
Calculation of selling price
Cost of one purse € 12.00
x Markup percentage 33%
= Markup amount € 4.00
Cost of one purse € 12.00
+ Markup amount € 4.00
= Selling price € 16.00 for one purse
The 33 percent markup must cover all operating expenses (wages, rent, advertising, etc.) and provide some margin of profit. For example, Lisa's Purse Shop may figure 10 percent for wages, 6 percent for rent, 4 percent for advertising and 13 percent for profit.
The markup is sometimes expressed as a percentage of selling or retail price instead of cost. Most retailers prefer to express their markup as a percentage of retail price. Using the example above you would determine the retail markup percentage as follows:
€4.00 = amount of markup,
____________________________________ = 25% retail markup
€ 16.00 = retail selling price,
A business might choose to use a standard markup percentage on all products, or it may have different markups for different goods. A problem with the standard markup is that it doesn't recognize cost differences in selling different products. If product A costs far more to advertise or sell than product B, a standard markup percentage may produce a loss on product A and a greater-than-average profit on product B.
It is important to maintain an overall or average percentage of markup to return the profit percentage you establish. You must also allow for markdowns. Therefore, you must establish an initial markup percentage, which becomes the average markup. The initial markup is figured as follows:
Initial markup percentage = Operating expenses + desired profit
divided by Net sales
Breakeven is simply the point at which all costs are recovered and you begin to make a profit. Once you have established an average markup, the breakeven point can be determined. There are several formulas to use in determining breakeven. One simple formula is provided here, but we recommend that you check with your accountant or an accounting textbook to fully understand how best to figure a breakeven for your business.
Breakeven point = Operating expenses
Divided by Markup percentage
€ 50,000 = operating expenses
_____________________________ = €166,666.67 breakeven sales
30% = markup percentage
The breakeven price is figured the same for a service business as it is for a product-based business. However, many business owners prefer to figure breakeven for individual products or services, so they know which products to promote or discontinue.
Suggested retail price. A common pricing practice among small businesses is to follow the suggested retail prices supplied by the manufacturer. This allows the business to avoid the decision-making process and the trouble of monitoring the competition. The suggested retail price is easy to use, but it can cause problems. It may create an undesirable price image, and it doesn't consider the competition.
Competitive position refers to a strategy in which a firm bases its prices on those of its competitors. A small retailer should compare prices with similar stores. Do not try to compete with the prices set by large stores they can buy larger volumes, so their cost per unit is less. Instead, look at nonprice issues. For example, compare the services offered by the competition. Often customers will pay more for merchandise to obtain the type of service that they seek.
Pricing below competition means beating the competitor's price. Many vendors have been very successful using this pricing strategy, because they have greatly increased sales. Because this pricing strategy reduces the profit margin per sale, a firm needs to increase its sales and reduce costs.
- Obtain the best prices possible for the merchandise.
- Locate the business in an inexpensive area or facility.
- Closely control inventory.
- Limit the lines to fast-moving items.
- Design advertising to concentrate on price specials.
- Offer no or limited services
Below competition pricing is a difficult pricing policy to maintain, because every cost component must constantly be monitored and consistently adjusted. It also exposes firms to pricing wars competitors can retaliate by matching the price cutter, leaving both parties worse off.
Pricing above the competition is possible when nonprice considerations are important to buyers. Nonprice considerations that may be important enough to customers to justify higher prices include
- service considerations, such as delivery, speed of service, satisfactory handling of customer complaints, knowledge of product or service, and a helpful and friendly attitude;
- a convenient or exclusive location; and
- exclusive merchandise. A store may carry lines of well-known or high-quality brand names that are not available elsewhere. A store might get particular brands for a given trade area. The use of exclusive agreements avoids competitive pricing.
Markdowns, or price reductions, are a necessary part of doing business because inventory levels may become too high as a result of overbuying, seasonal merchandise, shopworn merchandise, misjudged customer responses, poor personal selling, lack of promotion and advertising or the competition's lowering the price of the same merchandise.
There are a number of theories about when it is best to take markdowns. This is a decision that will vary greatly with the type of merchandise, amount of competition, season of the year and amount of stock on hand. Every business should try to avoid being left with a lot of dated merchandise that will be difficult to sell.
Price lining refers to a marketing strategy based on price. This strategy targets a specific segment of the buying public by carrying products only in a specific price range. For example, a store may wish to attract customers willing to pay over 50 for a purse. Price lining has many advantages, among them the following:
- reduced errors by sales personnel;
- ease of selection for customers;
- reduced inventory by limiting the number of items in a category;
- reduced storage costs as a result of smaller inventory;
- ease of merchandise selection; and
- merchandise targeted to clientele.
A disadvantage to price lining is that by focusing too much on price, the store may overlook issues of quality or consumer buying trends. It also limits the ability of the business to meet competitors' prices.
Odd pricing with figures that end in 5, 7 and most often 9 is used for psychological reasons. Consumers tend to round down a price of €39.95 to € 39, rather than rounding it up to €40. However, this is not considered to be as effective today as it was in the past.
Multiple pricing is the practice of promoting a number of units for a single price. For example, two for €1.98. This is useful primarily in low-cost, consumable products such as shampoo or toothpaste. Many stores find this to be a desirable pricing strategy for sales and year-end clearances.