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Online Pricing and Promotional Strategies

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In this chapter from e-Merchant, the authors dissect the elements that go into determining online prices, along with creating the promotional plans that relate to pricing.
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The assortment planning phase laid the groundwork for pricing. In this chapter, we dissect the elements that go into determining prices, along with creating the promotional plans that relate to pricing. Our hypothetical e-retailers make pricing and promotional decisions based on industry standards and their knowledge of their customers and retail strategies.

The Elements of a Pricing Strategy

During the "Big Bang" days of Web commerce, the prevailing popular wisdom was that e-retailers would sell at dramatically lower prices than their brick-and-mortar counterparts. Even with these low prices, e-retailers would continue to enjoy fat profit margins because they would not be burdened with the pesky expenses of inventory and real estate. Furthermore, the online shopping population would be made up primarily of bargain-hungry shop-o-matics, seeking hot deals on obscure items.

Since then, the universe has expanded. e-Retailers have learned that they do need inventory, at least for some portion of their assortments. Real estate in Cyberspace is nearly as pricey as the kind on land—and can be just as expensive to maintain. Many individuals do indeed use the Web to find the lowest price, and price-comparison tools and sites even automate that process for them. However, many more use and shop the Web to look for unique or hard-to-find items, to access targeted editorial content, or to benefit from the convenience of 24/7 shopping and home delivery.

So if you feared your pricing strategy would consist mainly of undercutting the competition while struggling to remain solvent, take heart. It turns out that pricing strategies for e-retailers differ from those of traditional retailers only marginally, if at all.

Most other books on e-retail and Web-based commerce pay scant attention to the nuances of pricing and profitability, offering only general advice such as "shop the competition" or "plan for enough profit to cover your fixed expenses." In a nutshell, you should price at or below your competition, as well as buy low and sell high.

There is much more to profitable retail pricing than that. At the macro level, pricing results from a careful consideration of two values—the ceiling and floor. The price ceiling is the limit of what the market will bear, that is, what is the absolute most a customer will spend to purchase a particular item. The price floor is established by the cost of the goods plus all the expenses of doing business. The space between the ceiling and the floor is the room in which you make your profit.

So how do you find yourself within that space? That is the micro level, which takes into account all the nuances of your market, your customer base, your retail strategy and assortment, and more. The next two chapters examine all of the variables that go into determining a pricing strategy and how to pull the finances of your operation together to make your e-retail site profitable.

Pricing should be determined in conjunction with a careful analysis of each of the following elements:

  • Cost of goods

  • Initial mark-up

  • Promotional strategy

  • Competitor price

  • Retail strategy

Cost of Goods

Buy Low, Sell High

Retailers make money by selling products at a higher price than that at which they purchased them. An exception to that rule, however, is when a retailer chooses to sell a particular item at or below cost. (By the way, they are not making it up on volume, as the old saying goes.) The product is a "loss-leader" and is intended to bring traffic into the shopping environment in the hope that shoppers will also purchase additional, profitable items.

Loss-Leader Merchandising

When traditional retailers use loss-leader promotions, the loss-leaders are strategically positioned in the store so that customers will have to walk past more profitable items in order to get to the deals. If you are going to use loss-leaders in your e-retail store, you must find ways to drive customer traffic through your site so that they have an opportunity to see the other items in your assortment as well.

For example, a sporting goods e-retail store may decide to run a promotion offering athletic socks at cost. The store sends out an e-mail announcement to valued customers, announcing the special deal. When customers then visit the site, the screen offering the promotion on socks also merchandises the newest styles in running shoes (which are not promotionally priced).

Remember that the fine print of the promotion must be communicated with every promotional announcement. Be sure to indicate clearly if the special price is contingent on an additional purchase ("buy one, get one at half price"), if there is a time limit on the offer, or if customers are limited by quantity.

You may also consider loss-leaders as a way to gain information about your customers. For example, the sporting goods e-retailer may offer the socks at cost to any customer who fills out an online questionnaire indicating gender and sports preferences and provides an e-mail address.

Loss-leaders must be chosen carefully, however, and kept to a minimum if the retailer is going to remain profitable.

The vast majority of products are priced to provide a sufficient mark-up or margin with which the retailer can cover all costs of business and realize a net profit.

To be certain your prices allow for such a margin, you have to know the full cost of purchasing and owning a given item for sale.

Purchase Price

The first variable is the cost of purchase from the manufacturer or distributor. Does the price fluctuate over time? This is common with commodity-based products like gasoline. Do you have access to volume discounts, and are these quantities reasonable for your business? Perhaps the distributor offers a price break when you order 100 of an item at a time. That is great...unless your buy plan calls for you to sell 15 of the item for the entire season. Are there multiple sources of the product you can rely on at different times? For example, buying local is usually cheaper. However, if the product is strawberries, you live in Newfoundland, and it is January, you will need to find an alternative source for the ingredients for your homemade strawberry preserves.

If the answer to these questions indicates there will be variation in the price you pay to stock the product over time, select an average price to use in your calculations for the purposes of planning.

Of course, if your product costs change predictably and/or seasonally (as with fresh fruit and vegetables), your customers will also expect the retail price to fluctuate over the year. If your product costs are being affected by less predictable variations (e.g., exchange rate fluctuations), then you will not want to alter your retail price to reflect each adjustment, but you should revisit your retail price periodically to ensure that adverse changes have not eroded your margins.

Table 6.1 Freight Terms to Know

Term

What it is

What it means

FOB (Freight on Board)

Refers to the location where the buyer takes ownership of the goods

FOB Hong Kong means you become responsible for the merchandise, shipping, insurance, and duty/airport fees in Hong Kong; FOB LA means you become responsible for the goods in Los Angeles. FOB is always used in conjunction with a specific location.

Landed Cost

Cost at the U.S. port of entry

Freight from the country of origin to the United States, customs, and duty costs are included in the quoted price. Freight from the U.S. port of entry to the retailer is not included. You might have the option to use the vendor's freight service or to choose and arrange your own.

Ex Works

Cost at the manufacturer's (or supplier's) warehouse

Freight is not included in the quoted price. You might have the option to use the vendor's freight service, or choose and arrange your own.

Free Delivery

Cost as of delivery

Freight is included in quoted price. You may have a say in the method of transportation used.


Country of Origin

If the product is not manufactured in the United States or one of its territories, there will be duty costs. In most cases, your cost includes these fees, but if you are buying direct from an overseas source, your quoted price may not include this additional cost.

Freight

Someone is paying for the movement of products from manufacturer to retailer. The question is who and how. Does your supplier include freight in the price quote, or is it calculated (and billed) separately for each delivery?

Table 6.1 defines the critical terms that are variables included in price quotes.

Chapter 8 explores how to negotiate for the best terms possible to reduce these costs and more. For now it is merely important to note that you should include all of the above variables in determining what the average cost of goods is in making your pricing decisions.

Freight-Free? Not Likely

Some e-retailers may think they can avoid the extra costs of freight by requiring vendors to ship directly to customers. This is a highly unlikely scenario. First of all, if a vendor is willing to participate in such an agreement, you can bet that the vendor will charge you for the service—probably in addition to any shipping charges the customer pays. Second, most vendors are not equipped to pack and ship single items to individual customers; their operations are designed for bulk shipments to the retailer.

If you are selling tangible goods, you are best off planning to pay for their movement from place to place, whether by air, sea, railroad, or camel.

If necessary customs charges and freight are not included in your purchase price, just keep in mind that these costs will need to be deducted from your gross margin—along with the other costs of doing business. If they are already included in your purchase price, however, you can forget about them for purposes of your profitability calculations in Chapter 7.

Cost of Goods is merely the first variable to consider when establishing your pricing strategy. The other variables are just as important and more often overlooked by novice retailers.

Initial Markup (Margin)

Initial Mark-Up (IMU) is the difference between your retail price and your purchase price. It is calculated as a percentage of your retail price.

(Retail price2Purchase price) 3 100 = IMU %
Retail price

Thus, if you purchase an item for $20 and retail it for $50, your IMU is 60 percent.

(50–20) 3 100 = ;60%
50

"Usual" margins vary widely from retailer to retailer, and from product group to product group. Apparel mark-ups at traditional department stores usually range from 30 to 50 percent. Basic items such as socks and underwear tend to have higher margins in this environment. Extremely high-fashion items also tend toward higher margins in these sales channels. Warehouse chains such as Sam's Club or Costco aim for mark-ups between 20 and 40 percent on most non-food products. Grocery margins tend to be much more narrow, with mark-ups from 2 to 15 percent. Table 6.2 lays out the general mark-up standards traditional retailers have experienced.

Table 6.2 Traditional Retail IMU Standards

Store Type

Standard IMU (%)

Specialty store

60 to 70

Department store

50 to 60

Mass store (i.e., Wal-Mart, K-Mart)

25 to 40

Warehouse store (i.e., Sam's Club, Costco)

10 to 20

Grocery store

15 to 20

Goods Type

 

Soft goods (apparel)

60 to 80

Hard goods (gifts, stationery)

45 to 60

Food and Health/Beauty

10 to 25


Some retailers alter the stakes of mark-up by relying primarily on private label goods, which offer greater margins because a middleman is eliminated. The Gap and its subsidiaries (Banana Republic, Old Navy) use this strategy. These retailers treat almost their entire assortment as "fashion" (rather than "basic") and rely on frequent markdowns and constant change of styles and items. As a result, their stock turns over quickly, but IMUs start between 50 percent and 70 percent to make up for the heavy promotional activity.

As you are determining what your own initial mark-up should be, keep in mind that the initial mark-up is not the same as your net margin. Chapter 7 includes discussion on the factors that reduce IMU to Net Margin. Never forget that it is from your net margin that all fixed costs must be covered. Hence, you can see why it is important that your IMU is high enough to allow for all necessary costs of business and to generate a profit.

Promotional Strategy

Your promotional strategy—whether you plan to regularly put items on sale and what percentage of your assortment you then expect to sell at "full-price" versus sale price—will affect your net margin, so it must also be considered in establishing your retail price. Chapter 7 shows you how to make the exact calculations of the "cost" of promotional activity and permanent markdowns on items. For now, you must determine the overall strategy you want to follow with regard to realized sales prices.

Table 6.3 Pricing and Promotional Options and the Messages They Convey

No promotional (short-term sales) activity

Encourages the customer to believe the product is "worth" the asking price.

Frequent promotional activity

Generates excitement in customer—opens the possibility for "getting a great deal."

Little or no "clearance" product

Retailer limits the proportion of "fashion" in its assortment. Implies a stable assortment.

Low price compared with the competition

Retailer has found a way to cut costs. This may be by cutting quality or the cost of services. The retailer is advised to "explain" the reasons behind its lower costs if it wants to reassure its customers that quality of products has not been sacrificed.

High price compared with the competition

Retailer offers advantages that competitors do not. It is best if the retailer spells out what these advantages are...and always delivers on these promises.


There are a number of promotional strategies that you can use and/or adapt for your business and audience. Different promotional strategies communicate different messages to your customer. Be aware of the unspoken message in any method you choose. Table 6.3 summarizes some of the pricing and promotional options you have and how they are generally perceived by consumers.

Everyday low price is a strategy that communicates two primary messages to your customer:

  • Items will not be put "on sale," so there is no reason to delay purchase to wait for a more attractive price

  • On average, items are available at prices lower than the existing competition (otherwise, you would go out of business soon)

The main advantage to this system is that it prevents a customer from become a "sale-shopper" who rarely (if ever) purchases goods at full retail. The disadvantage is that this retailer, in order to remain credible, cannot put items "on sale" to generate excitement or traffic, or to compete with special offerings from other retailers.

Although many retailers rely on the strategy of "everyday low price," Wal-Mart is the one who coined the phrase in the early 1990s.

With this type of strategy, there will be less of a difference between IMU and net margin. If everyday low price will be your calling card, you can afford to operate with a lower IMU than their competitors who choose other promotional strategies.

Hi-Low is the most common promotional strategy in today's retail environment, online and off. Full retail price is occasionally reduced for a specified "sales period," after which the price will return to the previous level. Some stores have weekly sales (you get the circulars with the Sunday paper), suggesting that customers should come in often to see what is on sale. Hi-Low can also be implemented through sales in conjunction with specific events—Mother's Day, Back-to-School, Holiday Rush, and so on. The same principles can be applied by e-retailers: communicate with your customers that a sale is happening (through advertising or a newsletter, or by other means), or make sales such a regular occurrence that shoppers naturally visit the site to find the latest deals.

Law and Order in Cyberspace

The Federal Trade Commission governs commercial activity in the United States, online and off. The FTC is the agency consumers complain to when they feel they've been ripped off. The agency is accessible via e-mail. If your customers have a complaint, it is very easy for them to let the FTC know.

Although the Web is still a relatively new selling medium, the FTC and the courts agree: All the laws that govern promotion, pricing, and consumer protection in print, TV, and radio also apply to the Web. Be sure you understand and follow the rules to avoid getting slapped with hefty fines—or even closed down.

Know and follow the basic principles of advertising law:

  1. Advertising must be truthful and not misleading.

  2. Advertisers must have evidence to back up their claims ("substantiation").

  3. Advertisements cannot be unfair.

The FTC has published a concise guide to help e-retailers understand their obligations. "Dot Com Disclosures" can be found at http://www.ftc.gov/bcp/conline/pubs/buspubs/dotcom. In fact, the entire FTC site (http://www.ftc.gov) is full of helpful information and resources for e-retailers and consumers alike.

The Hi-Low strategy is popular because "sales" are seen to increase shopper excitement and drive sales. If overused, however, shoppers are more likely to avoid ever purchasing at "full retail," and furthermore become suspicious of high retail prices in general. Hi-Low can also increase your customer service costs. When a sale ends, you will have to deal with customers who want to know if they can still get a sale price. Hi-Low can also complicate your returns activities, when customers return an item bought at full price during a sale period, or vice versa.

If you are going to pursue this strategy, be sure you are obeying the laws regarding promotional pricing. To protect consumers, there are rules about what can be considered original retail price, how long an item can be on sale in a given season, and how much time must elapse before an item is put on sale again.

Be sure you understand and follow these rules. Not only does it make you a more credible retailer, but the Federal Trade Commission can and does audit and penalize retailers who violate these rules.

If you would like to use a Hi-Low strategy, keep in mind that many brand owners have "rules" about if and when their products can be on sale. By ignoring these rules, you may jeopardize your relationship with a vendor and thus with the source of your product.

Finally, if you employ this strategy, the size of the impact on your IMU depends on how many items you sell at the promotional price versus how many items you sell at regular retail. If you anticipate a significant portion of your sales will come from promotional activity, you must increase your IMU accordingly.

Clearance pricing is used when an item is leaving a retailer's assortment. "Clearance" indicates that the new price is "permanent," and the retailer will not again raise the price. When you decide you will no longer be carrying a certain item, you will want to sell-through as much of your existing stock as possible. Most retailers attempt to do this by a series of permanent markdowns, in order to capture as many sales as possible at the highest price possible.

The Suggested Retail Price

Have you ever wondered what suggested retail price (SRP) really meant? Who is suggesting the price? Why are they "suggesting" it and not just "setting" it?

The federal laws governing fair trade state that retailers have the right to choose the price at which they sell their products. This means that the manufacturers and brand-holders that make the products you buy have, legally, no right to set the price the consumer ultimately pays.

They are, however, allowed to "suggest" a price to the retailers who purchase from them. Not all choose to do this, but many, particularly well-known brands, do.

So does that mean you, as a retailer, can ignore the suggested price and set whatever price you want? Yes and no. That is what the law intended. However, in practice, it seldom works that way.

If you want to set a price higher than the SRP, most brand owners and/or manufacturers will not have a problem with this. Since SRPs are often not communicated to the buying public, your customer base will not be aware of your choice to do this, unless the item is common and all your retail competitors have chosen to carry it at the SRP.

If you set a price lower than the SRP, technically the brand owner and/or manager has no legal recourse. However, brand owners are also legally permitted to choose with whom they do business and to whom they refuse to sell. Undercut their SRP, and you can forget about making future purchases from that brand.

In addition to providing SRPs, many brands want to control how often and at how deep a discount their products can be put on sale. These points should all be discussed during your negotiations with your vendors. The rules may be general guidelines (e.g., the number of days their product line can be sold at 20 percent off in the coming season), or specific rules (e.g., the exact dates their products can be put on sale).

Finally, in the case of "fashion" products that the manufacturer is planning to offer during a limited time, you may be "asked" to maintain the original SRP until a specified "break-date," which is the first time you are allowed to reduce the price. In fact, this "request" may apply even to "basic" items that are being phased out of manufacturer assortments. Vendors may allow you to "Hi-Low" after that date, but more likely they will also request that any price reductions are permanent. To them, these policies protect the integrity of their brands' prices.

Some brands protect their SRPs, promotional schedules, and permanent markdown break-dates more zealously than others. In general, the better known the brand, the more likely you are to jeopardize your future supply if you do not follow their rules.

Does all this mean that retailers are forever at the mercy of the brands they want to carry? Not entirely. While the suppliers are free to choose with whom they do business, retailers are free to choose as well. Just keep this in mind as you negotiate that you are building relationships with your product sources.

For example, you may have an item that originally retailed at $40. You have 100 left in stock when you decide not to reorder any more and sales at $40 have stalled.

Perhaps you have chosen 25 percent as the first level of markdowns. Your first permanent markdown takes the price to $30. You highlight this new price, reminding your shoppers that soon you will be out of stock on this item, and sell 40 units at this price over the next eight weeks. Your stock currently stands at 60 units, and sales in the last two weeks have slowed again.

You take your second permanent markdown to 50 percent off the original price and the item now costs $20. At this price you sell an additional 40 units over the next eight weeks. Your stock now stands at 20 units, which you can markdown again or choose to "salvage" out of your stock.

Thus you have maximized the profit you can achieve as you try to reduce your on-hand stock to zero.

There are a couple of things to keep in mind in terms of clearance pricing. First, in the case of most branded items, the brand holder may "request" that you refrain from marking down their items until a set "break-date," which will be identical for all retailers carrying that item (see The Suggested Retail Price, above).

Second, it is not necessary to rely on markdowns to get rid of product you no longer want to have in stock. Your other options for eliminating unwanted stock include "returns to vendor" and "job-lotting."

Returns on unsold inventory can be negotiated at the time of purchase, or at the time you want to remove the item from your assortment. The latter is more likely to work if you have an ongoing relationship with that vendor, and are purchasing a new item to replace the one you are discontinuing.

Job-lotting is when you find a purchaser for your remaining stock. It will be unlikely that you will find a "jobber," who will pay you more than your original purchase price...but in some cases, getting $5 per unit for an item you purchased at $10 per unit is better than getting nothing at all.

Clearance, like Hi-Low promotional strategies, also affects your IMU. The more product you sell at less than the original retail price, the greater the difference between your IMU and your net margin.

Everywhere and Nowhere: Limitations on Promotional Strategies

The Web's global presence creates some potentially complicated legal issues for e-retailers. By operating in a global environment, e-retailers face potential exposure to laws governing promotional activities—even if they have no intention of selling to the markets in question. For example:

  • Denmark bans advertising that targets children

  • France bans advertising in English

  • Germany bans advertising that explicitly compares prices with a competitor's prices

Will this affect most e-retailers? Probably not. However, it might not hurt to include in your policy statements something about the limitations on your marketing (e.g., "We market and sell solely to residents of North America."). If you do plan to market your products internationally, be sure you have in your corner a good international lawyer who can ensure that you are complying with all applicable laws.

Actually, you probably need a lawyer anyway! Make sure you bring up this issue in one of your discussions with said lawyer.

Naturally, you purchase items you expect to sell, but you would be foolish to believe you will always sell every piece you have in stock. In fact, if you did, you probably did not purchase enough in the first place and are a victim of lost sales (and income) as a result.

If you are dealing in sized items (apparel, shoes), you are bound to be left with "odd sizes," which will never leave your stock unless you mark them down, sell them to a jobber, simply throw them away, or donate them to charitable causes.

Talk to others in your industry to determine what percentage of your product you can expect to sell at clearance. The higher this number is, the higher your IMU will have to be to keep your business profitable.

Competitor Prices

You are, of course, not setting your prices in a vacuum. Other retailers will be offering the exact same items, similar items, or substitute items. Make a list of the most important of these retailers (important being the most important to your customers, of course) and visit them on a regular basis to check out their pricing and promotional activity. You do not have to slavishly compare item for item in your assortment. However, you should at least be aware of how key items in your assortment are priced by your competitors.

What you are aiming for is an understanding of how the customer regards her options. How does the marketplace look to the customer? How would she describe your prices in comparison to their other options for purchase? It all ties back to your initial retail strategy: why will the customer want to shop from your e-retail site rather than use any other method of acquiring a product? Elements like customer service and content are "softer" ways to position yourself in the marketplace. Price, on the other hand, can be objectively quantified and compared with the rest of the landscape.

Not that this translates into: undersell the competition at any cost. Remember that only a subset of Web shoppers use the Web to compare prices for each item they want to purchase—and perhaps none of your target market does this at all. Overall, shoppers are more likely to develop a general impression of prices in the marketplace, and your pricing image within that marketplace is far more important than the individual prices you set.

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