Designing a retail business, whether online or offline or a combination of both (omnichannel retailing) is cognitively very tasking. So many efforts go into your frontend or storefront design, store layout, shelf or gondola arrangement, product assortment category planning, supply and logistics chain management, and inventory management.

Website design and administration, staffing, customer segmentation, positioning and targeting, customer acquisition and retention, product or service pricing, and much more are other strategic and tactic issues that must be given conscious attention to details. Yet the single most important determinant of retail business success is your pricing method because out of the four marketing mix (products, pricing, location, and promotion), pricing is the only component of the marketing mix that produces revenue.

Definition of product or Service Price

According to management guru and bestselling author, Philip Kotler, “Price is the sum of all the values that customers give up to gain the benefits of having or using a product or service. Price is the only element in the marketing mix that produces revenue; all other elements represent cost.”

Why You Need a Retail Pricing Strategy

"....If you have to have a prayer session before raising the price by 10 percent, then you've got a terrible business" - Warren Burret

Retail entrepreneurs, like most entrepreneurs in other industries, strive for growth, market share, revenue, and profitability. Growth means more revenue. Growth does not always mean more customers. As an example, let us examine the revenue of two hypothetical retail organizations that are similar in all respect, except for their pricing method:

• Company A: has 200 customers with a cumulative basket size of $150 per month per customer

                            Total revenue per month: 200 x $150 = $30,000

• Company B: has 175 customers with a cumulative basket size of $200 per month per customer

                            Total revenue per month: 175 x $200 = $35,000

If we assume that other variables (like products cost, advertising, sales promotion, etc) are the same for both retail companies, a valid argument can be made that company B has a superior pricing strategy than company A. It is therefore pertinent to appreciate the fact that your pricing strategy will have an inordinate amount of effect on both the revenue and the profitability of your retail business. What you are worth to your customers will be determined by how you design your pricing strategy, and also by how you communicate the strategy to your customers.

Gut-Based or Cost-Plus Pricing Formula

Cost-plus is the generic, number-crunching, accountancy-based, age-old pricing formula in use by most organizations, especially the manufacturing industries. In a broad sense, this can be represented by this formula:

• Direct Cost = Direct materials + Direct Labour + Direct Expenses
• Cost of Goods Sold (COGS) = Direct Cost + Overhead
• Selling Price or Price = Cost of Goods Sold + Margin

As straight forward and as sensible as this formula is, the fact is that it is no longer a one-size-fits-all formula suitable for all pricing decisions.

The Strategic Pricing dilemma

The survival and profitability of your retail business rest squarely on your choice of an appropriate pricing strategy. This is because the price is the only element of the marketing mix (the 4P’s of marketing) that generates revenue. The other three elements of the marketing mix, that is, product, place (location), and promotion are expense-related and so they only add to your overall cost structure. Because the price is the only revenue-generating element of the marketing mix and because you cannot tell with certainty the value your customers will place on your product or service pricing, and moreover, as you must concurrently take into consideration the attitude or response of your competitors, pricing decision is complex. The least tasking option is to price your offerings on the bases of your gut feelings by simply adding a number or a percentage of say 20% or 30%, or more, or less to your total cost, and declare the figure as your selling price. This is the path of least cognitive resistance, and the path to least resistance invariably leads to the path of least revenue. The challenge is that this is a gut-based or gastrointestinal-based pricing strategy, and it is not generally very sustainable. An element of your total cost, for instance, if you need to add more staff to your labor force, or your store rent increases or your licensing fee is jacked up, any or all of these variables may suddenly go up and mess up your projected bottom line (revenue and profit). Where this is substantial, your profit margin may take a severe hit. If this trend continues, you may end up with zero or less than zero margins, especially if your customers and or your competitors fail to join you in raising the selling prices of products on offer. And if this trend sustains or even gets worse, you might be out of business altogether.

On the positive side, should some elements of your cost decline, like obtaining favorable discounts from your suppliers, automation of some processes in your operations, then your margin goes up. The central issue with cost-plus pricing is that you are exposed to expense elements that may not always be totally within your control.

Competitor-Based Pricing Strategy

Because of the extremely thin margin in retail businesses, to survive and thrive, your pricing strategy must be based on the elimination of all identified and non-value enhancing cost elements. This is no easy task. Pricing is a process aimed at being competitive compared with the products on offer by the same or similar retailers in your retail business segment. Done wrong, cost-plus pricing can place you at a competitive disadvantage. However, with competitor-based pricing strategy, you simply copy the pricing strategy of competitors by adopting same pricing strategy or tweaking your products’ prices either upwards or downwards with marginal differences when compared with what is obtainable from the competition. As a pricing strategy, competitor-based pricing is simple to use, the risk is also low in retailing as the products you offer are mostly the same or similar products or services to that offered by your competitors. The accuracy of your competitor-based pricing strategy is anchored on the supposition that if your competitors are still in business, offering same or similar products at the prices you have “plagiarised”, then you stand in a good chance of remaining in business too.

The competitor-based pricing strategy can still offer you opportunities for increased net revenue. For instance, if you are able to systematically analyze your entire value-creating chain, eliminating as much waste, non-value adding activities, and redundancies as you can possibly identify, or if your major supplier offers you unique volume-based discounts or advertising support, or you implement a low stock-keeping inventory policy or Just-in-time (JIT) inventory management policy, you can still maintain the same competitor-based pricing while retaining the cost savings in your retail business.

In an era of Internet-abled desktop, tablets and smartphone technology, most consumers begin their shopping journey by browsing the Internet for store locations, products varieties, pricing, augmented services like click-and-collect or home delivery. In a commoditized retail environment, you should seek avenues to differentiate your retail business from either a cost-plus pricing strategy or a competitor-based pricing strategy. You can do this by transiting to a pricing strategy that is focused on creating unique value for your customers that will allow you to adopt a value-based pricing strategy.

Value-Based Pricing Strategy

Most companies gravitate to either a cost-plus pricing strategy or to a competitor-based pricing strategy. This is usually because these two pricing strategies are easier to understand and implement, but the drawback is that they also generate the least amount of margins on sales.

As explained in her bestselling book, The Serving Mindset: Stop Selling and Grow Your Business, author Brock Farnoosh explained the underlining concept of what value-based selling means, and why it can be complex in execution for an independent retailer. Value-based pricing requires a deep-rooted paradigm shift in our perspectives. We must transition from our personal and inward-focused agenda of selling to earn revenue to an outwardly directed customer-focused value-based relationship of service. The concept of “value” is intrinsic and deep-rooted. What is “value” to your segment market? Is it the need for self-esteem? A sense of exclusivity and self-actualization? Safety? Insanely convenient product or service? Luxury?    

On the surface, value-based pricing may seem a lot more difficult to understand and implement. Cognitively, the perception of “value” attached to a product or service is intrinsic and innate to individuals. What constitutes value to John Doe may not necessarily command the same value perception with Jane Doe. For instance, Volvo employs value-based pricing by emphasizing quality and safety are the core value of Volvo vehicles. Porsche has priced on the basis of a perception of success attached to its ownership. Luxury and scarcity are the value perception attached to Bentley as no more than 1,000 units are produced each year, whereas performance and comfort are the key value propositions of owning a Mercedes Benz.

In the Fast-Moving Consumer Goods (FMCG) industry, like household goods (home appliances, consumer electronics, sports equipment, jewelry, etc), brand perception is a key component of value-based pricing of these FMCG. In this respect, features are positioned as benefits. In-store atmospherics is another key component of value-based pricing. A retail store with the perception of upscale, with stocks of premium products assortments category can afford a pricing strategy that is value-based. In food and lifestyle consumables, shoppers are becoming much more health conscious. A retailer who stocks and emphasizes nature-grown organic foods that are pesticide-free, low or sugar-free and gluten and other additive-free foods can employ value-based retail pricing strategy.

In Conclusion, Know Your Customers

In making your pricing decisions, you should know that your customer is someone who has purchased from you in the past, with the expectation that she will do so again in the future. It is not sufficient that you know your products, you also need to know the customer segments you to serve. Their demographics like age, gender, race, location, and employment status are important elements in your pricing decisions, but much more important is the nitty-gritty knowledge of the typical psychographics of your customers like their lifestyles, their personality type, values, attitudes, and interests. The demographics of your customers tell you what their character profile looks like. However, the psychographics of your customers will reveal to you their buying behavior. Knowing demographically that your typical customer is college-educated, lives in an upscale neighbourhood, is married and has two kids, ages 4 and 6 is less of a predictor of her purchase intentions than knowing her behavior-based psychographics like the knowledge that she likes to shop at upscale stores, consumes organic and sugar-free products, browses the web daily, is health conscious, and is addicted to the food channel of her cable TV subscription. Therefore, her psychographics is a better predictor of her buying behaviour. Understand the perils of cost-plus pricing and competitor-based pricing, and decide if your market segment is suitable for value-based pricing strategy.