by Joel R. Evans and Barry Berman, the Zarb School of Business
This is the fifth in our series of six columns on hints for price-setting by small firms. How would you respond to these questions?
- How do you use prices in competing with a larger firm? One of the most common myths in retailing is that small firms can never enter into price competition with the Amazons and Home Depots of the world. While it is true that small firms will generally have a tougher time if they try to compete on price across the board (due to the economies of scale of the discount chains), they can do so if they run sales or offer regular savings on selected items. By focusing on special prices for 10 to 25 noticeable items, small firms can highlight that they are viable options for their shoppers and attract customer traffic. This works best if a firm runs specials on different items than those featured by the large chains. Also, small firms may have a major advantage over these chains: The latter often often need some type of upper management approval to offer sales and individual outlets may not have the flexibility to match local firms.
- Have you formed a buying group (cooperative) with other small firms to get better terms on your purchases? Large firms can get good terms from suppliers and make special requests of them because of the buying power they wield due to the volume of business that they do with the suppliers. Small firms can gain in their own dealings with the suppliers by forming buying groups; this will then enable the firms to account for substantial dollar purchases and lead to better terms. Buying groups are common for hardware, furniture, appliances, groceries, and consumer electronics. Check with your own trade association for further information — and be sure that forming a buying group is legal.
- Do you use odd prices ($59.95) rather than even prices ($60)? Although the impact of odd pricing on customer behavior may be overrated (after all, most people do not consider a nickel off to be much of a bargain), there is one significant reason to use this practice: Consumers are more likely to believe that a firm plans prices very carefully and works hard to keep the prices as low as possible.
- When you take a physical inventory, how do you compute the value of the merchandise remaining in stock? The prices set for the merchandise remaining in stock (after a selling season or before a reorder is placed) should have some relation to the value placed on that merchandise. For example, if a firm knows the value of an item in inventory is $30 at cost and that firm wants a 50 percent markup at retail, the selling price would be $60. The computation is easy if merchandise costs are stable. If they are not, the firm should learn about the retail method of inventory planning (which is based on the average of merchandise costs, depending on the quantity bought at each cost level) and apply this concept. Several computer software programs are available to aid in this process.
- Do you understand the difference between an initial markup and a maintained markup? Do you use these concepts in setting prices? Initial markups often need to be higher than maintained markups if a firm is to meet revenue and profit goals. Thus, an initial markup for an item must reflect the fact that during a selling season there will be shrinkage, breakage, employee discounts, and end-of-season markdowns. A maintained markup represents the weighted average markup for an item, which is computed as: (total actual revenues received – the cost of goods sold)/total actual revenues received. A firm will make a serious mistake if beginning-of-season prices represent the average prices sought for the entire selling season.