EXERCISE HOMEWORK 2

Although most retailers have grown savvy about cutting costs, few have figured out how much money they have passed up by using outdated pricing strategies and tactics. After all, pricing is an important contributor to profitability. The price of an item multiplied by the quantity sold is equal to the retailer’s revenue, and Chapter 8 illustrated the correlation between revenue and profit. Nevertheless, retailers today tend to routinely overprice some products and under price others. When making pricing decisions, retailers must remember that they are never going to be right every time. However, such decisions are a great deal less difficult if the retailers have been performing their other activities correctly. Pricing, as we pointed out in our retail strategic planning and operations management model (Exhibit 2.6), is an interactive decision made in conjunction with the firm’s mission statement, goals and objectives, strategy, operational management (i.e., merchandise planning, promotional mix, building and fixtures, and level of service), and administrative management. However, as pointed out in this chapter’s ‘‘Retailing: The Inside Story’’ box, too many retailers believe that the only way to attract consumers is by running a sale. Today, when one retailer cuts prices, everyone seems to follow. A prime example of this ‘‘follow-the-leader’’ tactic occurred during the 2008 Christmas season when Saks Fifth Avenue chose to slash prices by 70 percent on its designer clothes prior to the holiday season even beginning. Almost at once, competitors and shoppers panicked—many retailers immediately matched Sak’s prices and saw their gross margins vanish; shoppers, worried they might miss out on the sale, rushed out and purchased. Saks, after all, had started this price war because it didn’t want to be stuck with inventory after Christmas; however, like all price wars, this one ended badly. Within a week, retailer after retailer dropped prices even further, resulting in the earliest shoppers having paid higher prices and all retailers suffering losses.1 For retailers selling services, pricing is even more difficult. This is because services are intangible, not easily stored, and cannot be returned to the vendor for credit. A movie theater, for example, running a hit movie during a blizzard has the same fixed costs of being open as it would any other night. The theater manager cannot resell the empty seats at a later date and he cannot increase attendance on the night of the blizzard by reducing ticket prices. Consequently, as discussed in Chapter 2’s ‘‘Retailing: The Inside Story’’ box, service retailers, like airlines, hotels, golf courses, and even universities, are now using yield-management techniques when making pricing decisions. Specifically, the decision to price an item at a certain level should be related to the retailer’s decisions on lines of merchandise carried, location, promotion, credit and check cashing, customer services, desired store image, and the legal constraints discussed in Chapter 6. Remember that just as each retailer is different, each retailer’s pricing decision must also be different.2 After all, price is the easiest element of the retail mix for a competitor to copy. Consider for a moment the price of gas. When a gas station lowers its price, all the other stations in the immediate area soon match or beat that price. This is why a long-term, differential advantage based on price is difficult if not impossible to obtain.3 Retailers should not set prices without carefully analyzing the attributes of the merchandise being priced. Does the merchandise have attributes that differentiate it from comparable merchandise at competing retailers? What is the value of these attributes to the consumer? Consider, for example, Wright’s Market in Opelika, Alabama, a small town near Auburn University. Jimmy Wright has made a success of a small grocery business (his store is only 22,000 square feet) by offering the highest quality meat available. Using the slogan ‘‘We have the best meat at the best price,’’ more than 50 percent of his $160,000 weekly sales come from the meat department. Merchandise selection presents the retailer with another decision: the range of prices to be made available to the consumer. Remember, the retailer’s controllable element of price can be either the cost of goods sold or the gross margin that is added to the cost. The retailer, in deciding to buy an item to sell at a specific price, may either purchase lower-cost merchandise and have a high gross margin to offset the higher expenses needed to sell at that price or purchase more expensive goods and reduce the gross margin and expenses in order to sell at a given price. One drug store chain has gone so far as to use algorithms to determine prices. As a result, the chain raised the prices of some cough medicines. (After all, sick people don’t shop around.) In addition, the per-pill price of the 50- and 100-pill bottles of certain pain relievers used to be lower than on the 24-pill bottle. Now it’s higher because the kinds of people who buy jugs of pills are a bit less sensitive to a higher unit price.4 The one situation in which price interacts only with merchandise for sale and not with the other retail decision areas is in the case of liquidators. Liquidators purchase the entire inventory of a ‘‘dead’’ retailer only to run a going-out-of-business (GOB) sale. They generally assume responsibility for everything and agree to take a percentage of what they sell. In some cases, they may agree in advance to purchase the existing inventory and gamble that they will be able to unload all merchandise at prices sufficient to generate a solid profit. All this is done within a given time period, usually eight weeks. Thus, GOB sales are unique in that there is a beginning and end. They must hit their sales goals each week and be gone in eight weeks. Consequently, they don’t concern themselves with long-term commitments, offering additional services, or even offending customers.5 The location of a retail store, as discussed in Chapter 7, has a significant effect on the prices that can be charged. The closer the store is to competitors with comparable merchandise and customer service, the less pricing flexibility the retailer has. The distance between the store and the customer is also important. Generally, if the retailer wants to attract customers from a greater distance, it must either increase its promotional efforts or lower prices on its merchandise. This is because of the increased travel costs (in both time and dollars) consumers incur when they are located farther from the store. Travel costs cut into the amount the customer is able or willing to pay for the merchandise, thus forcing the retailer to lower prices to attract more distant customers. For example, the lowest prices for many brand-name products can usually be found at factory outlet malls, yet these locations usually have the highest travel costs. This is why for many consumers it is cheaper to purchase the merchandise at a nearby retailer. However, catalog and online retailers break down location barriers by providing a national and worldwide presence. Pricing for these retailers is balanced between charging higher prices for providing greater customer convenience and lower prices for products with higher volume and lower operating expenses The next chapter illustrates how promotion can increase demand for the retailer’s merchandise. However, this does not mean that pricing and promotion decisions are independent. Rather, retailers that promote heavily while remaining very price competitive may experience increases in demand greater than either a high-promotion or lower-price strategy would produce independently. Imagine, for example, a retailer establishing low prices but not promoting them in the marketplace. How would consumers know of the price cuts? Alternatively, imagine heavy promotion but no cut in prices. Obviously, each would generate demand, but the interactive and cumulative effects of both are likely to be much greater. For a given merchandise price level, retailers that offer either purchases on credit, even if only using bank cards, or check-cashing services will often experience greater demand than those that offer neither. In addition, retailers who provide both financial services may be able to charge slightly higher prices than those who do not while generating the same level of demand. This has become increasingly true for check-cashing services over the past decade as a large number of consumers don’t have bank accounts. The offering of check cashing has been found to be an effective means to attract Hispanics, whose wealth is soaring, despite the fact that almost 60 percent of this market doesn’t have a bank account.6 E-tailers targeting teens also have a special problem with regard to credit. Online purchases require a credit card, yet teenagers under 18 are not legally liable for their credit-card debts. However, nothing prohibits an retailer from issuing a credit card to a minor. In fact, consumer advocates charge that both banks and click-and-brick retailers are loosening their rules about who can get credit and are carefully looking the other way when minors apply. This is because credit-granting retailers are able to develop a strong loyalty with those teenagers. They also assume that the parents will bail out the teenager if he or she gets into credit trouble. Retailers that offer many customer services (e.g., delivery, gift wrapping, alterations, more pleasant surroundings, sales assistance) tend to have higher prices. A decision to offer many customer services will automatically increase operating expenses and thus prompt management to increase retail prices to cover these additional expenses. However, such a policy may also result in higher profits. Consider the case of women’s dresses. Customer service used to be common in department stores that took 50-percent to 60-percent initial markups, but pricing pressure by discounters has forced most department stores to respond by cutting markups and service. Women purchasing dresses began to feel neglected in department stores, especially when they had to start paying for alterations. Specialty stores have picked up on this; as a result, they offer the consumer greater assistance in selecting and trying on a dress, something unheard of in the low-price stores. Another example of a retailer justifying a higher price by offering outstanding service is No Kidding. This small toy store in an affluent suburb just west of Boston cannot compete with the retail mega markets on either price or variety. Therefore, it does not carry the extremely popular items, such as Xboxes, which everybody else discounts; instead, it stocks items not available in the larger stores. What enables No Kidding to produce a profit at a time when most small toy shops fail is the makeup and behavior of its sales staff. This well-informed staff is primarily made up of moonlighting teachers who can discuss the finer points of play and inform the purchaser of what is developmentally correct for a child of a certain age. In addition, the store wraps gifts at no charge, accepts returns without a receipt, and donates part of its profits to local schools and public television.7 In fact; many consumers are willing to pay more for extra service. Consequently, it is important to remember that customer service decisions interact strongly with pricing decisions. It is also important to note that service standards vary greatly by country. For example, Japan has extremely high service standards in retail operations. In Japan, gift wrapping is customary, and retailers commonly accept merchandise for return even after the product has been well used. Alternatively, many countries throughout the world do not accept returns regardless of reason. In these retail operations, once the product is sold, it is no longer the retailer’s concern. This is truly a situation of caveat emptor—let the buyer beware. Given differences in expected service levels, retailers must adapt pricing levels accordingly. One of the cues a customer uses in determining a retailer’s image is the retailer’s prices. If not offset by a poor location with poor service and merchandise selection, prices aid the customer in developing an image of the store, either consciously or unconsciously. If an exclusive, high-fashion store, such as Nordstrom, started to discount its merchandise heavily, it simply would not be the same store in the eyes of its customers. The merchandise, store decor, and personnel might remain unchanged, but the change in pricing strategy would significantly alter the overall store image. Thus, pricing policies and strategies interact with store image policies and strategies. Pricing decisions must be made only after examining the impact of the legal environment. This is especially true for the retailer seeking to operate in more than one state, as laws often vary between states. As pointed out in Chapter 6, a retailer may not set a price in collusion with a competitor, may not offer different prices to different retail customers, may not sell below cost, and may not claim or imply in any ads that a price has been reduced unless it really has. The other environmental factors we discussed in Part 2 (consumer behavior, competitor behavior, channel relationships, the socioeconomic environment, and the technological environment) should also be considered when the retailer is developing its overall pricing and market strategy. Still, pricing decisions are easy to make in the United States when compared to some other countries’ retail environments. As pointed out in Chapter 6’s ‘‘Global Retailing’’ box, for example, laws in France require that products be sold to all retailers—big and small alike—for the same price, thus making it tough for discounters to get any kind of pricing advantage. Furthermore, while reducing prices is quite common in the United States and hardly seems controversial, it can present major problems for an American firm entering Germany, as discussed in this chapter’s ‘‘Global Retailing’’ box. In the United States, there are laws against vertical monopolies and other restraints on trade to ensure fair competition. American consumers can buy from a full-price retailer or a discounter. American discounters depend on bulk-purchase discounts from manufacturers, rapid inventory turnover, inexpensive real estate, and price-conscious shoppers who are willing to perform some marketing-channel functions themselves. A retailer’s pricing objectives should be in agreement with its mission statement and merchandising policies. Some objectives may be profit-oriented, some may be sales-oriented, and some may seek to leave things just as they are. However, by beginning with the proper pricing objectives, the retail manager can establish pricing policies that will complement the retailer’s other decisions and help attract the desired target customers many retailers establish the objective of achieving either a certain rate of return or maximizing profits A target-return objective sets a specific level of profit as an objective. This amount is often stated as a percentage of sales or of the retailer’s capital investment. A target return for a supermarket might be 2-percent net profit on sales. The objective of profit maximization seeks to obtain as much profit as possible. Some people claim that this pricing policy ‘‘charges all the traffic will bear.’’ Retailers know that if they follow such a policy, they are inviting competitors to enter the market. Thus, in general, a retailer should seek to set prices, not to get as much as possible from each customer, but at a level conducive to build customer loyalty and with stand the competition. However, in some cases, a retailer may have a temporary monopoly and want to take advantage of it. The first fast-food outlets in a university’s student center, knowing that others would follow shortly, often charged high prices, only to lower them when competition finally entered the market. This is known as skimming or trying to sell at the highest price possible before settling on a more competitive level.8 Other retailers may take the opposite approach and use penetration, which seeks to establish a loyal customer base by entering the market with a low price. For example, many locally owned retailers such as coffee shops often charge low prices, hoping to make stopping at their store a habit for their customers before a large chain operator such as Starbucks enters their trade area. Sales-oriented objectives seek some level of unit sales, dollar sales, or market share but do not mention profit. Two of the objectives most commonly used in retailing are growth in market share and growth in dollar sales. Although both of these objectives are used by many retailers today, especially smaller retailers, the

achievement of either does not necessarily mean that profits will also increase. After all, if a retailer lowers prices, gross margin will go down and sales may improve, but the retailer will not necessarily make more money. Retailers who are happy with their market share and level of profits sometimes adopt status quo objectives or ‘‘don’t rock the boat’’ pricing policies. Many supermarkets gave up on the extra profits and increases in market share that ‘‘double coupons’’ might have brought because they were afraid of what competitive actions would result. It should be noted that pricing actions such as double couponing are not always effective and profitable. Many times, especially when other retailers match the promotion, coupons are only used by the retailer’s regular customers, which simply reduce the retailer’s profit. Also, some retailers prefer to compete on grounds other than price. Convenience stores, for example, seldom match the prices of nearby supermarkets. Still, retailers such as McDonald’s and Burger King who want the consumer to focus on factors such as quality of food, service, and locational convenience instead of price are sometimes forced to drop prices by promoting ‘‘value meals’’ in the face of mounting competition just to maintain status quo market share. Pricing policies are rules of action, or guidelines that ensure uniformity of pricing decisions within a retail operation. A large retailer has many buyers who are involved in pricing decisions. By establishing the store’s overall pricing policies, top merchandising executives provide these buyers with a framework for adopting specific pricing strategies for the entire organization. A retail store’s pricing policies should reflect the expectations of its target market. Very few retailers can appeal to all segments of the market. Low- and middle-income consumers are usually attracted to low-priced, discount stores. The middle-class market often shops at moderately priced general merchandise chains. Affluent consumers are frequently drawn to high-priced specialty stores that provide extra services. Only supermarkets are able to cross the various income lines, and even then there is some basis for segmentation. Successful retailers carefully position themselves in a market and then direct their specific pricing strategies toward satisfying their target market. Many times the proper pricing policies influence consumers to patronize one store over another. In establishing a pricing policy, retailers must decide whether they should price below, at, or above market levels. Because of the recent economic slowdown, a large segment of any trade area now buys primarily on the basis of price. A below-market pricing policy is also attractive to many retailers such as discounters and warehouse clubs. Such a policy doesn’t mean that the retailer sells every item in its store at a price lower than can be found elsewhere in its trading area. Rather, the retailer is more intent on how its prices are perceived versus those of the competition. Remember that not even Wal-Mart will have the lowest price on every item a consumer will typically purchase during a given week. Instead, the chain endeavors to have the lowest total cost for all items purchased. Below-market retailers must buy wisely, which may include closeouts and seconds; stock fast-selling merchandise; curtail customer services; and operate from modest facilities. Also, some of them choose to stock private-label brands extensively and enhance their low-price image by promoting the price differences between their private brands and comparable national brands. That some retailers are successful with such a policy is evident by the fact that many local retailers, especially restaurants, now use warehouse clubs and supercenters as their suppliers. Besides being known as a ‘‘tough, obnoxious, and insane’’ competitor, the retailer who uses this policy benefits by discouraging some competitors from entering a given trading area so as to avoid head-to-head battles.9 However, for retailers to consistently price below the market and be profitable, they must concentrate on generating gross margin dollars per square foot of space, not the gross-margin percentage. After all, profitability is not directly related to the gross-margin percentage of the product sold but the amount of gross margin per unit sold times the number of units sold. Consequently, below market retailers must always try to increase the sales per square foot of store space since they have already reduced their markups. A growing number of retailers today are becoming increasingly concerned that the growth of the Internet will forever change the way retailers set prices. Because of eBay’s introduction of the cyber auction for overstocked, vintage, or used items; Priceline.com’s ‘‘name-your-own-price’’ policy for travel; and Amazon.com’s continued introduction of more general merchandise items to offer on the Internet, many people have come to believe that all retailers will soon be forced to sell below market. (Never mind that it is impossible for all retailers to sell below the average selling price for all items.) Nowhere is this more evident than in the chapter’s ‘‘What’s New?’’ box illustration, which shows that even the smallest of buyers and sellers can use cyberspace to learn what the ‘‘market price’’ is. Most merchants want to be competitive with one another. Retailers’ use of comparison shoppers—that is, having employees visit competitors’ retail outlets in order to compare prices—stems from this basic premise. Competitive pricing involves a price zone, a range of prices for a particular merchandise line that appeals to customers in a certain demographic group, such as Target selling women’s tops from $14.99 to $29.99. However, it is important to remember that zones may vary across groups. Dillard’s does not necessarily need to match the prices of Target, yet Dillard’s should maintain prices similar to those of Macy’s, particularly when they compete in the same mall. Alternatively, Target should be competitively priced with Wal-Mart. Pricing at market levels is extremely important for e-tailers given the ease with which consumers can compare prices across different Internet retailers. The size of a retail store affects its ability to compete on price. Small retailers usually pay more for their merchandise and have higher expenses as a proportion of sales than larger retailers. Although many small retailers have joined voluntary cooperative chains to reduce their expenses through quantity discounts, they continue to experience a cost disadvantage. For these reasons, small retailers such as mom-and-pop grocery stores and convenience stores often stress convenience and service rather than price in their retailing mix. However, even in these cases, it is important that one’s prices not be too far out of line. Sometimes, as this chapter’s ‘‘Service Retailing’’ box illustrates, circumstances force retailers to price at the market but at a price so low that it generates a very low profit. This is what is happening today with new car dealers as a result of the recent recession. Some retailers, either by design or circumstance, follow an above-market pricing policy. Certain market sectors are receptive to high prices because nonprice factors are more important to them than price. Some retailers such as Nordstrom offer such outstanding service that they have minimal price competition. Other retailers, such as small neighborhood drugstores and hardware stores, are forced to price above the market because of their high cost structure and low sales volume. Some other factors that permit retailers to price above market levels include the following.

 Merchandise Offerings. Some consumers will pay higher-than-average prices for specialty items, an exclusive line, or unusual merchandise. Prestige retailers such as Gucci and Neiman Marcus carry high-priced specialty items.

 Services Provided. Many communities have service-oriented merchants with a loyal group of customers who are willing to pay higher prices to obtain an array of services ranging from wardrobe counseling to delivery. Nordstrom’s clerks, for example, have a habit of doing such special things as dropping off purchases at a customer’s home, sending thank-you notes to customers, and even ironing a newly purchased shirt so the customer can wear it that day.

 Convenient Locations. The convenient location of gift shops in hotels, airline terminals, and even downtown office buildings allows them to charge higher prices. Knowing that consumers value time, fast-food retailers select sites adjacent to residential areas.

 Extended Hours of Operation. By remaining open while other stores are closed, some merchants are able to charge higher-than-average prices. Service plazas on interstate highways justify their higher prices by never closing.

Various pricing strategies are adopted by the traditional bricks-and-mortar retailers in an effort to achieve certain pricing objectives. The pricing strategies should be in accord with the other components of the store’s retail mix: location, promotion, display, service level, and merchandise assortment. Customary pricing occurs when a retailer sets prices for goods and services and seeks to maintain those prices over an extended period of time. Movies and vending-machine products are common examples of items that use customary pricing. Here retailers, such as movie theaters with their $8 ticket prices, seek to establish prices that customers can take for granted over long periods of time. Variable pricing is used when differences in demand and cost force the retailer to change prices in a fairly predictable manner. Flowers, for example, tend to be priced higher when demand is greatest around Mother’s Day and Valentine’s Day. It is a common practice for most resorts to increase their rates on premium rooms in June, a busy wedding time. Limo rentals are usually priced higher in the spring because of weddings, proms, and graduations. Tuesday and Wednesday nights tend to have lower demand for movies and dining out, so many theaters and restaurants offer specials on those nights. Fresh fruits tend to sell for less during their growing seasons when the retailer’s costs are down. In addition, many restaurants offer the same meal at lunch as for dinner but with a discounted lunch price (often 10percent to 20 percent lower) to increase demand. Flexible pricing means offering the same products and quantities to different customers at different prices. Retailers generally use flexible pricing in situations calling for personal selling. The advantage of using flexible pricing is that the salesperson can make price adjustments based on the customer’s interest, a competitor’s price, a past relationship with the customer, or the customer’s bargaining ability. Most jewelry stores and automobile dealerships use this pricing policy, although not all customers like it.11 For example, your college probably uses some form of flexible pricing for athletic events. Tickets on the 50-yard line are more expensive than those in the end zone. Also, student tickets are probably cheaper. This illustration highlights the key problem with flexible pricing—you don’t want those with the lower-priced tickets (students) being able to resell their tickets to the higher-priced market (the general public). Many types of retailers use flexible pricing by varying their prices and giving discounts to special consumer groups such as loyalty club members, senior citizens, and the clergy. Interestingly enough, some analysts predict that since a baby- boomer now reaches age 60 every eight seconds, senior-citizen discounts can be expected to disappear over the next decade. Today, some employee groups, credit unions, and housing or neighborhood groups have negotiated price discounts with selected retailers. In fact, the recent downturn in the economy has increased the importance of flexible price as more shoppers are engaging in old-fashioned haggling. This has forced retailers eager to make sales to become flexible. While most major chains don’t want to go on record saying they will engage in price negotiation, these retailers do say that the increased level of autonomy at the store level seems to be good for creating the impression that these are neighborhood stores, not just uncaring national chains. However, Americans are nowhere near what some Chinese consumers do to negotiate lower flexible prices. In China, to the dismay of many retailers, some of the country’s 1.3 billion consumers have started shopping in teams to haggle for bigger discounts. This team purchasing practice begins in Internet chat rooms (such as 51tuangou.com—the Chinese word tuangou means ‘‘I want to team buy’’), where they hatch plans to buy appliances, furnishings, food, and even cars in bulk. Next, they show up en masse at stores to demand discounts.12 Flexible pricing, although popular because it seeks to match levels of supply and demand, does have its disadvantages. Costs can dramatically increase, and revenues decrease, as customers begin to bargain for everything. Similarly, customers may get mad at the retailer and take their business elsewhere when they find that they paid more than a friend did for the same product. This is why the one-price policy is so popular in the United States. Under a one-price policy, the retailer charges all customers the same price for an item. A one-price policy may be used in conjunction with customary or variable pricing. For example, all people buying a Big Mac at the same McDonald’s will pay an identical price. Roland Hussey Macy, the founder of Macy’s Department Store, is often credited with the one-price policy, but recently the authors found evidence that a Sacramento retailer, Weinstocks & Lubin, was using this policy in 1875, nearly four decades before Macy’s.13 This policy allowed for efficiency and fairness in handling customer transactions in a large store, where the selling activity is delegated to salespersons that have varying degrees of loyalty to the retailer. If salespersons are permitted to bargain over price, then customers who are shrewd and assertive could conceivably negotiate terms that are unprofitable to the retailer. A one-price policy, therefore, speeds up transactions and reduces the need for highly skilled salespeople. Most catalog operators adopt a one-price policy since they are forced to retain their prices until the expiration date of the catalog, which can be six months from its issuance. Many manufacturers encourage retailers to follow a one-price policy to maintain the image of their products. They do so by advertising the suggested retail price on the packaging and using personal selling techniques to persuade retailers to maintain that price. However, such a pricing policy will work only if the vast majority of retailers voluntarily agree to stick to the plan. Otherwise, a flexible price retailer will know the price it has to beat. To simplify pricing procedures and help consumers make merchandise comparisons, some retailers establish a specified number of price lines or price points for each merchandise category. Once the price lines are determined, these retailers purchase goods that fit into each line. This is called price lining. For example, in men’s slacks, the price lines could be limited to $29.95, $49.95, and $69.95. The monetary difference between the price lines should be large enough to reflect a value difference to consumers. This makes it easier for the salesperson to either trade up or trade down a customer. Trading up occurs when a salesperson moves a customer from a lower-priced line to a higher one. Trading down, which gained in popularity during the recent slowdown, occurs when a customer is initially exposed to higher-priced lines but expresses the desire to purchase a lower-priced line. Retailers select price lines that have the strongest consumer demand. By limiting the number of price lines, a retailer achieves broader assortments, which leads to increased sales and fewer markdowns. For example, a retailer who stocks 150 units of an item and has six price lines would likely have an assortment of only 25 units in each line. On the other hand, if the 150 units were divided among only three price lines, there would likely be 50 units in each line. When retailers are limited to certain price lines, they become specialists in those lines. This permits them to concentrate all their merchandising and promotional efforts on those lines, thus defining their store image more clearly. In addition, they direct their purchases to vendors who handle those lines. The vendors, in turn, provide favored treatment to their large-volume retailing customers. Other advantages of price lining include buying more efficiently, simplifying inventory control, and accelerating inventory turnover. From the shopper’s perspective, it is easy to shop when price lining is used because differences are perceived among the various price points. An analysis of a store’s best-selling price lines is essential prior to making any decision to alter them. Generally, middle-priced lines should account for the majority of one’s sales. When the bulk of sales occur at the extremes of the price lines, the retailer should take corrective actions. These include altering the assortments in the current price lines, changing the price lines, redirecting the salespersons’ efforts, developing more effective promotions, or adjusting the total marketing mix to a new target market. The practice of setting retail prices that end in the digits 5, 8, or 9—such as $29.95, $49.98, or $9.99—is called odd pricing. A quick look at retail advertisements in the newspaper will reveal that many retailers use an odd-pricing policy. Retailers feel that this policy produces significantly higher sales, and recent evidence suggests they might be correct.14 Presumably, consumers tend to focus most of their attention on the digits left of the decimal and overlook the cents.15 Another theory suggests that the use of an odd price connotes ‘‘value’’ or a discounted price, thus encouraging the customer to purchase more units.16 While recent evidence suggests retailers may benefit from the way consumers perceive—or, more accurately, misperceive—odd prices, a more plausible explanation for its initial adoption back in the early part of the 20th century was the lack of a sales tax. In those days, merchandise was priced in even dollars, thus making it easy for salespersons to pocket the occasional one-, five-, or ten-dollar bill or gold piece since they did not have to make change for the customer. When Marshall Field caught on to this, he devised the first odd-numbered pricing system to stop the practice. Field ruled that, ‘‘We’ll charge 99 cents instead of even dollars. This will force the clerks to ring up the sales, open the cash register, put the money in and give the customer a receipt and change.’’ Because odd prices are associated with low prices, they are typically used by retailers who sell either at prices below the market or at the market. Retailers selling above the market, such as Neiman Marcus and Nordstrom, usually end their prices with even numbers, which have come to denote quality. These retailers would likely sell an item for $90.00 rather than $89.99. Prestige-conscious retailers are not seeking bargain hunters as customers. With multiple-unit pricing the price of each unit in a multiple-unit package is less than the price of each unit if it were sold individually. Grocery retailers use multiple-unit pricing extensively in their sales of cigarettes, light bulbs, candy bars, and beverages. Apparel retailers often sell multiple units of underwear, hosiery, and shirts. Retailers use multiple-unit pricing to encourage additional sales and to increase profits. The gross margin that is sacrificed in a multiple-unit sale is more than offset by the savings that occur from reduced selling and handling expenses. Generally, multiple-unit pricing can be effectively employed for items that are either consumed rapidly or used together. Bundling generally involves selling distinct multiple items offered together at a special price. Here the perceived savings in cost or time for the bundle justifies the purchase. At the same time, bundling can increase the retailer’s revenue since the customer may actually purchase more items than originally planned. For example, while airlines have been actively unbundling their prices, many travel agencies are now bundling their vacation packages. Here they package airfare, hotel, transfers, and meals together as a means of reducing price comparisons and increasing the number of options sold. Today, a small number of retailers are testing nontraditional forms of bundling to encourage customers to patronize their establishments by providing non related services gratis or for a small fee. For example, some movie theaters have found that the main obstacle encountered by parents when coming to the movies is finding child care. As a result, some theaters now offer either ‘‘Monday Night Is Baby’s Night’’ for very young babies, or child-care centers for children aged 2 to 8. This latter bundling program seems to be going over well with parents who previously

could only consider attending PG movies. Grocery stores and physical fitness centers are also testing the addition of child-care facilities. Such action shows that retailers are becoming more oriented toward their customers’ needs, especially when child and adult activities significantly diverge. Some parents, especially single parents, believe that certain errands and tasks, such as trips to the grocery store, can be sharing activities; however, these parents are also aware that most of the time their youngsters get

bored sitting in a shopping cart. The economic conditions of recent years have also caused some retailers, especially those selling services, to drop the idea of bundling their merchandise and instead unbundle them. These retailers hope that by unbundling their offerings they’ll increase revenues without offending their customers. For example, apartments near universities now charge for parking spaces rather than provide them for free. Nevertheless, while airlines now charge for ticketing, snacks, and carry-on luggage, they have backed away from charging for use of the toilet, something European discounter Ryan air proposed in 2009. When leader pricing is used, a high-demand item is priced low and advertised heavily in an effort to attract consumers into a store. The items selected for leader pricing should be widely known and purchased frequently. In addition, information should be available that will permit consumers to make price comparisons. National brands of convenience goods such as Crest toothpaste, Mitchum antiperspirant, Maxwell House coffee, and Coca-Cola are often designated as leader items.17 Leader pricing is usually part of a promotional program designed to increase store traffic. A successful program will produce additional sales for all areas of a store. In many instances, the price of the leader item is reduced only for a specific promotion. Some retailers, such as supermarkets, however, regularly feature leader items.18 Today, many convenience stores use gasoline as a leader. These retailers reduce their gas prices by a penny or two to get customers into their store. Once in the store, customers are exposed to fast-food sandwiches, groceries, fresh produce, beverages, and even fresh flowers. In such stores, the inside merchandise contributes more than 70 percent to the store’s gross-margin dollars and subsidizes its gasoline business. For those customers who just want gas, these stores have pay-at-the-pump facilities. A retailer using leader pricing should carefully evaluate its usefulness. If consumers are limiting their purchases to only those leader items, then the policy is ineffective. Because leader items may be sold at or near a retailer’s cost, higher-markup items must also be sold to generate a profit for the retailer. However, recent research has found that in the supermarket industry ‘‘cherry pickers,’’ shoppers who buy only items on sale, aren’t as numerous or as profit-draining as the industry once feared.19 An item that is sold below a retailer’s cost is known as a loss leader. For example, every St. Patrick’s Day, many supermarkets sell corned beef at a loss in hopes of attracting consumers to their stores and making a profit on the rest of their purchases. This chapter’s ‘‘Global Retailing’’ box shows the costly error made by Wal-Mart when it tried to use loss-leader pricing upon entering the German market. The pricing actions of discounters using below-market pricing have forced manufacturers to change their pricing strategies, thus endangering another group of retailers—those using leader pricing. Retailers using everyday low prices want vendors to offer them constant prices throughout the year by phasing out virtually all deep discounts and offering them the same low price every day. For example, instead of selling retailers a case of peanut butter for $20 one week and offering it on sale the next week for $15, they want it priced at $18 every week. This would limit the ability of leader prices such as supermarkets to continue their use of high–low pricing. High–low pricing involves the use of high everyday prices and low leader specials on featured items for their weekly ads. An example of a nonfood retailer that uses high–low pricing is JCPenney, which has regularly scheduled sales every week. The practice of advertising a low-priced model of a shopping good such as a television or a computer merely to lure shoppers into a store is called bait-and-switch pricing. Once the shoppers are in the store, a salesperson tries to persuade them to purchase a higher-priced model. Bait-and-switch pricing, which was discussed in Chapter6,is considered by the Federal Trade Commission to be an illegal practice when the low-priced model used as bait is unavailable to shoppers. Some in the industry describe the bait merchandise as being ‘‘nailed to the floor.’’ A private-label brand can often be purchased by a retailer at a cheaper price, have a higher markup percentage, and still be priced lower than a comparable national brand. Private labels also permit the retailer a large degree of pricing freedom because consumers find it difficult to make exact comparisons between the private and national brands. Many retailers, like Marks & Spencer, Sears, and Wal-Mart, price their private brands below the market. Canada’s Zellers, a division of The Hudson Bay Co., has relied on private labels to respond to Wal-Mart’s invasion of its Canadian market. Backed by its motto ‘‘The Lowest Price Is the Law,’’ Zellers uses private labels to give it exclusivity and quality, especially in apparel, where 80 percent of its line is private.20 Other retailers seeking to differentiate themselves from competitors are now using an above-market pricing approach for their private labels. Department stores that have been battered on price by discounters and specialty stores are now using private labels to improve their own image. Macy’s, for example, uses its own ‘‘Hotel Collection by Charter Club’’ label to sell Italian-made $1,350 duvets and $275 pillowcases.21 Another variation of private labeling is not to use different brand names. This is common for retailers selling products where customers have limited knowledge, such as those selling mattresses. These operators want the national brand’s appeal,

but instead require different model numbers. This degree of consumer ‘‘blindness’’ allows the retailers to avoid having to match a competitor’s price. A retail buyer should be able to calculate rapidly whether a proposed purchase will provide an adequate markup or gross margin. The markup can be expressed in dollars or as a percentage of either the selling price or the cost of the good. There are times, however, when a retail buyer needs to compute the markdown, which is a reduction in the selling price of the goods. Markdowns are made in order to move certain merchandise, especially when the color or size assortments are no longer complete. To calculate the selling price (or retail price), the retailer should begin with the following basic markup equation:

SP = C + M

Where C is the dollar cost of merchandise per unit, M is the dollar markup per unit, and SP is the selling price per unit. Thus, if the retailer has a cost per unit of $16 on a T-shirt and a dollar markup of $14, then the selling price per unit is $30. In other words, markup is simply the difference between the cost of the merchandise and the selling price, which is the same as gross margin. This markup is intended to cover all of the operating expenses (wages, rent, utilities, promotion, credit, etc.) incurred in the sale of the product and still provide the retailer with a profit. Occasionally, a retailer will sell a product without a markup high enough to cover the cost of the merchandise in order to generate traffic or build sales volume. For instance, many e-tailers originally expected high turnover to allow them to be profitable. However, low margins coupled with low traffic caused many to close before volume could make up for their low margins. This chapter, however, will only be concerned with using markup to produce a profit on the sale of each item. Markup may be expressed either as a dollar amount or as a percentage of either the selling price or cost. It is most useful when expressed as a percentage of the selling price because it can then be used in comparison with other financial data such as last year’s sales results, reductions in selling price, and even the firm’s competition. The equation for expressing markup as percentage of selling price is

Percentage of markup on selling price = (SP – C)/SP = M/SP

Although some businesses, usually manufacturers or small retailers, express markup as a percentage of cost, this method is not widely used in retailing because most of the financial data the retailer uses are expressed as a percentage of selling price. Nevertheless, when expressing markup as a percentage of cost, the equation is

Percentage of markup on cost = (SP –C)/C = M/C

Several problems occur when we attempt to equate markup as a percentage of selling price with markup as a percentage of cost. Since the two methods use different bases, we really are not comparing similar data. However, there is an equation to find markup on selling price when we know markup on cost:

Percentage of markup on selling price = Percentage of markup on cost/ (100% + Percentage of markup on cost)

Likewise, when we know markup on selling price, we can easily find markup on cost:

Percentage of markup on cost = Percentage of markup on selling price/ (100%-Percentage of markup on selling price)

The preceding equations convert percentage markup on cost to percentage markup on selling price and vice versa. Exhibit 10.2 shows a conversion table for markup on cost and markup on selling price. Let’s go back to our original example of the T-shirt and see how easy it is to determine markup on selling price when we know the markup on cost and vice versa. The retailer purchased the T-shirt for $16 and later sold it for $30. The difference between the selling price and the cost is $14. This $14 as a percentage of

selling price (markup on selling price) is 46.7 percent ($14/$30). This same $14, however, represents 87.5 percent ($14/$16) of the cost (markup). In this example, if all we knew was that the T-shirt had an 87.5-percent markup on cost, we could determine that this was the same as a 46.7-percent markup on selling price:

Percentage of markup on selling price = Percentage of markup on cost/ (100% + Percentage of markup on cost) = 87:5 %/( 100% + 87:5%) = 46:7%

Likewise, if we knew we had a 46.7-percent markup on selling, we could easily determine markup on cost:

Percentage of markup on cost = Percentage of markup on selling price/ (100%

- Percentage of markup on selling price) = 46:7 %/( 100% - 46:7%) = 87:5%

Exhibit 10.3 gives you the total picture of the relationships between markup on cost and markup on selling price. In Exhibit 10.3, you can see that dollar markup does not change as the percentage changes on cost or selling price. Dollar markup is presented as a percentage of cost or selling price. Exhibit 10.4 reviews the basic markup equations. Although quite simple in concept, the basic markup formulas will enable you to determine more than the percentage of markup on a particular item. Let us work with the markup on selling price formula to illustrate how an interesting and common question might be answered. If you know that a particular type of item could be sold for $8 per unit and that you need a 40-percent mark up on selling price to meet your profit objective, then how much would you be willing to pay for the item? Using our equation for markup on selling price, we have

Percentage of markup on selling price = (SP –C)/SP

40 = ($8-C)/$8

C = $4.80

Therefore, you would be willing to pay $4.80 for the item. If the item cannot be found at $4.80 or less, then it is probably not worth stocking. Likewise, if a retailer purchases an item for $12 and wants a 40-percent markup on selling price, how would the retailer determine the selling price? Returning to our original equation (SP ¼ C þ M), we know that SP ¼ C þ 0.40P since markup is 40 percent of selling price. If markup is 40 percent of selling price, then cost must be 60 percent since cost and markup are the complements of each other and must total 100 percent. Thus, if

60% SP =$12

then divide both sides by 60 percent:

SP = $20

Up to this point, we have assumed that retailers have been able to sell the product at the price initially set when the product arrived at the store. We have assumed that the initial markup (the markup placed on the merchandise when the store receives it) is equal to the maintained markup or achieved markup (the actual selling price less the cost). Since in many cases the actual selling price for some of the firm’s merchandise is lower than the original selling price, the firm’s maintained markup is usually lower than the initial markup. Thus, maintained markup differs from initial markup by the amount of reductions:

Initial markup = (original retail price – cost)/original retail price

Maintained markup = (actual retail price –cost)/actual retail price

Five reasons can account for the difference between initial and maintained mark- ups. First is the need to balance demand with supply. Since most markup formulas are cost-oriented, rather than demand-oriented, adjustments in selling prices will occur. This is especially true when consumer demand changes and the only way for retailers to reduce their inventory and make their merchandise salable is by taking a markdown or reduction in selling price. A second reason is stock shortages. Shortages can occur from theft by employees or customers and by mismarking the price when merchandise is received or sold. In either case, the selling price received for the goods will be less than the price carried in the inventory records. In fact, clerical error probably accounts for more stock shortages than theft. Third, there are employee and customer discounts. Employees are usually given some discount privileges after they have worked for the firm for a specified period of time. Also, certain customer groups (e.g., religious and senior-citizen groups) may be given special discount privileges. The fourth reason is the cost of alterations. Some fashion-apparel items require alterations before the product is acceptable to the customer. While men’s clothing is often altered free of charge, there is usually a small charge for altering women’s wear. Nevertheless, this charge usually does not cover all alteration costs, so alterations are actually a part of the cost of the merchandise. A fifth and final reason that initial markup may be different from maintained markup is cash discounts, which are offered to retailers by manufacturers or suppliers to encourage prompt payment of bills. Any cash discounts taken reduce the cost of merchandise and therefore make the maintained markup higher than the initial markup. This is just the opposite of the first four factors. Some large retailers ignore cash discounts in calculating initial markup because the buyer may have little control over whether or not the discount is taken. The reason for this is that achieving discounts through prompt payment is thought to be the result of financial operations rather than merchandising decisions, and there- for the buyer should not be penalized if the discounts are not taken. As the previous discussion illustrates, retailers do not casually arrive at an initial markup percentage. The initial markup percentage must be a carefully planned process. Markups must be large enough to cover all of the operating expenses and still provide a reasonable profit to the firm. In addition, markups must provide for markdowns, shortages, employee discounts, and alteration expenses (all of these together are referred to as total reductions), which reduce net revenue. Likewise, cash discounts taken, which increase net revenue, must be included.

To determine the initial markup, use the following formula:

Initial markup percentage= (operating expenses + net profit + markdowns

+ Stock shortages + employee and customer discounts

+ Alterations costs - cash discounts)/ (net sales

+ Markdowns + stock shortages

+ Employee and customer discounts)

We can simplify this equation if we remember that markdowns, stock shortages, and employee and customer discounts are all retail reductions from stock levels. Likewise, gross margin is the sum of operating expenses and net profit. This produces a simpler formula:

Initial markup percentage = (gross margin + alterations costs - cash discounts + reductions)/ (net sales + reductions)

Because some retailers record cash discounts as other income and not as a cost reduction in determining initial markup, the formula can be simplified one more time:

Initial markup percentage = (gross margin + alterations costs + reductions) / (net sales + reductions)

Regardless of which of the three formulas is used, the retailer must always remember the effect of each of the following items when planning initial markup: operating expenses, net profits, markdowns, stock shortages, employee and customer discounts, alterations costs, cash discounts taken, and net sales. At this point, a numerical example might be helpful. Assume that a retailer plans to achieve net sales of $1 million and expects operating expenses to be $270,000. The net profit goal is $60,000. Planned reductions include $80,000 for markdowns, $20,000 for merchandise shortages, and $10,000 for employee and customer discounts. Alteration costs are expected to be $20,000, and cash discounts from suppliers are expected to be $10,000. What is the initial markup percentage that should be planned? What is the cost of merchandise to be sold? The initial markup percentage can be obtained by using the original equation:

Initial markup percentage = ($270,000 + $60,000 + $80,000 + $20,000

+ $10,000 + $20,000 - $10,000)/ ($1,000,000

+ $80,000 + $20,000 + $10,000) = 40:54%

The cost of merchandise sold can also be found. We know that the gross margin is operating expenses plus net profit ($330,000). This gross profit is equivalent to net sales less cost of merchandise sold, where cost of merchandise sold includes alteration costs and where cash discounts are subtracted. Thus, in the problem at hand, we know that $1 million less cost of merchandise sold (including alterations costs and subtracting cash discounts) is equal to $670,000. Since the alterations costs are planned at $20,000 and cash discounts at $10,000, the cost of merchandise is equal to $660,000 ($670,000 – $20,000 + $10,000). We can verify our result by returning to the basic initial markup formula: asking price minus cost divided by asking price. The asking price is the planned net sales of $1 million plus planned reductions of $110,000 ($80,000 for mark- downs, $20,000 for shortages, and $10,000 for employee and customer discounts). The cost is the cost of merchandise before the alteration costs and prior to cash discounts, or $660,000. Using the basic initial markup formula, we obtain ($1,110,000 – $660,000)/$1,110,000, or 40.54 percent. This is the same result we achieved earlier. The preceding computations resulted in a markup percentage on retail selling price for merchandise lines storewide. Obviously, not all lines or items within lines should be priced by mechanically applying this markup percentage, since the actions of competitors will affect the prices for each merchandise line. Thus, the retailer will want to price the mix of merchandise lines in such a fashion that a storewide markup percentage is obtained. To achieve this, some lines may be priced with considerably higher markups and others with substantially lower markups than the storewide average that was planned using the initial markup planning equation. It will be helpful to explore some of the common reasons for varying the markup percentage on different lines or items within lines. In planning initial markups, it is useful to know some of the general rules of markup determination. These are summarized as follows:

1. As goods are sold through more retail outlets, the markup percentage decreases. On the other hand, selling through few retail outlets means a greater markup percentage.

2. The higher the handling and storage costs of the goods, the higher the markup.

3. The greater the risk of a price reduction due to the seasonality of the goods, the greater the magnitude of the markup percentage early in the season.

4. The higher the demand inelasticity of price for the goods, the greater the markup percentage.

Although these rules are common to all retail lines, other rules are unique to each line of trade and are learned only through experience in the respective lines—for example, how much to mark up produce in a supermarket during different seasons. Although retailers would prefer to have their initial markup (the one placed on the merchandise when the store receives it) equal to the maintained markup (the actual selling price less the cost), this seldom happens. Markdowns, which are reductions in the price of an item taken in order to stimulate sales, result in a firm receiving a lower price for its merchandise than originally asked. The markdown percentage is the amount of the reduction divided by the original selling price:

Markdown percentage = Amount of reduction/original selling price

Thus, maintained markup (sometimes referred to as gross margin or just plain gross) is the key to profitability because it is the difference between the actual selling price and the cost of that merchandise. For effective retail price management, markdowns should be planned. This is true in principle because pricing is not a science with high degrees of precision but an art form with considerable room for error. If retailers knew everything they needed to know about demand and supply factors, they could use the science of economics to establish a price that would maximize profits and ensure the sale of all the merchandise. Unfortunately, retailers do not possess perfect information about supply and demand factors. As a result, the entire merchandising process is subject to error, which makes pricing difficult. Four basic errors can occur: (1) buying errors, (2) pricing errors, (3) merchandising errors, and (4) promotion errors. Errors in buying occur on the supply side of the pricing question. They result when the retailer buys the wrong merchandise or buys the right merchandise in too large a quantity. The merchandise purchased could have been in the wrong styles, sizes, colors, patterns, or price range. Too large a quantity could have been purchased because demand was overestimated or a recession was not foreseen. Whatever the cause of the buying error, the net result is a need to cut the price to move the merchandise. Often the resulting prices are below the actual cost of the merchandise to the retailer. Thus, buying errors can be quite costly. As a consequence, you might expect that the retail manager would wish to minimize buying errors. However, this is not the case. The retailer could minimize buying errors by being extremely conservative. It would buy only what it knew the customer wanted and what it could be certain of selling. Buying errors would be minimized, but at the expense of lost profit opportunities on some riskier types of purchase decisions. Recall that when we reviewed the determinants of markups, we mentioned that the greater the risk of potential price reductions, the higher the markup percentage. This is simply another way of recognizing that taking a gamble on some purchases that may be buying errors, can be profitable if initial markups are high. You may want to review the most common buying errors discussed in Chapter 9. Chapter 3 explained that the demographics for baby boomers are different from those of Gen X or Gen Y consumers. These groups are not only different in age, but also in their buying behavior. However, many retailers employ buyers who are from the baby boomer generation. When boomers are buying for Gen X and Gen Y customers, it can be difficult for them to prevent buying errors unless they make an intentional effort to avoid such mistakes. Errors in pricing merchandise can be another cause of markdowns. Errors occur when the price of the item is too high to move the product at the speed and in the quantity desired. The goods may have been bought in the right styles, at the right time, and in the right quantities, but the price on the item may simply be too high. This would create purchase resistance on the part of the typical customer. An overly high price is often relative to the pricing behavior of competitors. Perhaps, in principle, the price would have been acceptable, but if competitors price the same item substantially lower, then the original retailer’s price becomes too high. Although many new retailers believe that carrying over seasonal or fashion merchandise into the next merchandising season is the most common merchandise error, it really isn’t. Failure by the buyer to inform the sales staff of how the new merchandise relates to the current stock, ties in with the store’s image, and satisfies the needs of the store’s target market is the most common merchandising error. Another mistake is the failure to keep the department manager and sales force informed about the new merchandise lines. Too many times, the new merchandise is left in the storeroom or the salespeople are not informed of the key features of the new item, and thus the customer will never be able to become excited about the new merchandise. Another merchandising error is improper handling of the merchandise by the sales staff or ineffective visual presentation of the merchandise. Mishandling errors include failure to stock the new merchandise behind old merchandise whenever possible or simply misplacing the merchandise. All too often a slow seller is a ‘‘lost’’ bundle of merchandise. Finally, even when the right goods are purchased in the right quantities and are priced correctly, the merchandise often fails to move as planned. In this situation, the cause is most often a promotion error. The consumer has not been properly informed or prompted to purchase the merchandise. The advertising, personal selling, sales-promotion activities, or in-store displays were too weak or sporadic to elicit a strong response from potential customers. Retailers will find it advantageous to develop a markdown timing policy. In almost all situations, retailers will find it necessary to take markdowns; the crucial decisions become when and how much of a markdown to take. In principle, there are two extremes to a markdown timing policy: early and late. Most retailers who concentrate on high inventory turnover pursue an early markdown policy. Markdowns taken early speed the movement of merchandise and also generally enable the retailer to take less of a markdown per unit to dispose of the goods. One of the author’s first bosses taught him early in his retailing career that ‘‘The first markdown is the cheapest to take. Therefore, once you take it, do not look back.’’ In other words, when you as a buyer make a merchandising error, take your loss early and do not look back because taking that early markdown will allow the dollars obtained from selling the merchandise to be used to help finance more salable goods. At the same time, the customer seems to benefit, since markdowns are offered quickly on goods that some consumers still think of as fashionable, and the store has the appearance of having fresh merchandise. For example, the top 20 percent of women’s apparel shoppers usually visit their favorite store three to four times a month. Thus, it is important for the retailer to always have the appearance of presenting fresh merchandise. Therefore, many fashion retailers use the following set of rules when taking early markdowns.

 after the third week, mark it down 25 percent from the original price.

 after the seventh week, mark it down 50 percent from the original price.

 after the 11th week, mark it down 75 percent from the original price.

 after the 16th week, sell it to an outlet store, give it to charity, or place it on an online auction.22

Another advantage of the early markdown policy is that it allows the retailer to replenish lower-priced lines from the higher ones that have been marked down. For instance, many women’s wear retailers will regularly take slow-moving dresses from higher-priced lines and move them down to the moderate- or lower-priced lines. Allowing goods to have a long trial period before a markdown is taken is called a late-markdown policy. This policy avoids disrupting the sale of regular merchandise by too frequently marking goods down. As a consequence, customers will learn to look forward to a semiannual or annual clearance in which all or most merchandise is marked down. Thus, the bargain hunters or low-end customers will be attracted only at infrequent intervals. Regardless of which timing policy a retailer follows, it must plan for these reductions. Markdowns are not always the result of buyer errors. They may simply be selling merchandise that is late in the season and before larger markdowns must be taken. Remember, when preparing a merchandise budget, the retailer must estimate reductions for that time period. An issue related to the timing of markdowns is their magnitude. If the retailer waits to use a markdown at the last moment, then the markdown should probably be large enough to move the remaining merchandise. As was mentioned earlier in this chapter’s ‘‘Retailing: The inside Story’’ box, the average American now considers 40 percent off the original price of an item to be a bargain. Thus, a late markdown should be at least this much. However, such a large amount is not necessary with an early markdown. An early markdown only needs to be large enough to provide a sales stimulant. Once sales are stimulated, the retailer can watch merchandise movement; when it slows, the retailer can provide another stimulant by again marking it down. Which strategy is more profitable depends on the situation. One rule of thumb for early markdowns is that prices should be marked down at least 20 percent in order for the consumer to notice. Recently, because they have lost their impact with the consumer, large chains have begun to move away from chain wide sales late in the selling season. They are now focusing on using early markdowns region by region based on supply and demand considerations.23 Remember, however, that while some general rules regarding markdown percentage were presented, the actual markdown percentage should vary with the type of merchandise, time of season, and competition. Often retailers are able to have their suppliers’ supplement their markdown losses with markdown money or some other type of price reductions.24 Here’s how it works: Let’s say Acme Clothing Company delivers 100 sweaters to Judy’s Dress Shop at the wholesale price of $40 each. Judy in turn plans to take her customary markup of 50 percent on the selling price in order to sell each sweater for $80, thus producing a gross margin of $4,000. However, after three months, Judy still has 50 of the sweaters in stock, which she puts on sale for $50 each in order to move the merchandise.

After selling the remaining sweaters, Judy’s gross margin is only $2,500: (50 x $80) + (50 x $50)–(100 x $40). The following month, Judy goes to market and visits the Acme showroom. Judy wants Acme to pay her the $1,500 she lost in taking the markdowns on their sweaters. Judy threatens Acme with a loss of future orders if it does not cover her losses. Does this sound fair to you? Actually, this type of scenario happens quite frequently when buyers go to market. Buyers maintain that manufacturers should share in the responsibility when the merchandise does not sell as promised. Buyers claim that if the supplier cannot deliver the gross margin desired, then there is no reason to reorder from that supplier again. From the retailers’ standpoint, when the manufacturer contributes markdown money, the manufacturers are really asking for a second chance to prove the salability of their lines. This markdown money could be in the form of cash payments or discounts on future purchases. Now let’s look at how the maintained markup percentage is determined. A retailer purchases the T-shirt used in an earlier example for $16 with the intent of selling it for $25 (an initial markup of 36 percent). However, the T-shirt did not sell at that price, and the retailer reduced it to $20 in order to sell it. This would result in a maintained markup of 20 percent:

Maintained markup - (actual selling price – cost)/actual selling price - $4/$20-20%

The following formula can also be used to determine the maintained markup percentage:

Maintained markup percentage - initial markup percentage

- [ (reduction percentage)(100%

- initial markup percentage)]�

where

Reduction percentage -amount of reductions/net sales

In the preceding example,

Maintained markup percentage -36% - [($5/$20) x (100% -36%)] �

-36% - 16% - 20%

WRITING AND SPEAKING EXERCISE

In March, you were hired by Jack Spengel to be his summer intern. Now it is late May and you have just reported for your first day on the job. Spengel’s is a locally owned furniture store in a town of 12,000 in southwest Missouri, and Jack has operated the store for almost 40 years. The closest big-box furniture operation is Haverty’s in Springfield, some 45 miles away. Unfortunately, today is the worst possible day to start work. As you arrive about 10 minutes ahead of time, you see Jack and his daughter Sue arguing in the back office. An accountant who lives in Chicago, Sue has brought the grandkids home for the Memorial Day weekend. As you approach the office, you can hear Sue saying rather loudly ‘‘Dad, you got it all wrong. Saying we are the cheapest is dangerous. You can’t position yourself by price, because all you are going to do is make your customers loyal to price. Besides, price is too easy to match or beat. And if you get your customers loyal to price, they will just drive over to Springfield.’’ Jack saw you and motioned you to come into the office. However, Sue continued. ‘‘Dad, you have to promote on the basis your location, outstanding service, your support of the local community, and just being price competitive. After all, the town folks won’t drive to Springfield to save a couple of hundred dollars on a bedroom suite. When you purchased your automobile here, was Joe’s [the local dealer] price as cheap as the dealers in Springfield? No, you bought it here because you wanted the convenience of having a local dealer servicing it. That’s what I am telling you to do. Go back to your old slogan of ‘Spengel’s: Where Good Furniture Is Not Expensive.’ Become more promotional. Dress up your store windows, rearrange your merchandise, set up a website, and shop the other stores in nearby towns to see what they are doing. Just get away from fighting a pricing battle that you can’t win. Haverty’s has too much buying power with the manufacturers.’’ With that, Sue left the office and never acknowledged you were there. Upon turning his attention to you, Jack apologizes for involving you in the matter but states that he would like your input concerning who you feel is right. Therefore, prepare a presentation or memo telling Jack what he should do and explain the reasoning for each of your recommendations.