Pricing in Retail in just 5 paragraphs

Pricing in retail is a complex process due to the large assortment. It is a process that demands analysis, choices, measurement and correction. And the price level that can be practiced is always a clear indication of the degree of customer acceptance of the services provided, being it the retailer's positioning in the customer's mind.

1.    Pricing Approaches
There are two basic approaches towards pricing: (a) economical, based on the formula cost + tax + desired profit; or (b) market, based on competition. In the first, the company uses its capacity of manufacturing or purchasing a product, as well as its needed or desired profit objective as basis for pricing. In the second approach, the company “looks outside" for the market to price and, consequently, the cost objectives.
The use of each approach is due to factors such as market share, product or service differentiation and degree of competition. It is possible that the same company may use both approaches for different categories of goods.

2.    Pricing Strategies in Retail
In retail the two more common pricing strategies are EDLP (Every Day Low Price) and HiLo (High Low).
In the first, EDLP, prices per product are regularly low, with little variation over time. This strategy works well for large companies with buying power, robust IT systems, and limited assortment and services. This model allows a more constant and predictable demand, reduced inventory, reduced spending on promotion, advertising and staff.
In the second strategy, HiLo, regular prices are higher, punctuated by frequent price promotions. This strategy allows attracting customers seeking low prices, and also allows the retailer to highlight other attributes than price, and allows it to normalize inventory.
In Brazil, there is no retailer that practices pure EDLP. There is always a combination of this strategy with a promotional activity. And it is a difficult to implement strategy as it depends on scale and that customers associate the retailer to a low price image.

3.    Pricing Area
Given the growth and the consequent increase in complexity, the (large) retail companies have established a pricing area / department. This area is of great importance for allowing the optimization of both the gross margin and sales. This is achieved with the use, by a specialized team, of modeling systems, competition shopping price surveys and market analysis.
When pricing, two dimensions are considered: store and product. At the store level, the factors to be taken into account are: location, competition and store positioning. At the product level, the factors considered are: objective category, sensitivity to price category, seasonality and regionalism.
The product categorization is based on their purpose: (1) Traffic Generation (Price image is critical); (2) Routine (price remains important and supports the price image of the store); and (3) Margin (is to optimize the margin, are categories with low sensitivity to price).
The calculation of the final price to be practiced at the store will be based on a reference price or objective margin, once considering the factors at store and product levels.
A well-located store, where there is not a lot of competition, can and should set a higher price than a poorly located one (where the attraction of traffic is required) and / or where there are many close competitors. Also, depending on the store location, a product can vary from category between Routine and Margin. Hence, the reason for pricing group of similar stores (clustering).

4.    Cost, Price and Margin Calculation
Theoretically, the price calculation formula is simple, or, product cost + tax + profit. There is, yet, confusion between the definition of markup and margin.
Markup is the percentage to be applied on the cost price, to set the selling price. Example: if the cost is R$ 10 and the markup is 50%, the selling price is R$ 15.
Gross margin, in turn, is product of the gross profit over the selling price. Example: assuming no tax on purchase or sale, and using the previous example, the profit of $ 5 (R$ 15 retail price – R$ 10 cost price) divided by the selling price of R$ 15 produces a gross margin of 33.33%!
The first important aspect to properly calculate profit margin is to have the costs of the products identified. The second aspect is to have the taxes on both the purchase as well as on the selling price well calculated, what in Brazil it is not a simple activity. Important is to have taxes (fees, rules) parameterized in a restricted access system that is periodically reviewed by professionals (accountant or tax area professional).
The last aspect is the definition of the objective margin to be applied on the product. It is called objective margin as it is not always achieved, as there are periodic promotions that will impact the final margin. This objective margin should be set considering the following aspects: Turnover (demand, what is important for the customer) and differentiation (what the retailer wants to be and how it can be competitive).

5.    Tips
When pricing keep things simple! Always try to have the customer's perception as to the value (product + other attributes) being offered to them. Do not be inflexible about the pricing strategy adopted; you can vary. And make no mistake: there is always conflict between market share and profitability. The element responsible for the resolution of this conflict is the price. Do not complicate or buy sophisticated systems if you have not already "done by hand"! Above all, do not make major changes without previously run tests (piloting).

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