How do you set your prices? Do you take a manufacturer’s recommended retail, a retail from your wholesaler or do you just make one up as you go?
My experience has been that most retailers do a mix of all three. The problem with taking predetermined prices is that it creates a national price bubble that just does not fit everywhere.
If you look at your local competition it will soon be clear that you cannot all thrive in a one-price- fits-all mentality. If you set your prices in the national bubble your customers may find them not on par with the other local prices and you will leave profit on the table.
Independent or local market pricing can pay huge dividends, but it is hard work and it is a job that is never finished. Most independent retailers simply do not have the staff to do a lot of local market pricing and must settle for their wholesaler’s recommendations. However, many medium to large stores and independents with multiple branches can do much better than a national average retail price.
If your national retail price is too low you leave gross profit dollars (GP$) on the table. On some low-priced blind items you can crank up the retails to a surprising level and still not get sales resistance from your customers. Some items will be priced too high for your market. If you lower the retail a bit you may be able to greatly increase your sales, and increase your GP$. It is important that the price on your merchandise be the right price for you, not for someone 500 miles away from you in a different competitive situation.
Analyze Your Situation
You can set a lot of your own pricing, but before you determine what your retail price will be you need to know who you are, where you are and what you are selling. The “who you are” part means what type of store are you? Are you an independent home center or hardware store, a lumberyard or a small specialty shop? The “where you are” part means where are you located in the market and what kind of competition do you have? Competition can be high or low depending on other stores in your trading area. Finally, the “what you are selling” element refers to whether an item is sensitive, competitive, non-competitive or blind. We need to clarify these terms.
High-volume, low-margin operations are found mostly in mass merchandising stores, because only high-volume stores can survive with the lower initial gross profit a low-margin operation will create. They make a smaller margin percentage but generate high GP$ from very high sales. They stack hundreds of items on endcaps with a very low price. This low margin does not create enough profit to provide for a high level of service, but it does create enough profit to provide stocking and cashiering staff, the only two requirements for this type of operation.
An example of a high-volume, low-margin merchant is Walmart. Customers enter Walmart with few expectations. They do not expect high-level service, and if the store staff knows where the bathroom is they meet expectations. Customers can usually find what they want without staff assistance and are willing to wait for long periods in line at the checkout. The high sales volume the mass merchants get helps them to get lower costs, which in turn allows even lower retails.
If you try to run a hardware store or lumberyard in the high-volume, low-margin price range you will do a great deal of work in ordering, stocking and selling, but produce a gross profit percentage that is too low to cover your staffing needs. Simply put, reduced margins demand reduced payroll and the bottom-line reality for an independent lumber or hardware operation is that it cannot survive long being the cheapest store in the market.
Most specialty shops work in the low-volume, high-margin range. These small stores survive because they support their high price point with an extremely high level of service, a level that the customer is clearly willing to pay for.
If you try to run a hardware store or lumberyard in the low-volume, high-margin arena, you should expect to make a high gross profit percentage, but not enough GP$ to pay the bills. You unfortunately have huge and necessary expenses that have to be met. If you cannot provide a superior level of service your high price will quickly drive sales down to a low level that will not provide your necessary GP$. The problem with the hardware business is that we sell thousands of products that are not so technical that they require expert sales help. We cannot justify expensive staff for everything we sell.
Where’s the Sweet Spot for Independents?
What is left then for independent hardware stores, home centers and lumberyards? The medium- volume, medium-margin arena is where we thrive. That’s because the combination of a medium volume and medium to high margin generates enough profit to provide sufficient payroll to hire experienced help for the areas that need expertise and provides a high enough level of service to keep customers coming back.
How does this work? When a customer enters your store they have certain expectations. They expect you to be small when compared to the big boxes, so being small is not a problem unless you make it so. They expect you to have a relatively high level of service in the technical products that you have for sale, so if you have poor technical service you will fail to meet their expectations and they may shop elsewhere in the future.
In most cases, they expect you to be somewhat higher priced than the big boxes so you can be and still meet expectations. Providing poor service is a serious problem, because they expect you to be good in that area.
Not all items are alike in the customer’s mind. The customer may have a good price awareness on some items but not on others. Items can be grouped into one of four classifications:
within 10 cents. You need to be right on the money.
be, but not exactly. You need to be close.
price, just a ballpark idea. You can be higher without a lot of resistance.
long as they think they can afford it they will make the purchase. You can make wonderful margins and still keep customers happy.
If you are the only store in the area that sells a particular product, then you have a huge advantage. Within reason, almost anything you do will result in continued business. That’s because the customers do not have a choice. However, the moment a second business opens in your market selling the same products that you do, the business geography permanently changes. Now you will be judged in the eyes of the customer and compared directly to their new “other choice.”
Are you higher or lower priced? Are you providing higher or lower service? Are you closer, more convenient or have a better selection? Everything you do will be judged and compared to the second choice. There is one simple phrase that sums up many years of retail experience—Do not do poorly what they do well. This is the secret to all success in every retail business. No matter what you do, or what business you are in, if there is another choice in the market you must never do poorly what they do well. Unfortunately, pricing is something that can be done poorly.
Case Study of Blind Item
Let’s look at a graphic comparison of pricing to see the differences. Graph 1 below depicts a theoretical item with a cost of $1.00. It is a blind item, so customers do not know what the correct price should be and will accept a wide range of possible prices and still meet expectations. If you look at the retail selling curve you can see the difference in profitability of an item based on different retail prices.
The blue bars in the graph represent the number of transactions, starting with the higher level (50 sales) on the left and dropping down to lower levels on the right. The drop in sales is directly connected with the increasing price. As the retail price increases from $1.00 to $3.20, customer resistance to purchase also increases and sales drop.
Point A on the left side is where the cost and the retail are the same and profit is zero, no matter how many you sell. The old theory of “lose a little on each one and make it up in volume” doesn’t work in the real world. You do not want to be there. On the other side of the graph is point E, where the price is so high that no one will buy it and all sales cease. Every item has a point E and you do not want to be there either.
The red bars in the graph represent the total GP$ generated at the retail level and the sales volume at that particular point. You will notice in the graph that 32 sales at a $1.80 retail make about the same GP$ as 20 sales at a $2.40 retail, yet create 60 percent more work in ordering, stocking and selling.
The maximum GP$ created by this item appears at 26 sales at a $2.10 retail. This is what I call point C. The big-box store will probably set their retail somewhere around point B, between $1.40 and $2.00 to get the most sales to keep their volume high. The specialty stores will probably set their retail somewhere around point D, about $2.50, and sell only a few.
The example in Graph 1 represents a blind item for which the customer does not have an exact price in mind and will tolerate a wide range of prices with little or no resistance. There is great margin opportunity on blind and non-competitive items and you should try to get your retail as far right as the local competition will allow. This is one of the times you can be a lot higher than the big boxes. However, the big boxes know what blind items are as well and will already be up the curve a bit more than normal.
Case Study of Sensitive Item
The example in Graph 2 represents a sensitive item that the customer has a very good idea what the correct price should be. Notice the fast drop-off in acceptable retails. Above a clear point all sales cease so you need to make sure that you are within the acceptable price range.
In this example, points C, D and E are very close together. This is one of those times you should not be a lot higher than Walmart or Home Depot. If a customer finds you very high on a sensitive or competitive item they will assume you are that high on everything.
Unlike the first example, this item has a reasonable price range of $1.60 to $1.90. If you try a retail price out of this range you will either give them away or not sell any at all. The mass merchant will probably be around $1.50 to $1.70 on this item.
So how can you determine what your retail price should be for a particular item? You do so by first defining what the item is and how it fits in your assortment. It is critical to know what your competition sells. It is important to know what products your big-box competitors sell, but it is just as important to know what they don’t sell. The items that only you sell automatically become more blind than normal. If they cannot be compared to anyone else you can crank up the retails. In the same way, the items that both you and your competitor sell become more competitive and need to be close.
John Franklin has more than 20 years experience as merchandise manager at Williams Lumber & Home Centers in upstate New York. He is available for retail consulting or you can contact him with questions or feedback at email@example.com.