How do retailers price things?

Factual Questions
1

I want to sell widgets. I use widgets daily and I’m tired of running out and I know to get a good price, I must buy enough to resell. The best widget-makers are out of the country, so I import them.
OMG the price difference! I am buying smallish amounts, so I am not getting the best available deals. Still, I pay $9 per widget and other people sell them for $100. More than ten times the price is highway robbery, isn’t it? Is that a usual markup?
So I think about how much it costs me to sell these. With advertising, time spent, gas costs, Customs fees, and everything, my total cost is about $11.00.
If I price my widget at $22, which still seems high but acceptable, nobody will buy it because they assume something is wrong with it to be so cheap. If I price it at $100, I feel like I’m cheating people. I just talked to a guy on the phone who offered me a two-widget deal for $330! And he gets it.
What is the usual pricing scheme for ready-made retail goods?

And then we get into the area of stuff I make. Widgets are useless by themselves- you have to turn them into Super Widgets. Any idiot can make a Super Widget but many people have been given the wrong instructions, or don’t have the time or inclination. It costs me about $.50 to make a Super Widget. Other people sell similar for $15.00. Mine are actually higher quality than the 15.00 ones. I can use the Super Widget to make Extra Super-Duper Widgets which are even easier to use. Extra Super-Duper widgets cost me about .25 to make. Extremely inferior ESDW sell for $2.00 to 5.00 apiece.
I can upgrade widgets while I read the boards or watch TV. It takes no skill or dexterity.
I’ve been told I can double my current prices and still give people a bargain. I don’t want to charge more than I would pay. Where is the middle ground?
Thanks,
HennaDancer

2

There was an excellent article in the SF Chron. recently about how little understood business pricing practices are understood. Unfortunately, it seems to have expired from their recent online archives. Two things I remember most:

  1. Everything you are taught in business school is wrong. Pricing has virtually nothing to do with cost of manufacturing. (Look at CDs for example.) It is a complete mystery to the “experts”.

  2. There was a great quote along the lines: “You are only as good as your dumbest competitor.” I.e., if a Tivo comes along and markets PVRs for far lower than the cost of making them, then no one makes any money on them. (Which is why most of the big companies don’t make them.) Airlines generally could be profitable with a less than $5 increase in ticket prices. (Present situation excluded. Maybe $10 now.) As long as someone is selling tickets for $5 too low, most of the industry is in trouble.

IIRC, a situation along the lines of the OP was actually discussed. Wish I had a link to it…

3

It is not a mystery. It is supply and demand. In general, if people will pay $100 for a widget, and buy lots and lots of widgets at that price, most of the widgets will sell for around that price, since that’s how you maximize your profit. Costs of manufacturing do enter into it, of course, but only as a minimum expense, or as a limit on the width of the marketplace (if it costs $30 to make a gadget, but nobody would pay more than $20, there won’t be any gadgets available for sale).

4

I guess it just seems wrong somehow, to charge so many times over.
Can I change the pricing model? I’m thinking of those discount furniture stores that sell the same quality stuff for a third less than anyone else. Those stores are always packed.
Then again, so are the the regular ones.
I did once set my prices about 20% lower than the other person getting the same widgets. I guess she lost sales, and lowered her prices.
I guess I’m not a very good capitalist.

5

I again apologize for not being able to find a link to that SFC article. But it made it abundantly clear the points made above have absolutely nothing to do with how prices are actually set. Everything taught in a business class about this is just plain wrong. Again, as the Tivo example proves, people sell things for more than their cost on a regular basis. (They hoped to make up for it on subscription service, but even with that factored in, they still lose money on each sale.)

Also compare CD prices for with DVD prices. I have seen ads recently where the soundtrack of a movie costs more than the movie itself. Despite that a DVD costs more to make, etc. The reason DVDs are so cheap (as has been mentioned in other threads here) is that WalMart insisted on reasonable prices.

6

Some Guy is correct; price is entirely determined by supply and demand. Of course, there’s “stiffness” and “lag-time” issues, which accounts for why prices on some goods stay stagnant for a while…

7

Well, I never thought I’d say this, especially not in connection with their entertainment department, but YAY for Walmart!
HennaDancer

8

Acquisition cost has close to zero to do with sale price. What has to do is what the market is and here it is not as simple as “a widget goes for X”. You can be selling widgets at twice the price of the guy next door and be selling more than him. You can have better marketing or provide a different service or “experience”. people seldom go to the absolute cheapest. Convenience stores sell things more expensively than grocery stores but provide convenience. etc.

So, in the end, a business model starts with a guy believing he can make a profit by selling widgets for $X and believing people will, in fact, pay $x for a widget. If his guess was correct he makes a profit, if not he loses money and either folds or tried to adjust his business model (lower price OR advertise OR . . . OR, etc). Thos who guess right make money and those who guess wrong too often go out of business. But even big Corps make mistakes a lot of the time. It is not an exact science.

9

I think the problem here is that the OP refers to what can be a vast subject, involving many different factors.

There are many different business models, and each has its pros and cons. At a basic level, if you sell a widget at a low price you stand to attract more sales (because your potential market is de facto larger than if the price is high ) but you will make less profit per sale. If the price is high, you stand to sell fewer, but the profit per sale will be greater.

There is a cost attached every sale - such as the cost of advertising to attract each sale, the cost of hiring staff to show people things in shops or to demonstrate widgets, or to process orders, or to water the plants in the office. What a business tries to do is optimise its profitability per cost of sale, and this is as much an art as a science.

Lots of other factors come into play, such as (a) the activity of the competition (b) the state of the market and what motivates people to buy within that market and © the core values of the company - some companies have a philanthropic aspect, and want to try and provide widgets at low prices so that more people can enjoy the benefits of having one - so long as this can be done profitably, this is as valid a plan as any other. Some companies want to make as much profit as possible. Some companies are set up for a short time purely to make a loss, for reasons to do with the parent company’s tax dues.

At its simplest level, companies are lazy, like people, and want to make as much profit with as little effort as possible. However, wherever there is healthy competition, this is seldom possible, and companies are forced to work hard for their profits, and to try and secure, develop or sustain a competitive advantage. But it is hardly ever a simple issue, and all the issues I’ve mentioned above - plus many more - come into play.

One key factor is that markets consist of people, and people are irrational, moody and unpredictable. There are countless examples of good products, way better than the competing products and sold at a great value price, which vanished without trace, and others which are or were rubbish but whichsold like hot cakes. That’s part of the fun of running your own business - if it was easy, or followed set rules, there’d be no challenge.

This is also what’s wrong with text books and business studies courses - the theory doesn’t really tell you anything about the reality. I’ve run my own home-based business since 1997, and truly the only way to learn is by doing!

10

Some comments from experience (my family ran a Saddle Shop/Tack & Western Wear/Boots store for many years, and I was present for many ‘discussions’ between my parents about the appropriate markup for various items.

One big factor for us (not mentioned here so far) was “style”. Some items, like clothing, which can go ‘out of style’ quickly, had a much higher markup (typically 100%) than other things. This was based on the fact that we had to expect to end up with a few unsold items still left when it went out of style, and they had to be paid for out of the markup on the ones that had sold.

Other items, like halters & lead ropes, were pretty much unchanged year after year, and the markup on them was much less (about 20-25%). Because we didn’t have to worry about being left with unsold items – they always sold, consistently. And keeping the price low on such basic items got the customers into the store.

That attracting customers idea also entered into setting markups. Items that were used regularily (like wormer) were often priced with very low markups. We even kept track of purchase dates, and mailed customers a reminder 3 months later that was also a discount coupon. With that discount, we were barely paying for the cost + shipping on our wormer. But it brought the customers into the store, and they nearly always bought other things while there. That’s the “loss leader” concept.

For us (a small family store, years ago) there was also an issue when costs went up on items. We had to set the price higher on the newly arrived ones to cover the increased cost + our markup. But did we raise the price on the ones we had in stock to match that price? My mother though we should (ought to have the same price on all of them on the rack); my father thought that we were overpricing the ones that hadn’t cost us more, and that was not quite moral, in his view. (Yeah, I know, he would never have made it in today’s corporate world!)

I remember an intense ‘discussion’ between them about this on a rack of blue jeans priced at $4.95, and a large shipment of new ones that had to be priced at $5.95. Plus I remember my dad complaining about that price – “Nobody is going to pay more than 5 bucks for just a pair of blue jeans! We’ll drive all our customers away!” (This was long before Jordache, etc. – quite a change from now!)

11

Don’t forget about ‘barriers to entry’.

If you can make a ton of money on something by having people by the short hairs it isn’t always in your best interest to do it. If you do, then it attracts competitors into your business and gives much incentive for your customers to find alternatives.

See OPEC and oil as an example. Those guys are great at pricing oil enough to make a ton of money but not so much as to hugely promote the search for alternatives whether that be non-oil energy or the opening of other oil fields.

12

The usual pricing sceme is cost-oriented pricing, but that doesn’t sound like that’s what these companies are doing. As mentioned, demand plays a strong role in pricing, and many companies will simply charge what the market will bear, while still allowing a profit.

The pricing strategy you describe could be called skimming, where the seller charges a high price on a new product, which usually happens when the seller has a monopoly on it. I think CDs and DVDs may fall under this category, to some degree, unless I’m not factoring in royalties properly.

Prestige pricing is coming into play here as well. People believe that if a widget costs $100 it will be better than a $22 one. The answer to this is better promotion.

13

I haven’t worked in retail for over a decade, but from speking to various shop owners in the malls I worked at, they generally charged twice the wholesale price they paid, regardless of the type of product (except for upscale items like jewelry with precious stones).

Of course, that was before the boom of the nineties…

14

Tivo strategy is simple: in the long-run, their captive subscriber base will generate more income than it costs to operate the service. Their real asset is the subscriber base, so it doesn’t matter if they lose money for every single year of operation for 10 years – they can still cash out after a decade (i.e. sell the company) and make a profit then.

The key is “in the long-run”, meaning “extend to infinity”. Given infinite time, every below-cost tivo box will be paid for by the subscription. There is a business term for this, but I don’t recall it right now.

Now time for pure speculation: I think DirecTV has been in operation since 1996 and I don’t think they’ve had a profitable year, yet. However, that was part of their gameplan (build a subscriber base at all costs). They just sold the company to New Corp (Murdoch’s) and got a nice return on their investment.

15

I wrote out a whole big ol’ response, but apparently laced it with hamster chow. Here’s the gist of it:

Retailers determine price by pricing the good at whatever they think will make them the most profit. Sometimes this means exchanging current losses for future profits, sometimes it means giving away some goods and selling related goods.

In the example given in the OP, I think there are two possibilities. One is that the retailers are adding value outside of the widget itself in the process. This may be value in not having to buy widgets by the metric ton, or it could be value in terms of displaying numerous widget models in a single location, but value to consumers is getting put in there that consumers are willing to pay for so as to not have to buy from the manufacturer. Another possibility is that there are barriers to entry that are preventing new firms from entering the market so as to reduce super-normal profits.

What happens if you enter the market and offer widgets at well below the price your competitors are charging? If you are covering your costs, including your opportunity costs, then either everyone else will drop their prices or you’ll capture 100% of the market. This is assuming that the value you as a retailer are adding is at least comparable to the market norm… if a gas station opens and offers comparable gas for 25% less than everyone else, they still won’t make money if the only gas station is in the middle of nowhere.

Also, as others have mentioned, the study of how prices are determined is huge and can’t be summarized in any thread… it’s called “economics.” But the gist of it is: people set prices at the level they think will eventually make them the most money.

16

If you think you can sell a widget for much under the going price, you are either a genius or a dunce. Recheck your math.

If you greatly undercut the market, one of three things are likely to happen:

1)If you remain a small player in the widget market, you will likely be left alone.

2)If your company starts taking more and more of the market, the big boys will drop their price perhaps even below yours, dropping your sales below the breakeven point.

3)You are already below the breakeven point. You are pricing widgets as a loss leader except there’s too much loss and too little leader.

17

There are three factors in any retail transaction.
[ul]
[li]Price [/li][li]Availability / quality[/li][li]Service[/li][/ul]

The buyer gets to choose any two. So if you want it now and and service is important, don’t even ask about the price.
Proof of this would be Snap-on tools. Or clothes from Nordstroms.
If on the other hand, price is a prime mover and service is important availability / quality will suffer. Craftsman tools would be an example of this. Less expensive than Snap-on, but not as high a quality. or perhaps clothes from Target.

So getting back to widgets, if everybody else is getting $100 bucks and you can make good money selling them for $25, then either there is a quality issue, availability issue, or the other guys are giving way more service than you had factored in.*