Every retailer is torn between selling for less to create sales and selling for more to create profits. Survival depends on finding the narrow ground between.
But that thin space isn’t clearly defined. The price at which profits disappear isn’t just the wholesale cost—it must include a share of the many individual expenses incurred by the business.
Even when we know where our prices should stop, our competitors often don’t. Sometimes they’re too inexperienced to recognize it; sometimes they miscalculate it; most often they simply don’t do the math. They eventually succumb to their lack of profitability, but it matters little since they’re soon replaced by another with all the same lessons to learn.
Ultimately only those retailers survive who correctly estimate the balance point and have the discipline to maintain it despite competitors’ miscalculations.
Some retailers have a sense for pricing that both enhances their profits and creates customers. Others price according to an old and unsophisticated rule of thumb—fixed percentage markup from wholesale.
Percentage markup assumes that all of the expenses of a sale are determined by the product’s wholesale cost. While a few are (cost of capital, insurance, etc.), far more are functions of labor, occupancy, support, and all the other expenses of retail.
Pricing correctly means individually and by feel, with consideration given to the total expenses of the sale, customers’ price sensitivity, competitive options, and the sale’s potential contribution to other business.
Only occasionally and by coincidence should markup percentages match.
According to the US Economic Census, the net profit of a retailer after everyone and everything else are paid is typically 1-3 percent of total sales.
When we’re too aggressive in our pricing, give unnecessary discounts, or make any of the myriad mistakes in buying and selling, a sale easily turns into a loss—and the loss isn’t limited to the 1-3 percent we hoped to make. We dig deeply into our back pockets to pay for each of our mistakes.
A rookie retailer doesn’t sense the price of his mistakes as he makes them—they’re obscured in an ocean of transactions. But after a few year-ends in which he contemplates miniscule or negative returns for his year of labor, his mistakes take on painful new meaning.
Chasing sales becomes so habitual and impulsive for retailers that we sometimes forget that the goal is not making more sales but making a profit. The two don’t necessarily go together—when we price too low they’re inversely related.
Many business fables tell of retailers being “busy until the day we went out of business.” No matter how many times we’ve heard the lesson, the irony of losing money while making sales continues to surprise and amuse us.
A wise retailer doesn’t set goals only for the top line of the financial statement; he focuses equal attention on the critical lines below. Only the combination determines whether and how his efforts are rewarded.
The price paid the manufacturer is only the first of many expenses in a transaction. Sales can’t be made without expenses for rent, salaries, advertising, utilities, telephones, freight, maintenance, taxes ….
Just because a sale has a gross margin doesn’t mean it’s profitable. Unless the price covers all of the sale’s expenses we take money out of our pockets to make it.
Weaker competitors instinctively know they’ll be the customers’ choice only if they offer lower prices. Many simply set their prices below the other stores as a matter of habit. Instead of understanding their costs they grasp at every potential sale and cross their fingers that there will be a little profit left when the dust settles.
It’s futile and suicidal to try to price below these competitors—when you drop your price, they drop theirs further.
Most of us have been tempted to help them destroy their pesky businesses by pushing prices lower. It’s a pleasant daydream but a costly and usually ineffective tactic. New competitors would quickly fill the void like the never-ending swarm of mosquitoes from a forest. And prices often become entrenched at the lower levels and are difficult to restore to reasonableness.
Differentiation is almost always a better strategy—offer better products and services that customers are willing to pay more for.
Price sensitive items are those bought frequently and advertised often. In a grocery store they might be bread, milk, and soft drinks; in a musical instrument store they include strings, reeds, and picks. Because customers buy them often, price differences are more apparent.
Pricing these items low creates a value image for the store. Higher margins on other merchandise allow the store to cover its expenses, stay in business, and occasionally even make a profit.
(If you have trouble reconciling this idea with the idea that each sale should cover its own expenses, think of price-sensitive items as an advertising and promotion expense.)
Buying mistakes, technology and fashion evolution, and other demand changes cause dead inventory to accumulate and threaten to bury us.
Typically we recognize the problem but resist the solution. We hold onto our mistakes, irrationally hoping customers will appear looking for just such outdated, overpriced merchandise and bail us out of our problems. Occasionally it happens, but seldom is it worth the holding costs (investment, space, insurance, shrinkage, missed opportunity, etc.).
A product’s value is determined by the market. What we paid for the product is not a factor in what it will sell for and should not influence our willingness to sell it for what it’s worth now. It’s almost always more profitable to move it out and put the investment and floor space to more productive use.
Our cost is a criterion in whether we stock the item again and what we would pay for it, but not in what we can sell this item for. The mistake was in buying; trying to make up for it in selling only makes the mistake more costly.