By Graeme Caldwell
Retail is easy to describe. A company buys a product. They sell it for more than they paid. The difference is their profit.
In reality, retail is complicated because everyone involved seeks to maximize the difference between a product’s value and what they pay for it. Manufacturers want to sell for as much as possible. Customers want to buy for as little as possible, or, more accurately, they want to feel as good as possible about their purchase—that doesn’t always mean paying the least. The retailer is in the middle, competing with other retailers playing the same zero-sum game.
Pricing is a critical factor in deciding the winner of that game, especially in the e-commerce world where customers can easily compare prices. Every e-commerce retailer has to answer the same question: How much should I charge for this product?
Let’s look at some of the strategies retailers use to decide. We’ll consider a widget bought from a wholesaler for $10 per item—how much should an e-commerce retailer charge a customer who wants to buy our $10 widget?
Basic pricing strategies
Keystone pricing is the most straightforward strategy. The retailer doubles what they paid for the product, and that’s the price they charge customers. Expressed differently, the retailer puts a 100% markup on their products. Our widget costs $10, so we sell it for $20.
This gives us a gross profit margin of 50%. The net profit is lower because we haven’t accounted for marketing costs and other overheads, but for many retail businesses, the net profit from keystone pricing is acceptable. Keystone pricing has the advantage of being simple. It’s easy to decide how much to charge.
But there are obvious problems with this pricing model. As I’ve mentioned, it doesn’t account for marketing costs or overheads. It also ignores competitor pricing. Blanket keystone pricing is a bad idea because some products won’t sell at double the amount a retailer paid, especially when alternatives are readily available. Keystone pricing is, however, an effective way to establish a baseline, a reasonable price point that can move up or down depending on other factors.
Many retailers use a more complex method that accounts for cost, overheads, and an acceptable profit margin. If we’re happy with a 20% net profit, and we spend an average of $5 on marketing and customer acquisition for every sale, and our overheads are $2 per sale, we’d charge the following:
($10 + $5 + $2) * 1.2 = $20.40
It’s easy when we’re making up figures, but it can be challenging for a business to itemize its costs and overheads. And, once again, this pricing model fails to account for the competitive landscape. It’s a viable model for stores that sell unique goods that aren’t available elsewhere, but if you’re in a competitive market, both of these models might leave you trailing the competition.
Competitive pricing strategies
No retailer is an island, and it’s a rare e-commerce merchant who can ignore their competitors. In the offline world, retailers have a little more flexibility with competitor prices. Customers remember prices for a small number of products and few are diligent comparison shoppers. But, on the web, it’s easy to compare prices, and price comparison sites make it even easier.