Setting retail prices for your products is a balancing act. If a retailer prices products too low, it might see a healthy stream of sales without turning any profit (and we all like to eat and pay our bills, right?). But when products are priced too high, a retailer will likely see fewer sales and “price out” more budget-conscious customers.
Ultimately, retail brands have to do their homework. Retailers have to consider factors like production and business costs, revenue goals, and competitor pricing. Even then, setting a retail price isn’t just pure math. In fact, that may be the most straightforward step of the process.
That’s because numbers behave in a logical way. Humans, on the other hand—well, we can be way more complex.
Yes, you need to do the math. But you also need to take a second step that goes beyond hard data and number-crunching.
The art of pricing requires you to also calculate how much human behavior impacts the way we perceive price.
To do so, you’ll need to examine different pricing strategies, their psychological impact on your customers, and make your decision from there.
Retail price: Choosing the right pricing strategy for your brand
Many retailers benchmark their pricing decisions using keystone pricing (explained below), which is essentially doubling the cost of the product to set a healthy profit margin. However, in many instances, you’ll want to mark up your products higher or lower, depending on your specific situation.
Here’s an easy formula to help you calculate your retail price:
Retail Price = [(Cost of item) ÷ (100 – markup percentage)] x 100
For example, you want to price a product that costs you $15 at a 45% markup instead of the usual 50%. Here’s how you would calculate your retail price:
Retail Price = [(15) ÷ (100 – 45)] x 100
Retail Price = [(15 ÷ 55)] x 100 = $27
While this is a relatively simply markup formula, this pricing strategy doesn’t work for every product in every retail business. Because every retailer is unique, we’ve rounded up 10 common pricing strategies and weighed the advantages and disadvantages of each to make your decision-making simpler.
Manufacturer suggested retail price: What is MSRP?
As the name suggests (no pun intended), the MSRP is the price a manufacturer recommends retailers use when selling a product. Manufacturers first started using MSRPs to help standardize prices of products across multiple locations and retailers.
Retailers often use the MSRP with highly standardized products (i.e., consumer electronics and appliances).
- Pros: As a retailer, you can save yourself some time simply by using the MSRP when pricing your products.
- Cons: Retailers that use the MSRP aren’t able to compete on price—with MSRPs, most retailers in a given industry will sell that product for the same price.
Keystone pricing: A simple markup formula
This is a pricing strategy that retailers use as an easy rule of thumb. Essentially, it’s when a retailer would simply double the wholesale cost they paid for a product to determine the retail price. Now, there are a number of scenarios in which keystone pricing may be too low, too high, or just right for your business.
If you have products that have a slow turnover, have substantial shipping and handling costs, and are unique or scarce in some sense, then you might be selling yourself short with keystone pricing. In any of these cases, a retailer could likely use a higher markup formula to increase the retail price for these in-demand products.
On the other hand, if your products are highly commoditized and easily available elsewhere, using keystone pricing can be harder to pull off.
- Pros: The keystone pricing strategy works as a quick-and-easy rule of thumb that ensures an ample profit margin.
- Cons: Depending on the availability and the demand for a particular product, it might be unreasonable for a retailer to markup a product that high.
Multiple pricing: The pros and cons of bundle pricing
We’ve all seen this pricing strategy in grocery stores, but it’s common for apparel as well, especially for socks, underwear, and t-shirts. With the multiple pricing strategy, retailers sell more than one product for a single price, a tactic alternatively known as product bundle pricing.
For example, a study looking at the effect of bundling products found in the early days of Nintendo’s Game Boy handheld console, it sold the most products when the devices were bundled with a game rather than individual products alone.
- Pros: Retailers use this strategy to create a higher perceived value for a lower cost—which can ultimately lead to driving larger volume purchases.
- Cons: When you bundle products up for a low cost, you’ll have trouble trying to sell them individually at a higher cost, creating cognitive dissonance for consumers.
Discount pricing
It’s no secret that shoppers love sales, coupons, rebates, seasonal pricing, and other related markdowns. That’s why discounting is the top pricing strategy for retailers across all sectors, used by 97% of survey respondents in a study from Software Advice.
There are several benefits to leaning on discount pricing. The more apparent ones include increasing foot traffic to your store, offloading unsold inventory, and attracting a more price-conscious group of customers.
- Pros: The discount pricing strategy is effective for attracting a larger amount of foot traffic to your store and getting rid of out-of-season or old inventory.
- Cons: If used too often, it could give you a reputation of being a bargain retailer and could hinder consumers from purchasing your products for regular prices.
For more information on how to build a discount pricing strategy, read these related posts on the topic:
- How to Offer Retail Discounts Without Slashing Your Profits
- The Science of Sales: How to Move More Merchandise with Discounts
Loss-leading pricing: Increasing the average transaction value
We’ve all done this: We walk into a store lured by the promise of a discount on a hot-ticket product. But instead of walking away with only that product in hand, you ended up purchasing several others as well.
If so, you’ve gotten a taste of the loss-leading pricing strategy. With this strategy, retailers attract customers with a desirable discounted product and then encourage shoppers to buy additional items.
A prime example of this strategy is a grocer that discounts the price on peanut butter and promotes complementary products like loaves of bread, jelly and jam, and honey. The grocer might offer a special bundle price to encourage customers to buy these complementary products together rather than simply selling a single jar of peanut butter.
While the original item might be sold at a loss, the retailer benefits from the other products customers purchase while in-store.
- Pros: This tactic can work wonders for retailers. Encouraging shoppers to buy multiple items in a single transaction not only boosts overall sales per customer but can cover any profit loss from cutting the price on the original product.
- Cons: Similar to the effect of using discount pricing too often, when you overuse loss-leading prices, customers come to expect bargains and will be hesitant to pay the full retail price.
FURTHER READING: Learn how bundling your products can help you increase your retail sales.
Psychological pricing: Use charm pricing to sell more with odd numbers
Studies have shown that when merchants spend money, they’re experiencing pain or loss. So, it’s up to retailers to help minimize this pain, which can increase the likelihood that customers will make a purchase. Traditionally, merchants have accomplished this with prices ending in an odd number like 5, 7, or 9. For example, a retailer would price a product at $8.99 instead of $9.
In Willian Poundstone’s book Priceless, he picks apart eight studies on the use of charm prices (i.e. those ending in an odd number), and found that they increased sales by 24% on average when compared to their nearby, ’rounded’ price points.
But how do you choose which odd number to use in your pricing strategy? The number 9 reigns supreme when it comes to many retail pricing strategies. Researchers at MIT and the University of Chicago ran an experiment on a standard women’s clothing item with the following prices $34, $39, and $44. Guess which one sold the most?
That’s right—pricing the item at $39 even outsold its cheaper counterpart price of $34.
- Pros: Charm pricing allows retailers to trigger impulse purchasing. Ending prices with an odd number gives shoppers the perception that they’re getting a deal—and that can be tough to resist.
- Cons: When you’re selling luxury goods, lowering your price from a whole number like $1,000 to $999.99 can actually hurt your brand’s perception. This pricing strategy can give luxury customers the impression that the products are defective or are market down for a similar reason.
Comparative pricing: Beating out the competition
As the name of this pricing strategy suggests, comparative pricing refers to using competitor pricing data as a benchmark and consciously pricing your products below theirs.
Outpricing your competitors can influence price-conscious customers to purchase your products over similar ones. However, this “race to the bottom” from a pricing perspective isn’t always the best strategy for every business and product.
Here’s how we sum up the advantages and drawbacks:
- Pros: This strategy can be effective if you can negotiate with your suppliers to obtain a lower cost per unit while cutting costs and actively promoting your special pricing.
- Cons: This can be difficult to sustain when you’re a smaller retailer. Lower prices mean lower profit margins, and so you’ll have to sell higher volume than competitors. And, depending on the products you’re selling, customers may not always reach for the lowest-priced item on a shelf.
Going high-end: Above competition pricing
Here, you take the pricing strategy from above and go to the other end of the spectrum. Brands benchmark their competition but consciously price products above theirs and brand themselves as more luxurious, prestigious, or exclusive. For example, this strategy works for Starbucks when people pick them over a lower-priced competitor like Dunkin’ Donuts.
A study from economist Richard Thaler looked at people hanging out on a beach wishing for a cold beer to drink. They’re offered two options in this scenario: purchasing a beer at either at a run-down grocery store or a nearby resort hotel. The results found that people were far more willing to pay higher prices at the hotel for the same beer. Sounds crazy, right? Well, that’s the power of context and marketing your brand as high-end.
- Pros: This pricing strategy can work its “halo effect” on your business and products. Consumers perceive that your products are better quality and more premium due to the higher price compared to competitors.
- Cons: This pricing strategy can be difficult to implement, depending on your stores’ physical locations and target customers. If customers are price-sensitive and have several other options to purchase similar products, the strategy won’t be effective. This is why it’s crucial to understand your target customers and do market research.
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