Pricing Strategy

Everyday value or deep-cut promotions? Nick Shanagher considers the best approach

What works best: everyday low prices or markdowns? A new study by Özalp Özer and Karen Zheng at MIT Sloan School of Management says the answer depends on studying shopper habits.

Although their study is based on an analysis of garment sales, the findings are likely to hold true for convenience products, Professor Özer says. Ignoring the way people shop means retailers are missing out on around 14% of sales because they have understocked.

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Retailers are foregoing up to 14% of potential demand by not stocking enough of the products that they will mark down

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In terms of pricing strategy, retailers should favour an every­day low-pricing model on products that shoppers think will always be available or for which shoppers have a ready substitute. In the garment trade, an undershirt falls into this category.

But garment retailers also sell products such as a fashion jacket at a high price and then mark them down to sell out. Shoppers know that there is a chance that the item will be marked down so they can get it cheaper if they wait.

This purchase decision is made by balancing two fears. The first is that if they wait, the product won’t be available in their size when the markdown happens. The second is that if they pay the higher price now, they may find the product in their size at a lower price later.

Therefore, if you are selling products that you will discount to clear, the trigger to get shoppers to buy at the higher price is to highlight inventory information: the message ‘Only three left in stock’ is better than ‘Don’t miss out.’ This is a marketing tool used by Amazon, which tells its customers how many items are left in stock.

[pull_quote_right]The messagr ‘Only three left in stock’ is better than ‘Don’t miss out’. This is a marketing tool used by Amazon[/pull_quote_right]

Özer, who is co-editor of The Oxford Handbook of Pricing Management, believes that retailers need to pay more attention to pricing as a lever for shopper decisions.

He has developed an algorithm to find the optimal every­day low price or markdown strategy. His findings suggest that retailers are foregoing up to 14% of potential demand by not stocking enough of the products that they will mark down.

“Given that retailers operate with slim profit margins, 14% is a very significant number,” says Özer. “It could result in 10% of profits.”

For the convenience channel, this study is useful in understanding seasonal sales opportunities such as Easter eggs, where overstock is marked down to clear on the Monday, even though few consumers want to give Easter eggs as gifts then. It also applies to barbeques, patio furniture, plants, inflatable swimming pools and similar seasonal products.

The study did not cover promotional strategies where prices alternate over time between a ‘regular’ price and a promoted price. There may be similar results, Özer says.

As the independent channel seeks to develop its offer of fresh and chilled products, more work on how to get the pricing right would be welcome. Independent retailers tend to adopt the same pricing strategy across all their product ranges and, with the focus on everyday low prices grabbing the headlines, may not identify the profit potential of perishable products.

“I suspect many retailers around the world are making suboptimal pricing and stocking decisions,” says Özer. “They leave money on the table. This also hurts consumers on average because they either pay higher prices in some cases or they face a stock-out situation more than they should.”