The Math, Psychology, and Technology Behind Effective Retail Prices

“How much does this cost?”

If you work in retail, you probably hear that question several times a day. People care a great deal about product prices — and in many cases, an item’s price is a deciding factor in their purchase decisions.

This is why it’s so important to get your prices right. You want them to be attractive enough that they entice people to buy, but not to the point where you miss out on profits or damage your brand.

Easier said than done? You bet. Retail pricing is a tricky beast, and there’s no one-size-fits-all method for coming up with the best prices. The key is to explore different strategies and practices to figure out the best one for you.

Need help with that? Here’s an overview of some of the top pricing strategies in the retail industry. Check them out below to see if you can apply them to your business.

Do the math.

Let’s start with the most straightforward method: calculating your prices based on your costs. Most retailers use the keystone method to do this. Keystone is the practice of selling merchandise at a rate that’s double its cost or wholesale price — essentially adding a 100% markup to the cost.

Let’s say it cost you $20 to create a product. Using the keystone method entails doubling that cost, which means your retail price would be $40.

Many merchants use the keystone pricing formula because it’s simple and usually covers costs while providing a sound profit margin.

That said, the right markup for your pricing will still depend on market conditions, your brand image, and your company’s performance. In some cases, keystone pricing (i.e. having a 100% markup) won’t make sense for you and you’ll need to go above or below the typical 100% markup.

For instance, luxury brands or retailers who sell designer merchandise can have markups of 300 or even 1,000 percent. According to Sumocoupon, some designer boots have markups as high as 354%, while markups for designer lingerie can be as high as 1,100%.

The industry that you’re in can also be a factor. Consider the wedding industry. Sumocoupon has found that markups for wedding dresses can go up to 290%.

Bruce Clark, an Associate Professor at Northeastern University, adds that retailers should also consider their objectives, demand, and competitors. “I call these the four legs of the coffee table. If you can have some intelligent thoughts about each of these dimensions, you’ll hone in on a pretty good price,” he says.

“For objectives, are you pricing for volume or margin? The former price is lower than the latter. For demand, is this a product everyone wants or one that is hard to move? The former price can be higher than the latter. Competitively, what do customers pay for competing products at competing stores. If your product line has a competitive advantage, you can price this higher. If it’s a commodity, you’ll need to price it lower.”

The bottom line is there are no hard-and-fast rules for calculating your prices; instead, you should factor in your costs, industry, and brand when you’re setting them. It’s also important to consider customer perception and behavior when pricing your merchandise.

Further reading
There are several other measures you can use when setting your prices. Download Vend’s Retail KPIs guide, a resource that gives you a deep look at the metrics you should be tracking in your business to learn more about them.

Download the guide and you will:

  • Learn which metrics can help you make smarter decisions (about pricing and beyond)
  • Discover the formulas that’ll help you identify your KPIs so you can start measuring your way to the top
  • Wise up on the metrics that you need to track, and know exactly when and how to measure them

Factor in shopper psychology.

Finding that pricing sweet spot isn’t just about doing the math. Yes, you have to run the numbers when it comes to your costs and profit — but these aren’t the only factors that come into play when setting your prices.

Plenty of studies suggest that implementing psychological strategies can also impact how consumers perceive prices and products. That’s why more and more retailers are taking steps to understand how the minds of their customers work and are using those insights when pricing their goods.

The question is, are you? If not, keep reading. Here are some of the psychological factors you should consider when setting your prices.

Using the magic number 9 vs. whole numbers

Ending prices in “.99” is one of the oldest tricks in the pricing playbook. Numerous studies have shown that prices ending in .99 outperform those that end in .00. Why? Because consumers have been conditioned to associate 9-ending prices with bargains or deals.

Check out this neat chart by Gumroad, a platform that enables creatives to sell directly to their audience. Gumroad analyzed the purchases made on its site and compared the conversion rates of items in whole dollar prices with those that ended in .99.

As you can see, products with prices ending in .99 outperformed the ones with whole numbers across the board — and in one case, the conversion rate was twice as high.

The reason for this? Consumers experience the “left-digit effect,” which is the brain’s tendency to pay more attention to digits on the left side of the decimal point. What happens is people base their purchase decision on the first digits they see, rather than the price as a whole.

The same thing can be said about prices ending in .97. Most retailers running deals end their sale prices in .99 or .97 to make them more enticing.

So should you start eliminating whole numbers from your price list? Not quite. The left-digit effect may work well when you’re selling to bargain-hunters, but if you’re catering to a high-end or exclusive market, you’re better off using whole numbers.

Research has shown that “there is a perceived relationship between prices ending in 0 and overall quality, and prices ending in 9 and overall value.” In other words, it appears that people associate whole-number prices with higher quality.

Take a look at the examples below. The top one is a screenshot from upscale department store Nordstrom’s website. Notice something about the prices on the page? Yup, they’re all whole numbers, indicating that the products are for customers willing to spend more.

But if you head to Nordstrom Rack, the company’s outlet store that’s known for price cuts and sales, you’ll find that almost all the items are priced at xx.97.


Nordstrom Rack

The takeaway here is that ending your prices in .99 or .97 won’t automatically attract more customers. You have to consider what it is you’re selling, who you’re selling it to, and the perception you wish to convey.

Ditching the dollar sign

Here’s another pricing test you may want to try. Consider removing currency symbols when displaying your prices. Research indicates that doing so may increase consumer spending.

Consider this: When researchers from Cornell University ran a test on menu pricing format and typography, they found that “the largest total checks came from menus that used numerals only and did not mention dollars, either with a word or symbol.” In other words, it appeared that diners spent more when they had menus that only listed the number (i.e. 10) versus when they had menus that listed the currency ($10.00 or ten dollars).

It’s important to note, however, that the results from the experiment were not statistically significant enough to form a solid conclusion. As the researchers mentioned, “As much as we might like to believe that we can earn a quick buck by changing the type and presentation of our menus, it is clear that larger operational factors have a much larger impact on purchase behavior than price typography does.”

What does this mean for you? The rules on pricing format and typography aren’t set in stone. Dropping the dollar sign may work for upscale restaurants that want you to focus on the food rather than the price, but the same thing can’t be said for, say, outlet malls or bargain retailers.

Take this pricing insight into consideration, but don’t blindly implement it. The best way to know for sure which pricing format works for your store is to run tests of your own. Implement a different typography in a particular branch or store section first, and see if it has any impact on sales before rolling out the changes in your entire business.

Using price anchors

Companies that implement a tiered pricing strategy aren’t just doing it for the heck of it; Jedi mind tricks psychology also plays a role. When you give customers two or even three price options (ex: basic, plus, premium), the most and least expensive price points act as anchors and create the perception that they’ll get a better deal if they go for the middle option.

Case in point: in the 1990s, retailer Williams-Sonoma unveiled the bread maker and priced it at $275. Sales were slow following its release, and to address this, the company decided to introduce a more expensive, better-functioning one at almost double the price. The result? The original bread maker started flying off the shelves.

When Williams-Sonoma released the more expensive bread maker, it gave consumers a point of comparison that made the $275 option look more attractive.

See if you can implement this strategy in your store. Give customers price anchors to create a perception of value around the products you want to sell.

Be dynamic.

Dynamic pricing is the practice of adjusting your prices in real-time in response to market demands, trends, or even the prices of your competitors.

Consider, for example, the dynamic pricing battle between Amazon and Best Buy, which were both selling a GE microwave oven.

According to the WSJ:

Sellers on Inc. changed its price nine times in one day, with the price fluctuating between $744.46 and $871.49, according to data compiled by consumer-price research firm Decide Inc. for The Wall Street Journal. Best Buy Inc. responded by lifting its online price on the oven to $899.99 from $809.99 after the Amazon prices rose, then lowering it again after Amazon prices for the oven dropped.

So how does dynamic pricing work? Retailers typically use algorithms or dynamic pricing platforms that automatically factor in trends and crunch the numbers to determine the best prices to serve up on a website. In some cases, shopper behavior also becomes a factor, and customers see prices based on their likelihood to convert.

For instance, if a store’s marketing or pricing platform determines that a shopper is more likely to convert at a discount, then the retailer might offer a lower price to that customer. Conversely, if the technology determines that a shopper would purchase a product at full price, then they wouldn’t be offered a discount.  

Some retailers take a different approach. David Mercer, at Smart Modern Entrepreneurs, says that they monitor sales and price performance of competing products on Amazon using a price tracker tool, and they get alerts about pricing and sales.

According to Mercer, “This helps us monitor the pricing changes… and helps inform decisions on how to price our own products, along with a bunch of other benefits — like knowing when competitors’ products are selling well and being able to work out what marketing they used to drive those sales.”

Note: it’s not for everyone.

Dynamic pricing can be a good way to automate and optimize your retail prices, but exercise caution when implementing this strategy. A survey by Retail Systems Research found that consumers generally aren’t fans of the practice.

In her article on Forbes, Nikki Baird, the managing partner at RSR, shared that “71% of U.S. consumers surveyed didn’t like the practice, and another 23% thought it was merely ‘okay.’” Not surprisingly, the survey also found that millennials are more likely to accept price matching, with 14% indicating that they “love it.”

Bottom line? Consider what you’re selling, the market you’re in, and who your customers are before implementing dynamic pricing.

As Baird notes, “there are use cases where dynamic pricing makes sense – during intensely competitive shopping times, like on Black Friday, or for items with short life spans, like coleslaw at the end of the day. But as far as a general strategy for retail, it appears that consumers don’t appreciate it – and that retailers are getting the message.”

Bundle it up.

Bundling — the practice of grouping products together and selling them as a package — is another popular pricing strategy in retail. A survey conducted by Software Advice found that 90% of merchants implement the strategy in their businesses.

Bundling can have a lot of advantages. For one, it helps you sell more products. Sure, the final bundle price may be a bit lower compared to how much customers would pay if they bought the items separately, but ultimately, it helps you move more merchandise and improves your bottom line.

Packaging your products can also lower your marketing costs, because you’ll spend less time and money marketing individual items.

Depending on what you’re trying to sell, there some ways to bundle products. Try the following methods:

Bundle multiple units of the same item. This tactic works best if you’re trying to move small- to medium-sized items. Group several units of the same product, and sell them as a package. For example, if you’re looking to move merchandise that comes in multiple colors, bundle them together to see if they sell faster.

In Software Advice’s pricing report, they give the example of how online retailer DoitWiser approaches bundling. “DoitWiser sells water bottles for $19.75 each, but the price drops to $18.76 per bottle when three or more are purchased.”

Bundle complementary products. Do you have items that complement each other? Considering bundling them up and selling them for one convenient price.

Travel booking services do this all the time. Check out what Travelocity is doing. The website encourages customers to purchase their flight and hotel accommodations together by offering a special price for the bundle.

Bundle your slow-moving merchandise with faster-moving ones. If an item isn’t moving as quickly as you hope, see if you can pair it with a product that has a faster sell-through rate.

That’s what T-We Tea, a San Francisco-based retailer that sells house-made teas and accessories, did with its products. They noticed that their low-margin items (such as tea accessories) were moving faster than their high-margin ones (house-made teas), so they opted to group them together at a slightly lower price. As a result, they were able to move products faster while maximizing profits at the same time.

Bottom line: the right price is a moving target.

We wish we could tell you that there are some sure-fire pricing strategies that’ll work across all products, industries, and customers — but the fact is that the perfect price is a moving target. And while the above tactics can help you determine your prices, they’ll only work when you combine them with thorough market research and testing.

What other pricing strategies do you implement in your store? Tell us in the comments.

About Francesca Nicasio

Francesca Nicasio is Vend's Retail Expert and Content Strategist. She writes about trends, tips, and other cool things that enable retailers to increase sales, serve customers better, and be more awesome overall. She's also the author of Retail Survival of the Fittest, a free eBook to help retailers future-proof their stores. Connect with her on LinkedIn, Twitter, or Google+.

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