Product Pricing The cost of an "everyday low price" toy: $19.95. The cost of a Rolex watch: $2,465. A great paper explaining why corporations put these prices on products: priceless. Wal-Mart has become the leader in "everyday low price" pricing, and the number one retailer has brought many businesses to their demise because of their pricing strategy. Recently, Wal-Mart has expanded their sales niche to the toy department putting many specialty toy stores near or completely out of business. This paper will discuss how Wal-Mart priced their line of toys, why Wal-Mart used toys as "loss leaders" to attract customers, and two alternate methods of pricing marketers can use based on demand and reputation.
Toy Pricing Pricing is an important aspect of every business. Chief Financial Officer's (CFO) use pricing to create financial projections, establish a break-even point, and calculate profit and loss margins (Power Point, 2005). It is the only element in the marketing mix that produces revenue. Price is also one of the most flexible elements of the marketing mix as it can be changed very quickly. This is usually done to beat competitor prices in an attempt to fix the product's market value position very low (Anderson & Bailey, 1998).
After all, high prices make it difficult to become the market share leader. The leading US retailer, Wal-Mart, is an expert at low product pricing as evident in 2004 with $250 billion dollars in sales to their 138 million weekly shoppers. However, they are also responsible for reducing prices so low that it drives specialty stores out of business. This is the effect Wal-mart has had on many toy stores and has almost closed the doors of the famous toy store Toys "R" Us Inc. Wal-Mart set extremely low prices on toys in a very successful pricing strategy to attract customers and become the leader in toy sales (Grant, 2004).
This pricing strategy is called market penetration pricing. Penetration pricing is used to enter the market quickly and win a large market share (Anderson & Bailey, 1998). These low prices have taken their toll on toy stores. Toys "R" Us is now the second largest toy seller in the U.S. behind Wal-Mart.
Toys "R" Us was recently bought for $6.6 million by investors who hope to transform the store into a more viable store for the entire family (D'Innocenzio, 2005). Other toy stores are not as fortunate. FAO Inc., parent of toy store FAO Schwarz, filed for their second bankruptcy in 2003 and KB Toys filed for bankruptcy in January 2005, saying it would close nearly 400 stores (Bhatnagar, 2004). Wal-Mart has certainly made a name in toy sales with their pricing strategy, but left much money "on the table" in the process.
Wal-Mart has recently announced their plans not to lower their toy prices as much as last year, yet still keep prices lower than toy stores like Toys "R" Us (Grant, 2004). Loss Leaders A loss leader is a product sold below cost to draw customers into a store where they are likely to buy other products. The business expects the customer to purchase other items at the same time as the loss leader and that the profit made on other products will result in an overall profit. A loss leader is typically placed in the back of a store, so customers have to walk past higher profit margin goods (Loss, No Date). Wal-Mart uses toys as a loss leader.
As previously mentioned, price is one of the most flexible elements of the marketing mix as it can be changed very quickly. Pricing goods below the competition can be difficult to sustain because it exposes the possibility of a price war. Wal-Mart, however, sets their prices lower than distributor cost, forgoing significant revenue on that specific product, only to attract customers and make up the lost revenue in other product sales. For example, Wal-Mart willingly loses money selling CDs for $10, $2 less than what it bought the CD for from distributors. However, Wal-Mart anticipates that the lost revenue will be made up when customers purchase a CD player (or any other merchandise) while shopping for the CD (Cohen, 2004). This "loss leader" pricing strategy sent millions of new customers to Wal-Mart instead of Toys "R" Us for toy purchases.
Determining Product Price Wal-Mart prices toys using penetration pricing. While this may work for a sales giant like Wal-Mart, it does not work for other businesses. Pricing and price competition is the number one problem facing many marketing executives (Anderson & Bailey, 1998). Several other means exist for businesses to price their products including price skimming and prestige pricing.
These two pricing techniques focus on higher pricing rather than the low pricing technique of penetration pricing. Price Skimming, commonly known as "skimming the cream", involves placing a high price on a newly invented and promoted product. This pricing strategy is most effective for the first 3 to 12 months after product release. Typically, when a company launches a new product, they charge higher prices in the beginning to help recoup research and development expenditures quickly. If the market for the product is new and the product itself is innovative and attractive, a high sales price can be placed on the product. Price skimming is the opposite of penetration pricing and is often referred to as 'top pricing'.
This technique is designed to give a business high profit initially. However, sales will taper off and the business could lose a large number of customers if the price remains high and demand for the product goes down (Price, 2005). Therefore, in order to keep customers, business must lower their prices after sales start to decline over the life cycle of the product. Prestige pricing closely resembles price skimming concerning high product prices.
The difference between the two pricing strategies is brand reputation and life cycle pricing. Almost everyone knows that purchase prices for brand names such as Rolex, Ferrari, and Armani are high. Customers go into the store or showroom floor knowing they are going to pay too much for the product. But, these companies have a prestigious reputation of high quality products and exceptional customer service. In today's world where everyone wants to be unique, demand for high price merchandise is high because price as an indicator of prestige (Johnson, 1999). Advertisement and marketing can segment people who are looking for uniqueness and have a high income to buy their high-dollar products.
Also, consumers do not usually see prices decline on prestige's products. This means that the price of the product will not decline throughout the life cycle of the product. As with anything in life, there are pitfalls to this technique. The most important downfall of prestige pricing is customer service.
If the product does not work as advertised (e.g. the product breaks often), customers feel they are cheated and they will search elsewhere for their product. Business that use prestige pricing must have the highest quality customer service to keep customer loyalty. Summary Wal-Mart wanted in the toy industry and successfully did so by pricing toys lower than their competitors. In fact, the price was lower than the distributor price Wal-Mart paid for the product. Their strategy was to attract new customers and steal competitors customers by using toys as a loss leader. When was the last time you went to Wal-Mart to buy one specific item, only to leave the store with many items?
As a discount store, Wal-Mart can price items as discussed. High pricing strategies like price skimming and prestige pricing at Wal-Mart would send their loyal customers elsewhere. Price skimming is reserved for new and "hot" products that eventually declines over the product life cycle while prestige pricing is reserved for unique and reputable products that rarely declines. All pricing strategies come with downfalls. Companies must consider their goals and vision when pricing products to ensure they reap the maximum benefits for their business.
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