In a highly competitive environment, having the lowest prices may help to win a battle; but eventually the war will be lost!
The “theory” put forth has always been, that by reducing prices, more revenue will offset the profit margins lost by taking “reactive” markdowns. Retailers often “assume” that customers shop price and their only motivation to buy a product is low price. Retailers of this mindset, shop the competition for price, police all the advertisers and adjust prices based on their findings. In the end, the only thing that measures success and continued growth and investment is net profits and not the daily deposits due to sales! Think of it this way. Many retailers operate on a net profit after taxes of less than 5%. The following is an example of what can take place during a season of heavy price reductions:
1 .gross margins (profits on sales after markdowns, cost of goods and transport expense) average 40%.
2. operating expenses average 35%:
3. “reactionary additional markdowns” are taken reducing the gross margins to 35%
If operating expenses are held at 35% of revenue due to no increase in total revenue, the business is at a break even no matter how much business is generated!
Reducing gross margins by 5% may sound significant, however it can happen quite readily. For instance, if the average price of goods is $50 and the markup is 50% or $25, it would only take and additional $2.50 in markdowns to erode the 5% margin utilized in the example! (e.g. $2.50 at retail!)
The other problem that develops is that markdowns for “aged and distressed” merchandise suffer due to budgeted markdown monies being used to “match” or beat competition's prices.
The worst case scenario that portends is the possible debacle that takes place if markdowns continue to erode margins and expenses increase. Expenses such as rent, common area costs, employee wages and benefits, advertising expense, remodeling costs etc. oft times escalate and are not directly under the control of the business owner!
Another example of what can take place, and oft times does, is expenses are reduced arbitrarily due to unforeseen markdowns or price adjustments taken as a result of competitive pricing. The usual expenses victimized are wages, advertising, training, maintenance, display, store updating etc. Good businesspersons that are totally involved in the business can imagine the affect reductions in these areas would have in terms of immediate and long range impact!
This piece illustrates the problem of using “best price” as your competitive advantage and the short and long range affect it can have on your business! Our style is to provide our readers solutions, and not only point out the problems. With that in mind, check back next week for Part two of Price Wars a losing strategy!
By Randy Snyder
Randy is a regular contributor to Salesheads! His experience encompasses 30 years with national chains and 10 years as an International Retail consultant and has worked with three International chains developing franchises and re engineering of the companies! Randy can be reached at rsnyder921@aol.com or (p) 239 481 0844.
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