Jumat, 15 Februari 2008

Bottom Up Pricing is Made for the Internet

by Nathan Lewis

The Internet has brought to the forefront a pricing strategy that has never caught on in the traditional marketplace. This pricing strategy looked at how much you need to make off of each item rather than look at the retail price as a percentage of the cost. This new pricing model is simply more bad news for the traditional retailers who find themselves competing with online merchants.

For centuries the dominant pricing strategy involved taking the cost of the item and adding a margin percentage to come to a selling price. Depending upon the vertical market this margin percentage ranged greatly. Overall, market demand dictated what the margin percentage would be for each vertical market.

What items went into the creation of this cost amount could include raw materials, freight and labor (including benefits) that it took to create the item and get it ready for sale. Or it simply could be what the merchant paid for the finished product from the manufacturer. No matter, the point is that a margin percentage was added to this cost to obtain the selling price.

Traditional Pricing Strategy vs. Bottom Up Pricing

The Internet has brought back a different pricing philosophy that has not been used by traditional retail merchants because of the heavy overhead that they incur simply by opening their doors every day. A traditional merchant must pay for their floor space, utilities and labor every time they open their doors. By the act of unlocking the doors one more day, they commit to pay their expenses one more time.

This commitment to monthly expenses mandates that the traditional merchant charge more for their product. In order to easily calculate the amount to add to each item the traditional merchant will add a percentage to the cost to cover of expenses and hopefully enough for a profit.

Why an Internet Merchant is Different

The Internet merchant is totally different in their business philosophy. As such, their pricing philosophy is also quite different.

The Internet merchant’s store is virtual. They do not have a huge overhead commitment similar to the traditional merchant. I recently helped a merchant:

* Incorporate their business Buy their domain name
* Obtain a hosting account with:
o Unlimited number of stores
o Unlimited number of E-mail addresses
o Free shopping cart software (Installed for them at no charge)
o Free blogging software
* Open a bank account
* Create a relationship with a vendor that agreed to drop ship their orders

Within a week’s time we had completed all of the above and began loading items onto the virtual store shelves. By the end of the following week they were open for business.

The total outlay for this merchant to open their store was less than $300. Their monthly commitment for their phone and credit card processing was less than $50 per month. That is, if they did not sell a thing they would only owe $50 for being open for that month.

This gives the Internet merchant a much greater ability to price their items competitively and more aggressively. Without the huge overhead commitment the Internet merchant can price their products from the bottom up or cost plus.

Recently, I heard the partners of this new website ask each other, “How much do we want to make?” They were talking about retirement. They were talking about how much they wanted to make per item. This is what I am talking about in this article.

What they found was that their competition had settled on less than a 20% margin. For this particular group of items this calculated out to be about $40 per item for items with a $400 to $600 suggested list price. It didn’t take them long to decide that $40 was plenty to make off of a single item and they decided to price all of their items cost plus $40.

Other Internet merchants do the same. They will say, “If I make a dollar on this item it is a dollar I didn’t have yesterday.” With technology doing more and more of the work that means that Internet merchants have less to do and find that smaller margins are not a problem. It is not hard to find Internet merchants working on margin percentages that would bankrupt traditional merchants.

For advertising purposes this makes the traditional merchant look silly. If a shopper compares pricing they will immediately see a huge discount off of the exact same price shown on their shelves. Discounts of 30% - 60% are not unheard of when using this pricing model.

This means that about the only advantage a traditional merchant has over an Internet site is pre-qualified traffic. Once Internet merchants conquer this hurdle traditional merchants are really going to hurt.

About the Author

Nathan Lewis has earned a solid reputation helping small to medium sized businesses expand their reach through niche market websites such as My POS Printer. New receipt printers from Star Micronics Receipt Printers.

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