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A view of the industry through the eyes of a chain buyer.

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What's the Best Pricing Strategy?

A new study reveals retailers can increase profits by changing pricing strategies.

by Staff Report (January 18, 201009)

According to a press release from the University of Miami, new research from the university's School of Business Administration shows retailers can substantially increase sales and profits if they increase the price of a sale item to its original cost in gradual steps, rather than in one swift move. A 30-week field study showed a 200% increase in sales and a 55% increase in profits by using this strategy, coined "Steadily Decreasing Discounting," or "SDD" by the researchers.

SDD was tested against two commonly used pricing strategies, Everyday Low Pricing (EDLP) and Hi-Lo Pricing. EDLP, used by discount stores such as Wal-Mart, consistently features items at low prices that are seldom on sale. Hi-Lo pricing occurs when stores offer significant discounts on selected items for a limited time period.

"SDD starts like Hi-Lo pricing in that you have a big sale, but the main difference comes after the initial sale when you progressively increase the price back to its regular level versus in one shot," says Michael Tsiros, an associate professor and chair of the Marketing Department at the University of Miami School of Business and the study's lead author. "By doing so, SDD avoids a key problem of the Hi-Lo strategy the big dive in sales at the end of the promotion that results from people stocking up on the item during the promotion or because they perceive the price to be too high because it was recently much lower," added Tsiros, who conducted the research with David M. Hardesty of the University of Kentucky.

The research found that SDD is more effective than EDLP and Hi-Lo pricing for two primary reasons. First, consumers not only consider past prices, they also forecast what prices will be in the future. So when buyers see a trend of increasing prices, they forecast higher future prices and are more apt to make a purchase today. Second, buyers have been shown to anticipate feeling regret after they miss a sale. So if they expect prices to increase, then they are more likely to make a purchase to avoid the feeling of regret in the future. If they fail to make that purchase during a sale and see a large price increase from $50 to $100, for example consumers might delay their purchase. With the incremental approach of SDD from $50 to $60 to $70, and so on the price increase is comparatively less significant, and the consumer is more likely to buy immediately, even after having missed the initial sale.

The research included both lab and field studies. One field study took place in an upscale kitchen appliance store that sold wine bottle stoppers for $24.95. The store alternated between SDD and Hi-Lo pricing every week for 30 weeks, with the average price held constant between the two approaches.

SDD pricing was 30% off the first day, 20% off the second day, and 10% off the third day. Hi-Lo pricing was implemented in two ways. The first was the "same depth" as the SDD approach: 30% off for two days. The second was the "same frequency" as SDD: three days at 20% off.

The result? When compared to selling the wine stoppers at the regular price, same-depth Hi-Lo pricing increased sales by 63% and same-frequency Hi-Lo increased sales by 75%. But SDD boosted sales by 200%. When it came to margins, same-depth Hi-Lo increased profits by 5%, while same-frequency Hi-Lo actually decreased profits by 12%. SDD drove a 55% profit increase.

"SDD could be particularly effective in the current economic downturn," says Tsiros. "Many retailers have been offering discounts of 60% or even 80%, and stores can't offer those prices forever. But if they bring prices back up in increments, consumers will have time to adjust. Likewise, SDD could have implications for the holiday shopping season because American consumers expect big sales after Thanksgiving and often delay purchases after the sales end. But with SDD, buyers may decide to purchase now, while the price is still relatively low. That's a prospect that could please consumers and retailers alike."

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