Nothing impacts on your bottom line more than how you set prices. Not only does it impact on your overall margin and volume directly, but because most people tend to make multiple product purchases in a single trip, your pricing on certain “headline” items can generate spillover sales and profits.
To manage price effectively there are “3 C’s” you need to consider: Costs, Competition and Customers. Surprisingly, many community pharmacies and other small retailers only consider two of these directly when, in fact, their success depends more on the “missing C”.
Cost Issues
It is estimated that over 80% of all firms set prices using a process called “cost plus pricing”. They take the invoice price charged by a supplier, add what they feel they need to cover overhead and profit needs and the sum becomes their price. The rationale for cost plus pricing is that it insures that, in the battle for consumers, businesses are certain to recover all of the costs and profit needs required to stay in business.
However, while the cost-plus approach sounds simple, knowing the real total costs associated with a product is harder to identify than many people realize. This is because total costs are largely made up of two components. One part is what we pay a supplier for the physical product. This cost is easy to identify, and can be taken right off the supplier invoice. The other portion is comprised of a proportion of overhead and other fixed costs – rent, heat, staff and the like – that we incur in order to have a venue in which to sell that product.
These costs are easy to know in the aggregate since we can read them in our financial statements, The hard part comes when we try to allocate those costs to individual products. The standard approach is to calculate an average percentage of costs that are due to overhead and other fixed costs and add that percentage to the invoice price of each product. For example, if you found that your invoiced cost of goods sold in a month was, say $240,000 and your total overhead costs were, say, $30,000, you would add (30/240=) about 12.5% to the invoice price plus your desired profit margin to arrive at a final selling price.
Indeed, while manufacturers cannot legally set the retail selling price, their recommended pricing usually includes a margin that is believed sufficient to cover overhead and profit needs for an average business. This is why retail margins tend to vary depending on product category.
Because the markups like this reflect an average cost of doing business, the practice of using a standard markup across all products can result in you over- or under-charging relative to your real costs. This is because the amount of overhead that should be charged to a product is not constant: it may have less to do with the selling price and more to do with some other characteristic like physical (bulk) size, turnover rates and whether special equipment or displays are needed.
For example, a fast moving item in a small footprint package which requires no in-store promotion or special equipment, costs you much less to carry than a big bulky item that is infrequently bought and requires special equipment like refrigeration. When you apply an average overhead charge to all products you essentially overcharge on the fast moving item…which usually means it won’t stay fast moving for very long – especially if your competition is taking turnover rates, footprint and the like into consideration in setting their prices.
The Fallacy of Competition-based Pricing
Some people believe that in adopting competition-based pricing they are outwitting their competition by scooping sales based on the smaller store’s ability to make quick adjustments. While that agility is to be applauded, if your realized price isn’t covering costs and profit needs then they’re really outwitting themselves.
The problem here is that larger stores almost always have lower costs than smaller stores and so, on the same item, they do not need to charge as much to cover costs and profit needs. There are four reasons for this. First, larger stores tend to receive higher rebates and volume discounts from suppliers. Second, larger stores are often in a better position to negotiate special promotional considerations. Third, larger stores usually have enough volume that they do not require wholesalers or other intermediaries between them and the supplier. Finally, a big part of the big box or large store business model is based on their lower overhead costs (as a percentage of sales). This was covered in a post on cost reduction.
The bottom line: if you are going to compete against someone bigger than you, you won’t be successful selling the same thing they do.
The Missing C
The missing C in most cases is the customer. This sounds improbable since prices are supposed to reflect what will attract buyers. But there is more to it than the price of individual items.
When you sell on a product-by-product basis you play right into a large chain store’s hands. Brand X is brand X, no matter where it is sold. Thus the appeal is universal. The goal is to use the feature priced item to build store-wide traffic.
An insightful small retailer can negate that advantage by selling “bundles of products” under a “bundled price”. These bundles should reflect the peculiar shopping habits of the small retailer’s neighborhood. Because chain stores need to run the same promotion everywhere, the more peculiar the bundles are to a neighborhood, the less able the chain store is to copy them. In addition, selling bundles enables you avoid “cherry picking” customers who only buy the featured item.
Some examples of bundles that you can match with therapeutic categories:
- If you sell a lot of, say, diabetic medications you might want to offer a bundle of mega-vitamins, test strips, supplements, foot care products and diabetic candies.
- For pharmacies near a pediatrics clinic, the “chicken pox” basket – Aveeno colloidal oatmeal for baths, calamine lotion, and Tylenol.
- A “healthy snack food basket” for people with high blood pressure or high cholesterol.
- Seasonal promotions for flu kits
The idea is that you can encourage customers to buy products they might not otherwise try and perhaps encourage them to stock up while the sale is on. Price-wise, the attraction is that you can usually provide a bigger discount on the bundle than you could on any one product.
This practice also enables you to connect your front-of-store and back-of-store operations in a data-driven way, using prescription data to tell you what bundles to offer, If you check your records you might even find that there is a pattern to when certain types of medications are most often purchased and you can time promotions accordingly.
The Bottom Line
Community pharmacies will never win against bigger rivals when selling individual products. The cost and competitive factors work against them. However, if they can shift competition to something that requires local knowledge more than scale, they can attune pricing to customers and shift the game in their favor. Price for the customer and the rest will take care of itself.
