Rafi Mohammed

The Pricing Strategy that Can Save Brick & Mortar Stores

Posted on January 4th, 2011 (0 Comments)

Reprinted from the Harvard Business Review website.

As retailers tally up sales from the crucial holiday period, the early returns look good: spending rebounded in 2010, with MasterCard reporting a 5.5 percent increase over the previous year.

But those gains haven't been spread equally. Online spending jumped by 15.4 percent — and the 2010 holiday season may mark the first time that online spending accounts for more than 10 percent of all gift purchases. Even before the holidays, brick-and-mortar retailers were suffering: when Best Buy reported disappointing third-quarter results in early December, analysts attributed the poor numbers to increased competition from online retailers — and Best Buy's stock dropped 18 percent in one week.

The proliferation of smart phones and apps like ShopSavvy, which allow mall-goers to easily compare online prices to get the best deal, will only increase the threat to physical stores.

But even as Americans embrace e-commerce, physical retailers still provide a valuable service — and I've been thinking about a new system that would allow them to better compete.

I was reminded of the value offered by brick-and-mortar retailers during my own recent holiday splurge. Every time I entered my local Costco store last year, I was greeted by banks of flat screen televisions blasting vivid cinema-like images. When prices dropped over the holidays, it was time to make my purchase.

I searched around online, and settled on a highly-discounted model from an Internet retailer. Before buying it, I stopped in at Sears to check its selection. A helpful sales associate came by to talk about my choice. I'd focused on brand and pixel clarity as my primary criteria. The associate explained why I should also focus on other attributes such as the refresh rate (important for fast moving images) and LED backlight (which provides brighter display and greater contrast). That brief tutorial made me rethink my purchase — and in retrospect, he saved me from buying a model I'd have regretted.

The televisions at Sears cost more than they do at e-commerce sites. That makes sense: physical retailers have to cover costs (such as pricey mall real estate, store fixtures, cashiers and sales associates) not incurred by Internet retailers. Online stores further benefit as many states do not require them to charge sales tax. In an increasingly tech savvy and price sensitive world, how can physical stores compete?

The conventional wisdom is that consumers will pay a premium for the convenience and service provided by brick and mortar stores. But as online retailers' growing market share attests, that CW isn't holding up. I went online to buy the TV the Sears associate helped me select, and I saved $150. As the sliding value of Best Buy shares confirm, too many shoppers aren't willing to pay a premium for sales associates, in-person demonstrations, or the ability to get a product right now. The current retailing model, which expects consumers to pay this premium, is starting to look broken.

It's time for a new system in which manufacturers help compensate physical retailers for the value they bring to the sales proposition. They can do that by offering brick and mortar retailers lower wholesale prices than their web counterparts. I call this discount the Physical Store Equalizer, or PSE.

Retailers' pitch to manufacturers to try to gain this discount should be straightforward: "As a brick and mortar retailer, we add value and generate higher sales of your product. Our stores increase your brand awareness, provide a venue for people who want to touch and feel the product before they buy it (whether they buy it from us or online), and our sales staff help educate your buyers. We bear costs for these services, so it's impossible for us to match online prices of your product. To be fair to us, we require a wholesale price that is 10% less than what you are offering web retailers."

This discount can vary based on the value-added: products that benefit more from being sold at physical outlets (appliances, for instance) can have a higher discount while those that receive fewer benefits (which include homogenous, less expensive goods on which people aren't as price sensitive). These terms should also apply to "like" products. This prevents manufacturers from circumventing this clause by adding a superfluous attribute or simply changing the model number.

This strategy focuses on a key pricing principle that all B2B and B2C companies need to practice: articulate and charge for the value that you provide. Faced with a Physical Store Equalizer, manufacturers will have to decide whether the value provided by a brick and mortar retailer merits the smaller margins — and the potential backlash from Internet retailers.

As consumers become more comfortable with online shopping and price comparison technology becomes ubiquitous, physical retailers must confront this pricing issue today. Brick and mortar retailers need only look at Borders' recent announcement that it is delaying payments to vendors to see what is potentially on the horizon for them if they don't work to change the existing economic model.

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