The price is right Revisited

This spring, as you contemplate the state of the economy, your business’ cost structure and prices in general, some timely real-world information might help. With the price of so many products on the rise, this might be the right time to increase your prices. But you may be wondering with so many people and companies having a tough time economically, should you keep prices steady and absorb the rising costs and take a hit on profits?

Pricing greenhouse plants has the appearance of being cost-based and somewhat mathematical until you realize the art involved in finding the right price. Even more important today, is determining when is the price right.

Consider your costs
Both direct and indirect costs, are key components of the pricing equation. But simply adding a percentage mark-up to a product cost might not get you to the right price. Many growers don’t develop a system to help them calculate their costs on a regular basis. This is a system that is needed, since costs quite often change on just about everything these days.
 
Most growers start the pricing calculation by marking-up items using a standard percentage. A simple mark-up on cost formula uses a set percentage and multiplies that by an item’s cost. If the standard percentage mark-up on the cost for a 4-inch pot is 200 percent, and the pot has direct and indirect costs of $1.37 then the retail price is calculated by:
2.00 (or 200 percent) = (retail price - $1.37)/$1.37
$2.74 = (retail price - $1.37)
$4.11 = retail price
 
The mark-up on cost percentage may vary by product line. For example, the mark-up might be 150 percent on fertilizer and 300 percent on annuals. Doing the calculations is important, but how do you know if the prices are right?
 
A grower or retailer who can cover all costs and generate sufficient profit to sustain the business is the one with the right prices. If you sell out of product too quickly, you probably didn’t set the price high enough. If there is product left on your benches or there is a surplus in the market, you may not be asking as competitive a price as you need to move enough units to make an item profitable.

Real world pricing
We were interested in learning how cost increases for inputs from containers to transportation influenced prices from one year to the next. In spring 2007, we surveyed Michigan greenhouse grower-retailers about their prices for some of their common annual plant container sizes. We collected the same data in spring 2008. The prices were collected through a convenience sample of 79 (in 2007) and 58 (in 2008) businesses in a six county area of western Michigan. The sample represented 95 percent (2008) to 98 percent (2007) of the businesses for which prices had been requested. All of the businesses were independent greenhouse grower-retailers. The prices were obtained during the first week of May. These were the initial prices of products before any discounts were made later in the season.
 
One objective of the study was to show retailers how some pricing strategies are detrimental to everyone, including their own businesses. Another objective was to show retailers the upper end of possible prices, giving them some objective information on which to base next year’s pricing decisions. A third objective was to determine what changes had occurred from 2007 to 2008.

Price differences for pots
The first item for which pricing data was collected was for a single-item 4-inch pot. Figure 1 shows a plot of each retailer (each data point represents a single business) and the price (in dollars along the Y axis) they initially charged for 4-inch pots in 2007 and 2008. In 2007, retail prices ranged from $1.50 to $4.99 with an average retail price of $2.83. In 2008, prices ranged from $1.50 to $4.99 with an average price of $3.03.
 
The average price for 4-inch pots increased 7.1 percent over the year. Neither the lowest price point nor the highest price point for this size container changed, but the average climbed 7 percent. The reason for the increase was because most firms in the study did raise their prices.
 
Was the 7.1 percent increase enough to account for rising costs and inflation? Maybe not. A verbal estimate from Erik Runkle, Michigan State University associate professor and extension specialist, was that most input costs conservatively increased 10 percent in that area of Michigan between 2007 and 2008. So even an average increase of 7 percent per 4-inch pot may not have been enough to keep this product profitable.
 
Looking at Figure 1, the price for 4-inch pots plateaus at key price points. A number of grower-retailers charged the same price at $1.99, $2.49, $2.99, $3.49 and $3.99, which is indicated by the line flattening at those points. There are some points in between these price plateaus that represent growers who are selling the pots at another price point.

Range of prices
How can some growers charge $1.99 while others in the same market charge $4.99 for virtually the same product? This is a pivotal pricing question. It’s highly likely that cost inputs do not account for all of the spread in prices. This shows the tremendous range of prices that retailers can receive for a product that is most likely available elsewhere at a lower price.
 
Being the low price leader in any market is a tenuous position at best, since all another business needs to do is lower its price.

Raising prices
Given the cost increases of so many other products, now might be a good time to consider a price increase. How much should you raise your prices? Pricing literature would tell you to raise the price to the next key price point. If the current price is $3.49, you might consider increasing it to $3.99 rather than $3.79. Why? Many, but not all, consumers perceive a 50 cent increase the same as a 20 cent increase. Don’t leave that extra 30 cents on the bench. If you are priced in between a key point (i.e., $3.79 in 2008), strongly consider the $3.99 price point. This will help you add to the profit margin, cover costs, and extend the next price increase a bit further into the future.

Price differences for flats
The price data collected from Michigan grower-retailers for a 36-count flat is shown in Figure 2. In 2007, prices ranged from $5.29 to $12.29 or $7, with an average price of $8.93. In 2008, prices for flats ranged from $5.79 to $12.99 or $7.20, with an average price of $9.58. The price range expanded only slightly, with the minimum price going up 50 cents and the maximum price increasing by 70 cents.
 
The parallel lines show that, as with the 4-inch pots, most grower-retailers increased prices. The average price rose 7.3 percent which was similar to the price increase for 4-inch pots.
 
Some retailers at the low end of the price range are likely to sell flats below cost. What does this pricing strategy do to the entire market? It is difficult for some customers to differentiate between products. When they can’t tell a big difference between two retailers’ flats, they will differentiate solely on price.
 
Our inability as an industry to differentiate between products is exaggerated by retailers who sell at or below cost. This practice only pushes growers and retailers closer to the mature stage of the product life cycle where profits only exist to those who sell massive quantities. This tactic undermines everyone’s ability to generate profits.

Price differences for hanging baskets
Figure 3 shows the changes in the prices of 10-inch hanging baskets. In 2007, prices ranged from $5.98 to $21.95. In 2008, the price range for the same size basket was $7.49 to $25. The low end of the price range was raised substantially and the high end also increased sharply.
 
Notice how the data points are almost directly on top of each other for the two years. This means that there was very little change in most prices.
 
With such big changes in the low and high end prices, why did the average price for the hanging baskets only increase 1.8 percent from $13.06 in 2007 to $13.29 in 2008? There probably were several reasons why basket prices didn’t increase more.
 
A 10-inch basket may be approaching the mature state of its product life cycle.  Mature products don’t have as rapid of an increase in the growth in sales. This makes it harder for a retailer to increase the price and maintain sales.
 
Another reason may be that 10-inch baskets are great signpost items. Signpost items are products about which consumers make inferences about prices of other products. Signpost items are common among retailers, making it easy to compare them or “price check.” If a signpost item is priced low or what is perceived to be a real value, then generally consumers are more likely to think that the prices of other products may be low. But, most likely retailers may fear that they would lose a significant number of sales if they did increase the price, even enough to account for the cost increases.

The right price
Who has the right price? The grower or retailer who can cover all of the costs of production and generate sufficient profit to sustain the business is the one with the right prices.
 
If you sell out of product too quickly, you probably didn’t set the price high enough. If there is a surplus on the bench or in the market, you may not have as competitive a price as you need to move enough units to make an item profitable.
 
With most of your costs increasing, have you taken a long hard look at your prices? Maybe it’s time to devote some new energy so your customers will say (and buy to show) that the price is right.

Bridget Behe is professor, Michigan State University, Department of Horticulture, (517) 355-51291, Ext. 1346; behe@msu.edu. Thomas Dudek, is district extension horticulture and marketing educator, Michigan State University Extension-Ottawa County, (616) 994-4580; dudek@msu.edu.