Advantages of a High-Low Pricing Strategy (With Examples)

Advantages of a High-Low Pricing Strategy (With Examples)

What is a High-Low Pricing Strategy?

Also referred to as “hi-lo” or “skimming” pricing method, high-low pricing is a common retail pricing strategy where a product (or service, in some cases) is introduced at a higher price point, and then gradually discounted and marked down as demand decreases.

High-low pricing strategy example
Although the concept is simple, knowing when (and how) to use a high-low pricing strategy can be difficult.

So when is this strategy most useful?

Examples of High/Low Pricing

High-low pricing is often applied to brand new products that are just being introduced to the market:

Example 1: Smartphones

Virtually all smartphones (especially flagship and mid-range phones) are introduced at a high price point, and gradually discounted as hype dies down (and new models are announced). While Apple popularized this approach to smartphone pricing — this is now standard across most brands including Samsung, Google, Huawei, etc.

Example 2: Video Game Products

While not all video game products use this strategy (video game accessories like controllers almost never drop in price) — this is the primary pricing strategy for mass market game consoles and game software. Game publishers introduce their products at peak price (59.99 USD / 79.99 CAD for a video game), only discounting as demand wanes (after weeks, months, or years, depending on the product).

The major exception to this strategy is Nintendo — who almost never discounts their products, even after years of being on the market.

Example 3: Mid-Range Sports Apparel

High-low pricing is the preferred strategy for many mid-range sports apparel retailers (especially those found in North American malls). New designs are released at peak price at the onset of a new season, and are discounted as demand wanes. This strategy does not extend to high-end sports goods (professional equipment, official team jerseys, etc.) or sports departments in EDLP retailers.

What is the Benefit of High-Low Pricing?

High-low pricing is a particularly useful pricing and marketing technique when you don’t have any sales history to base pricing decisions on.

Your goal as a retailer is (typically) to increase profitability, so it’s reasonable to start your pricing strategy by maximizing your gross profit.

But because calculating the optimal price point for a new product is very difficult without sales history, high-low pricing allows you to start high and keep lowering the price until you get to a point where the Sales x Gross Margin results in the most absolute profit.

Advantages of High-Low Pricing shown in a graphThe graph above shows a hypothetical use of high-low pricing:

  • As Price goes down, so does the Unit Profit
  • At the same time, Sales increase
    (because more people buy at the sale price)
  • Total Weekly Profit increases for several weeks
    (because the Sales increase is bigger than the Unit Profit decrease)
  • Finally, Total Weekly Profit quickly falls at the end
    (because Unit Profit continues decreasing and Sales stops increasing)

Assuming there is nothing else impacting your product demand (like seasonality), the high-low strategy can theoretically help you discover an ideal price point for a particular product. In our hypothetical example above, this would have been Weeks 7 – 8, where Weekly Profit was highest.

This strategy of incremental markdowns is also used as a product is nearing the end of its season. For example fashion retailers may start incrementally lowering the price of winter jackets as winter ends and spring begins — especially if they happened to overstock on inventory.

Despite this being a viable strategy in certain situations, there are a few considerations you should keep in mind:

  • Once you offer a product at a certain price to your customers, increasing the price of the product later on in the season can be very difficult
  • In some cases, when demand unexpectedly spikes for a product (like hand sanitizers during a pandemic) significantly increasing the price on this product may hurt your business reputation (or may even be illegal)
  • On the other hand, few will complain about a decrease in price
    Therefore it makes sense to introduce a product at a higher price, observe the reaction from consumers and then gradually decrease the price to increase demand/sales.

When Not to use the High-Low Pricing Strategy

A high-low pricing strategy would not be effective in several situations:

Commodity Pricing

If the item is a commodity, the price will typically fluctuate depending on the retailer’s cost to acquire the product, as well as overall demand for the product.

In this situation the market sets the price, and introducing the product at a high price will not generate any sales since customers intuitively know how much the item should cost. For example you can’t simply start selling cucumbers at $10 a piece.

EDLP Strategy (Every Day Low Pricing)

Some retailers compete primarily on price. They typically employ an “Everyday Low Price Strategy” (EDLP). These discount retailers are focused on keeping prices lower than the competition, so they will often offer price matching and consistently maintain low prices throughout the entire season.

Luxury Brand Pricing

On the other side of the spectrum you have high-end, luxury retailers.

Strong brands in this segment will typically stay away from high-low pricing, because their prices are strategically high to begin with. Reducing prices may damage the perception of luxury among consumers.

Some high-end retailers destroy unsold inventory at the end of the season instead of marking it down — for this very reason.

Loss Leader and Market Penetration Pricing Strategies

“Loss Leader” and “Market Penetration” strategies are also at odds with high-low pricing.

Loss Leader pricing is when a retailer intentionally discounts the price of a product (sometimes below cost) in order to generate extra demand and traffic into their store (hoping consumers will purchase additional products on their visit).

Market Penetration is when retailers intentionally lower the price of a product in order to gain market share over competitors.

Where Does High-Low Fit in the Big Picture?

High-Low pricing is a relatively simple strategy that relies on a bit of guesswork.

Retailers may prefer to use it when it is too difficult to calculate, set, and manage optimal prices throughout the season for each product on an individual basis. Although it can’t compare to a more comprehensive pricing plan — it’s useful in this particular instance.

To put this in perspective, if you have 100 stores and 10,000 products, you are looking at 1,000,000 Store/SKU combinations (each with their own demand curves and optimal price). Effectively managing prices for so many store/SKU combinations is simply not possible for a human.

So it’s no surprise why some retailers use simpler rule-based pricing strategies (like high-low) to manage their product prices.

But despite its simplicity, high-low doesn’t provide a foolproof approach to pricing, and its success is (at least in part) determined by guessing correctly:

  • How high should the initial price be?
  • How often should prices drop?
  • How big should the price drops be?
  • How much inventory is needed for each price point?
  • What should the pricing floor be?

Each of these questions is difficult to answer without some sort of advanced analytics or a powerful demand forecast.

And if you could answer these questions accurately, at scale, for every Product / Location, you would no longer be thinking of pricing strategy in concepts like “high-low.” You would be more concerned with concepts like AI-driven price optimization.

That’s why high-low pricing is a great option for smaller retailers that are trying to find an optimal price on a small number of products. But at higher levels of retailer complexity, it is difficult to implement this strategy broadly without making a lot of guesses (and relying on luck).

Instead, more sophisticated retailers use advanced pricing tools like retail AI and Predictive Analytics.

Implementing Advanced Pricing Strategies

As millions of Store / SKU combinations move through their own life-cycles, prices may need to be adjusted in several stages for each (initial pricing, regular pricing, promotional pricing, and markdown pricing.)

Purpose-built artificial intelligence like Retalon (designed and made for retailers) can do this completely automatically.

Retalon’s retail AI engine is able to look at dozens of critical factors that affect demand:

  • Price elasticity of the product
  • Seasonality
  • Effect of sales promotions
  • Competitor pricing
  • Price zones
  • Cannibalization of related products
  • And much more

The system will then calculate the optimal price point or discount for each product at every location to maximize gross margin and profitability without leaving you overstocked at the end of the season or out of stock on merchandise that is in high demand.

Initial pricing of a product doesn’t exist in a vacuum and should incorporate promotional strategies, as well as markdown optimization.

Here is a short video about how Retalon’s Price Management solution optimizes prices throughout the entire product life cycle:

If you would like to learn more about price management strategies and how retail predictive analytics can help your specific business, get in touch to request a demo or an assessment on your own data.