Pricing your products and ensuring you have built-in sufficient margins to sustain your e-commerce business is one of the most important decisions you’ll make.
This brief guide will walk you through a simple process for combining standard markup pricing with market research, using a provided spreadsheet to determine the appropriate manufacturing costs, margins and pricing for your products.
Are you a craftsperson or an entrepreneur?
This is a personal lifestyle choice – but be clear on which you have chosen. As a craftsperson, you can be perfectly content creating handcrafted products in low volumes and selling them to a niche audience. If this describes you, you can ignore the rest of this post. You just need to cover your material and living expenses in order to continue doing what you love.
However, if you are an entrepreneur with a vision of building a scalable venture, you need to understand and adhere to established business principles, such as standard markup pricing.
Even if you’re small now, you need to plan for big.
If you’re just starting out, you may not realize how much margin you will need to build into your retail price in order to build a viable, long term business. While selling solely through a website is a great first step, most brands need to explore other channels to accelerate their growth.
If you get your pricing and margins wrong, you’ll be in for a rude awakening when you start approaching retailers (and you’ll probably end up with a greater appreciation for why so much stuff get’s manufactured overseas!)
Combining standard markup pricing with market research.
If you’re basing your price strictly on a multiple of your costs -also known as Standard markup pricing you’re starting at the wrong end of the equation. I strongly suggest starting with a target retail price and working backward to see if your product will be viable.
You will still need to ensure you are able to generate a sustainable profit margin – thus the need for standard markup pricing – but you’ll be imposing an additional level of discipline by aligning your numbers with the reality of the marketplace.
Here is a step by step guide to using the Indie Brand Builder Margin Calculator to determine standard markup pricing:
1. Research your industry and competitors to determine high and low retail price thresholds
You will need to determine how the quality, features and benefits of your product measure up against both direct and indirect competition.
By direct competition, I mean any other product that has similar features and is used to solve the same problem or address the same desire of the consumer.
By indirect competition, I mean products that aren’t in your category but provide a similar outcome or function for the consumer (ie – a book vs. an e-reader).
Make a quick spreadsheet listing each competitor’s name, product features and retail price.
2. Pick your target product price
After doing your research, you should have a reasonable idea of the general price range you expect consumers will be willing to pay – also known as the MSRP (manufacturer’s suggested retail price). You will now need to choose a target price that you think represents an optimal balance between generating revenues and generating demand. At this point, the price is simply a hypothesis as you will still need to factor in manufacturing costs
Keep a laser Focus on your gross margins. Anything less than 50% – 60% and you may be headed down a slippery slope
3. Plug the numbers into the Pricing and Margins Spreadsheet Calculator
- Input your target retail price in on the far right to match your figure
- Next, plug in your target wholesale price at half of your retail price. You will now see your “retailer” margin at 50%.
- Adjust the freight and duty percentage as required. By default, it is set to 20% – which is a conservatively high ratio (our e-commerce business’s freight and duty is typically around 17% coming from China) . Before making any final decisions, you should validate this by talking to shipping and customs brokers. You can also use this estimator tool.
- Start playing with your manufacturing cost numbers to see what they should be to get your gross margin to 60%
- This will allow you to target an acceptable manufacturing cost
4. Negotiate with your factory or suppliers.
Now that you have a target cost, you can take this to your factory or use it as an internal target for producing your goods. If you are manufacturing internally, note that this number is just meant to capture your Cost of Goods: that is the cost to produce one unit of product.
While it will include labor cost related to manufacturing, it should not include overhead costs associated with running your business such as administration, marketing or selling your products.
5. Negotiate with retailers and distributors.
Your target wholesale price is just that: a target. If you are negotiating volume transactions, retailers will typically ask for a discount. When they do, you can simply plug this into your spreadsheet to see how it affects your margins.
If you’ve calculated for 60% margins, this will give you some room to maneuver and still make a reasonable profit. Distributors will expect at least a 20%-30% off your wholesale price – though sometimes they will be able to give you an order that can be taken directly to the factory (if applicable) and shipped straight to them, which reduces your risk and cost of carrying the products.
Why you need to target a 60% profit margin when pricing products:
- You will likely have other selling costs such as marketing, paying commissions to sales reps, shipping merchandise and providing samples.
- Larger retailers will ask for a discount off your wholesale price
- You need to cover all of your business overhead, including your own salary
- Your business needs to generate a profit in addition to your salary in order to be viable over the long term.
- You may have to sell a portion of your inventory at a discount or write it off completely
- You will need to generate enough cash flow to continue financing the business.
Other Factors to Consider
Economies of scale
In the short term, you may be willing to settle for slightly lower than standard markup pricing margins as you build your volume up to a point where you can realize efficiencies in your manufacturing costs.
Just be sure these cost projections are based on solid agreements with your suppliers, rather than wishful thinking.
What I’ve proposed here is based on a traditional wholesaling model – but the world is changing quickly. If you are committed to an online-only approach, integrating with your own retail location or going the multi-level marketing route, then these rules may not apply.
Other entrepreneurs have been very successful blazing their own trail – but having more margin always allows you more flexibility if things don’t go as planned.