The Price is Right: How to calculate margin and pricing for maximum merch profits
You just wrapped up your new merch order and you are PUMPED to start sharing those items with your team and customers. But wait. You need to determine a retail price to sell the merch at. What price do you charge? Do you simply go with the manufacturer suggested retail price (MSRP), or did you add some custom features that need to be taken into account in your price to consumer (PTC)? While it is something we often take for granted as a consumer, pricing is a delicate and very important balance to maintain. If you charge too much, you risk turning consumers away and getting stuck with excess inventory. If you charge too little, you may be leaving money on the table. What is a fair margin to expect? We’re here to help you answer all of these questions and give some brass tacks advice on how to navigate potential pricing pitfalls (say that 5 times fast!). Peep the deets below!
Margin vs Mark-up.
We’ve often heard the terms “margin” and “mark-up” used interchangeably, and while they are similar in that they both deal with profit, they each convey different information and it is important to know the difference between the two.
Profit Margin - Margin is the revenue a company makes after paying their cost of goods sold (COGS), which is calculated by subtracting the COGS from the revenue generated, and then dividing that by your total revenue, often displayed as a percentage. For instance:
You sell a branded jacket for $90 and it costs you $40 to produce/procure.(AKA- COGS). To calculate gross profit, subtract your COGS from your revenue. $90-$40= $50 gross profit
To show your profit margin as a percentage of revenue, simply divide your profit margin by the revenue. 50/90 = .55 (or 55%)
In short: Your profit margin determines the amount of additional money generated on a particular product or service after your COGS are paid for, or in other words, how much of your sales are turning into profits.
Mark-Up - Your mark-up, on the other hand, measures the relationship of your sales price to your COGS.
To calculate mark-up, divide your Gross Profit by your COGS. Using the jacket example above, we know that gross profit is $50
Next, you’ll calculate the mark-up by dividing gross profit by COGS, so $50/$40= 1.25 mark-up (or 125%)
Similar to margin, the higher the mark-up rate, the more net profit you are generating per sale, and the more net profit generated per sale means more money to invest back into the business (or heaven forbid, take as a distribution!)
Sorry for the essay in finance, but the differences between margin and mark-up are important and worth knowing. Your bottom line will thank you, and your accounting department will thank you! Happy Accountants = Happy Life. That’s how the old saying goes, right? Main takeaway: Margin is the relationship between gross profit and revenue, whereas mark-up is the relationship between gross profit and COGS. Knowing both of these figures allows you to compare the profitability of the various items you sell. Thank you for coming to our TedTalk.
2. Understand Your Customer.
Understanding your core customer allows you to select a product mix and price point that appeal to them. Do your customers have higher levels of disposable income and value high quality, eco-friendly products? Having some sustainably sourced and higher quality items that are also higher priced is probably reasonable. Perhaps your customers are more value-driven and prefer items with more approachable price points to spendier items? In this case it would make sense to have a product mix of lower cost items that reflect your customers’ values and budget. Put simply, if you are offering items that are outside of your target customer’s budget or do not appeal to their values and sensibilities, you’ll end up with stranded inventory and slow-moving merch sales.
3. Set Your price.
Time for Econ 101. Anyone remember the supply and demand curve? Well here’s a quick refresher. As the price of an item increases, the demand for said product decreases. As the price for an item rises, the ability for the supplier (you) to produce (supply) the product for your customer increases. Charge too much and you end up with low sales and excess inventory. Charge too little and you end up without good sales, but you’re frequently sold out of product and there’s unsatisfied demand. The solution: set the price where supply and demand meet. Well great. That’s super not helpful unless your customers give you a supply and demand graph with their preferences.
Who remembers this little guy from econ class?
The real solution: Talk to your customers to see if you can find out what their price tolerances are. Test out different prices to see how well things sell at different price points. There are some rules of thumb though for where to start.
Once you have your product mix dialed-in and understand your core consumer, use that handy-dandy markup calculation we mentioned before in section 1.
A retail industry guideline is that a good mark-up percentage is roughly 100%, which is double your COGS. (PS-Don’t forget to include those pesky shipping costs and setup fees in your COGS). Now, this may or may not work for you. You may be able to price premium items higher (120% markup or more). Non-premium items (commodities) might not tolerate such high mark ups and you may end up down near 80%. Pricing is an ongoing discussion that should evolve over time, so be willing to be flexible with your pricing strategy as your business grows. Pricing isn’t something that you should set once and forget, but rather something you revisit regularly. Other factors to consider with regards to pricing:
Where are your competitors pricing their products? Are you on-par? If not, why not?
Are there external economic factors that may impact your consumer? Good/Tough economic conditions, supply chain issues, cost of living changes, tax rates, etc. are all important considerations.
Don’t hesitate to have clearance items that you sell for 0-50% markup. If something isn’t selling, get it gone! Take what you can get and use that cash to invest in a product that will sell.
What does your gut tell you? Put your consumer hat on for a few minutes and think about how much you would be willing to pay for something like this. If you think your price is too low or high, determine why and adjust your price accordingly if need be.
What are your customers telling you? In order to maximize profit, your goal should be to sell as many products at as high a price as the customer will tolerate. Try selling products at different prices and see how well they do. Change the price, how do they do now? Do the math. One way will make you more profit without having a significant negative impact on sales. That's the way to go!
Now that you have read through all of that, pricing should be clear as mud, right? We get it. Pricing can be a difficult and even touchy subject for many, but with some careful thought and a willingness to make changes as your business evolves, you can determine a solid pricing strategy that will not only appeal to your customers, but will help you maximize profits for your business as well.
