I am often asked as a consultant, “what is the first thing you will do after I hire you, what’s your plan of attack?”. The answer is simple, pricing. This might seem strange to most people as I am sure you can think of a plethora of other things you would rather have me working on than pricing, however the simple fact is, if your pricing does not work we are finished before even beginning.
Product pricing should be an essential first part of your overall go to market product strategy, however again and again I see companies leaving this to the end and in some cases simply guessing. There seems to be a mystique around pricing a product that often scares companies into a panic and this is where mistakes get made that can cost thousands of dollars down the road. The mystery of margin, program, net, gross, delivered, FOB etc can leave you feeling overwhelmed and therefor uninterested.
Well; not to worry. You can put away your taro cards and cancel your appointment at the physic. We are going to take the mystery out of pricing by showing you:
How to determine MSRP (Manufactures Suggested Retail Price)
How to determine your raw cost
How to determine your raw landed cost
What is MAP pricing and should you use is?
What is gross margin and how to determine it?
What is “Program” and how does it affect your price structure?
What is net margin?
What is adjusted net margin and what should this number be to keep your business moving forward?
How to price your product to best avoid knock offs.
The difference between pricing your product online and pricing it for a retailer.
Alright, let’s get right to it!
1. MSRP – Determining your manufactures suggested retail price is critical to the rest of your pricing strategy. Every retailer, buyer, distributor and etailer will want to know this number as they want to remain competitive with the market. Before simply applying a 6 or 7 multiple to your cost in order to gain your retail I suggest you do some due diligence on your competition. What are the other items in this category selling for? Is your product better, worse or the same as what is on the market. Does your product have features that separate it from the competition and can bring a premium retail price or is it a value offering from the competition and needs to be priced lower. To bring a bit of clarity to this subject let’s create a scenario. Let’s say your company has created a new smart phone case and you need to establish a base MSRP. Your Raw Landed Cost(you will learn this below) on this item is $ 7. If you times your cost by a 7 multiple to gain your retail you end up with a $ 49.99 MSRP. On the surface this MRSP seems to work, however after some research you find the competition has this type of product retailing at $ 39.99. This is where you will have to decide if your product (an unknown) can bring a $ 10 premium to known brands already on the market. If not you will have to bring your retail down to $ 39.99 and rerun it through our proprietary pricing worksheet to see how this new retail affects your over all profit number. At the end of the day please remember this one truth, MSRP is created by the customer. To be more specific your product is really only worth what customers are willing to pay for it and not a penny more which is why pricing is such an important part of the process.
2. Raw Cost – This is the number your company pays for a fully packaged, production quality product at the manufacture. Please note that a production product is not a hand made sample or one of a few sample products run from your factory. A production product is a product pulled directly off the production line ready to go to a retailer. It is this cost you are after.
3. Raw landed cost – This is the number your company pays for a fully packaged, production quality product including the cost of bringing the product to the US if it is manufactured overseas or to your warehouse if it is manufactured somewhere different then where you will be warehousing it. How much should you factor into your product cost to land your product here in the US from overseas? As a rough estimate only, you can take $ 4700 / the units of product that fit into a 40ft container. This will give you a rough idea of how much you should add to your unit cost to have a complete landed raw cost. Please keep in mind this is for rough estimates only, you should replace $ 4700 with your actual cost when you are receiving logistics quotes. Ex. If your the raw cost of your product at the port in China is $ 1.47 and you can fit 10,000 units in a 40ft container your cost per unit to flow the product to the US would be $ .47. This would make your Raw Landed Cost on this item $ 1.94. If your product is manufactured in Wisconsin and your are bringing them to your warehouse in Texas you would simply substitute the $ 4700 for the cost of shipping the product from WI to TX.
4. MAP Pricing – MAP or Minimum Advertised Price is a policy used by some manufactures to create stability in advertised pricing of their product. It means that no retailer or etailer can list or advertise a MAP’d product under the MAP price set by the manufacture. Brick and Mortar stores can sell these items or even list these items in store for any price they choose as long as they do not advertise them for less than MAP. This sound like a pretty good deal and you are probably saying to yourself, “Why wouldn’t I create a MAP policy?” Here are a couple things to consider when making this decision; 1. Once you establish a MAP policy and distribute it to your retailers you must treat each retailer the same irrespective of their volume. This means if you stop supplying a small retailer because they violated your MAP 3 times and this is clearly stated in your policy then you would also have to stop supplying a large big box chain if they did the same or risk a huge law suit, 2. Some retailers simply don’t want to do business with products that are MAP priced as it creates issues with their marketing plans.
5. What is gross margin and how to determine it – Gross margin is the difference between your selling price and your raw, landed product cost. It is generally expressed as both a percentage and a dollar amount. To determine the dollar amount the formula is SP-Cost. To gain your gross margin % you would use the following formula formula: (SP-Cost)/SP. SP = sell price. If your selling price is $ 79.99 and your raw landed cost is $ 27.5 the equation for gross margin dollars would look like ($ 79.99-$ 27.5). Your gross margin dollars would be $ 52.49. To gain your gross margin percent the equation would look like this ($ 79.99-$ 27.50)/$ 79.99. Your gross margin for this item is 65.62%.
6. What are program costs – Program costs can be considered any additional cost the retailer is going to ask you to be responsible for paying. These costs should be built into your cost structure prior to quoting. Not taking the time to understand these costs of build them into your cost structure prior to quoting pricing to a retailer is a recipe for disaster. Your company must be able to incur these costs and still produce a healthy margin. Some common program costs are:
Returns allowance – A retailer might ask for a % off invoice to cover any returns. This % can range from 2%-10% depending on the product.
Freight – At times retailers will ask for a “Delivered Cost”. Delivered cost means that you will have to pay to deliver the product to the retailer therefor you must factor this cost into your pricing structure.
MDF – MDF stands for Marketing Development Fund. This would be money that your company would accrue for future promotional opportunities or a retailer will require that you contribute to a fund.
Mark Downs – This is a fund you would accrue for use in liquidating slow moving inventory from a retailer. Many times retailers will not mention this, but will come to you later asking for money to help move stagnate product. It is best to accrue for this on your own so you have money when the time comes. For example; some club stores do not transfer merchandise from warehouse to warehouse which means you might get an order from warehouse A, while getting a markdown request from warehouse B only 5 miles away.
It is important to note that some retailers will negotiate program costs with you upfront and will deduct the negotiated percentage direct from the invoice when paying you. Other retailers will not negotiate this upfront, but will still make deductions from your invoice when paying.
7. What is Net Margin – I calculate Net Margin is your “Gross Margin” minus all of your program costs.
8. What is adjusted net margin and what should this number be to keep your business moving forward – Adjusted net margin is your “Net Margin” minus any rep or broker commissions. If possible always insist that you pay commissions on net margin. In some cases the broker or rep will be the one negotiating the program costs and he or she will be more likely to negotiate better on your behalf if their commission is affected. Achieving the best ANM will depend on several factors including your business structure and volume. Generally I like to see Club Store ANM above 25%, regular Big Box above 35% and Specialty retail above 45% if possible.
9. How to guard against knock offs by pricing your product correct the first time – Today’s manufacturing is much different then in years past. It is very common for companies to have product produced overseas, a world away from where their company resides. It can be costly to spend the needed time overseas to manage the manufacturing process and as a result companies send their product ideas to overseas factories in an effort to get product produced cheaper and more efficiently. The most common fear I hear when companies are shopping for a factory to produce their goods is they do not want to get knocked off. While this is a legitimate concern it cannot keep you from moving forward. There are two strategies, I believe, will give you the best protection against knock off product if it shows up.
If at all possible be first to market and establish your product brand as the authority as quickly as possible. In the bedding market there are plenty of competitors to Tempurpedic, however customers still prefer the Tempurpedic brand over the competition as they were first to really bring memory foam mattresses to market in a big way. Price your product to be competitive right from the beginning. Gouging the customer simply because there is no current competition will not serve you in the long term. When the knock offs come calling, and they will, the buyers who carry your product will be reluctant to change if the difference in price is not more than 15%. However, if you went out with high cost and the competition is now knocking at a much lower cost and retail, the buyers will be more likely to seriously consider it.
10. The difference between pricing your product on your website and pricing it for a retailer. – Many retailers will begin by selling their products on their own retail website, which I encourage with all my clients. I am always reluctant to work with clients who are not willing to sell their own products directly to the customer. When selling online the pricing formula is simple. It costs X to make my product, I sell it for Y and get to keep the difference. Once you establish this retail online it becomes known and can be difficult to adjust later. When you begin selling your product to retailers they will want to use your current online retail or lower as their go to market retail. Now you must take your retail and deduct 40-65% margin that the retailer will want, program costs they will want your company to pay and then finally your cost of goods. What is left over, at this point, can be to little to run a company and in some cases flat out in the negative. Because of the above it is important to establish your entire pricing structure right from the beginning. Below are some categories to consider when creating your pricing structure.
Big Box retail
Specialty retail
Club store retail
E-tailers
Department store retail
Your website
11. Getting ready – To recap, below is a list of the items you will need to create the cost structure you will quote to the retailers you are wanting to carry your product. Have fun and good luck.
MSRP – You must have an idea of what your product will retail for (see MSRP noted earlier in this article).
Margin – If you don’t yet know what margin your target retailers are looking for you can obtain help with one of our pricing worksheets noted below.
Program costs – If you don’t yet know these numbers see how to obtain our pricing worksheets at the bottom of this article.
Raw landed product cost – We can’t help you here. In order to finish your pricing you will need to have this number.
Rep or broker commissions – If you will be using a rep or broker and have negotiated their commission rate you will need to have this number handy.
Units sold – This section is where you will estimate your units sold to this retailer for a 12 month period. Creating this number will also help you with your volume projections and production planning.
