Over the last couple of posts we worked our way through cost and profit. We are finally ready to determine our shelf price. This involves factoring in the required margins of our retail partners. Just like you, retailers need to make a healthy margin, so that they can cover the high overheads of running a retail operation while making a profit to help finance their growth and development. All of a retailer’s business calculations are based on their margin, so anything occupying space on their shelves must sell quickly and at a price that clears that margin.
Your Manufacturer Suggested Retail Price (MSRP) is the shelf price or “price point” that you want retailers to sell your product for. “Suggested” is the operative word here — the reality is that retailers will sell it for whatever they need to. But retailers will abide by your MSRP if it moves at that price and affords them the margin that they require.
Scope Out the Competition
To determine your MSRP, begin by examining the shelf price of your competition. Since different stores will price products differently on their shelves, you’ll want to check prices at as many different stores as you can, and use that information to estimate your competitor’s MSRP. In all likelihood, you will have multiple competitors, so you should do this for each competitor in your category.
Make sure you check prices at stores outside of your local area, wherever you can envision selling your product. A lot of startup producers assume from their local success that they’ll be just as successful wherever they go, forgetting that when you expand beyond your home region, you lose your “local producer” appeal, plus your shipping costs will increase, making your product a tougher sell. Pricing your product for those markets now will set you up for success when the time comes. You don’t need to travel to all different cities, of course. Just pick up the phone call a sampling of stores in a sampling of the cities that you plan to target, and pretend that you’re a customer inquiring about their selection.
You will likely discover that there’s a range of MSRPs among your competitors, the result of different producers having different cost structures and pricing strategies. If MSRP was the only thing a producer used to differentiate its products from the competitions’, then the producer with the lowest cost structure would win. Fortunately for most of us, consumers also consider a product’s features and amenities when weighing their options. If you can’t out-compete your competitor on price, it’s not the end of the world, and in fact might be a good thing, considering that price-conscious consumers usually aren’t the most loyal customers. Instead, focus on enhancing the perceived value of your product over theirs via your Unique Selling Proposition (USP).
For now, just make sure that your MSRP will land within the existing range of your competitors’ MSRPs, and if not, that you can justify your higher price tag. If your MSRP is coming in high and you can’t justify it through your USP, then it is unlikely that your product will sell, which means that you don’t have a viable wholesale product and it’s back to the drawing board for you.
The Retailer’s Cut
Like you, retailers will need to make a gross margin in the range of 40–60% for any product they sell. A retailer’s COGS on the sale of your product includes your wholesale price plus any shipping or delivery fees that you pass on to them. Thus, if your wholesale price per unit is $10 + $1 shipping, and a particular retailer requires a 45% margin, that retailer would calculate the shelf price for your product as follows:
Shelf Price = COGS / (1 - Margin)¹ = $11 / (1 - .45) = $20
Side Note: Another way to look at a retailer’s margin is in terms of “discount.” Since this retailer requires a 45% margin, you must in effect offer them a 45% discount off of your MSRP if you expect them to put it on their shelf at your MSRP.
50% is the most common margin that a retailer will require. It is so common, in fact, that it has its own name in retail: “keystone pricing.” A retailer utilizing keystone pricing will take your wholesale price (plus any shipping or delivery fees) and double it to arrive at their retail price. This is a quick and easy rule of thumb for retailers that more or less guarantees they’re achieving an ample margin to cover their overhead and turn a profit. Therefore, you should plan on setting your wholesale price at about half of your MSRP.
Don’t Forget the Middlemen
It is important at this point to ask yourself whether you foresee working with distributors down the road. There may very well come a day when your business stands to benefit from working with one or more distributors to extend your market penetration. Distributors take a cut of your wholesale price, rather than marking up your wholesale price before selling your product to retailers. This way, the retailer’s cost is consistent whether you are selling your product to them directly or through a distributor, and it will land on the shelf at the same price regardless. In other words, selling through a distributor should have no effect on your MSRP.
A distributor’s discount will be in neighborhood of 30% off of your wholesale price.² You will likely need a broker too, in order to get the most mileage out of your distributor. Brokers will take a 5–8% commission from all of their sales.³ If you foresee one day partnering with distributors and brokers, then you have two options:
- Build a distributor margin and broker commission into your overhead now so that when you pick up with a distributor you can still make a profit.
- Wait to raise your MSRP until you actually start selling through a distributor, and hopefully by then you will have discovered ways to reduce your costs so that you don’t have to raise it by much.
Setting Your Price
Returning to our woodworker now, we can finally answer the question we began this pricing series with: How did she arrive at her wholesale price of $25? Not by picking a number out of thin air! She began by working out her COGS ($13). She also pondered the distributor question, and decided to cross that bridge if and when she gets to it — she is confident that she has plenty of interest from retailers who purchase from her directly to keep her busy for at least a few years, plus she prefers to cultivate direct relationships with buyers, and thinks she can achieve better shelf presence (and sales) as a result.
Now, in our previous post we calculated her margin to be 48%, but that calculation assumed that we knew what her wholesale price was. In reality, wholesale price and margin are arrived at simultaneously while determining a product’s market positioning.
For example, let’s say that in studying the market for handmade cutting boards, she found that her competitors’ boards have MSRPs ranging from $35-$60. Knowing that her retailers would probably keystone her wholesale price, the question became, Could she afford to wholesale her cutting boards for $17.50 to $30? $17.50 would mean that her gross margin would be an abysmal 26%. Subtracting out her overhead expenses (GP x 30% = $1.35) would leave her with a mere 18% net margin— yeesh! Very little wiggle room there to account for volatility in the cost of her materials and supplies, etc.
$30 would be ideal, but she doesn’t believe that she can compete with the selling points of that particular competitor, who is using wood from a local species of tree after being knocked down in storms. Our woodworker is using nice reclaimed wood, but it isn’t local, so she wouldn’t be able to fetch that premium price.
$25 affords her a 48% gross margin, or 34% net margin. Not bad at all, and it gives her room to play around with opening order discounts and shipping incentives. When keystoned, it would land on the shelf at $50. This is a good round number and not something that a retailer would be tempted to round up, which retailers will often do when a product would otherwise land on their shelf at a weird number like $53 — why not just make it $55?
Bear in mind too that your price relative to your competition’s is a statement about your product, technically part of your Unique Selling Proposition. Is your product the budget option, the luxury option, or somewhere in between? Knowing your target customer means knowing how best to appeal to them through your price. In this respect, price can actually help you stand out on the shelf. A higher price can signify better craftsmanship and higher quality ingredients/materials, while a lower price can signify functionality over frills.
So there you have it: our woodworker has found the sweet spot between her costs, her profit, and her MSRP, and she can feel completely confident that $50 is her MSRP— nothing more, nothing less. As a salesperson for a small wholesale producer, having that confidence in your pricing goes a long way in helping you pitch the product better. It’s nice to be able to tell a buyer that your MSRP assumes a 50% margin for them, and it’s very motivating to know that your sales successes truly are turning a solid profit for your company.
One final point to make about pricing: once you settle on an MSRP for your product, you must sell for that price wherever you sell direct-to-consumer, whether on your website or in your storefront or at a market. Otherwise, you are undercutting your retail partners, and they most certainly will not appreciate that.