Sometimes you want to set the record straight.
So speaking as someone who has led pricing at four companies, three of which were wholesale distributors – most of what is written about how to calculate a wholesale price is wrong.
Here’s the right approach.
Stop Talking About Markup Percentage
Most wholesale pricing articles start with some formula for deriving markup percentage. And that is where the whole process falls apart.
Speaking as a distributor, I couldn’t care less what your overall markup percentage looks like. I’ve made money shipping product at five percent gross margin. I’ve lost money shipping product at thirty percent gross margin.
When I see a new product, I think five things:
- How much do I need to spend to sell it?
- How much does it cost to ship?
- What’s the minimum buy? ($$ at risk)
- If it works out, how fast should it sell?
- What does the typical buyer expect to pay?
Those numbers are different for every target market and product line I’ve ever managed. There is no one number.
Keystone pricing, where you mark up items by a specific amount (2X product cost), doesn’t work outside of tiny shops and convenience items. The real world is far more complicated.
Put differently, as a manufacturer you’re buying a service – from me. Wholesale margin is my fee.
Let’s break it down a bit further.
Start with Retail Price
The most important number in the game: what is my customer, the retailer, going to change a retail customer?
This is ultimately dictated by three things:
- The price of your top competitor
- Premium / Discount for perceived value
- How badly you want the volume
In my past life, I sold an off-brand product that competed with the national brand. Their main product was priced at $15. Consumers needed an incentive to buy our brand, which experience showed was a 25% discount due to our lower perceived value. So our target retail price was $12. Assume we can sell about 100 units per week at that price.
Demand for our product went though the roof when we went on sale. This was especially true if a retailer featured us in their advertising and displayed our product at the front of the store. While we needed to cut our price 33% for one of these week long events ($8), we could sell 20 times more units during one of those weeks.
Understand Retail Margin
Continuing the traditional wholesale pricing example, you might believe that retailers have a standard margin. Except this is often incorrect.
A wise retailer is focused on their total $$ per week that they generate from an item. This is especially true if they put it on promotion.
In the example I provided above, my typical retailer wanted to make a gross margin of at least 33% for an item sitting on the shelf. Every week, they would sell 100 units at $4 per unit: $400 per week of gross profit.
Considering they would sell 2000 units during the week we went on sale, they were quite a bit more accommodating that week. I could let their margin drop to $1 per unit and they would still make $2000. Along with any ad fees or other incidentals (net these out of your invoice price).
In practice, this meant they needed a $9 cost to make the math work for shelf business and a $7 cost to support a $8 sale price for a big sale. While earning an 33% margin on the former and a 12.5% margin on the latter (with 5 X the profit).
In short: don’t just use a flat percentage; look at what the deal does for the retailer’s economics. Align your retail markup target with what the “end of channel” partner needs to compete. You can provide them with a recommended retail price and appropriate costing to support it.
Wholesaler Markup Percent
And now for the distributor’s profit margin. Another frequently misunderstood piece of the puzzle. My profit margin target as a wholesaler is completely driven by the amount of work I’m going to have to do to earn the business.
First and most significant question: are you finding new customers or am I? It takes a lot more time to generate new demand for a product than take orders. My sales reps will need to be compensated for pushing your item. This can increase my margin goal by 5% – 20%. In practice, I like to model this as an estimated return on distributor selling hour or sales call, adjusted for the likelihood of success.
It’s also worth remembering that many items are “sell once, enjoy forever”. Once you convince a retailer to take your product, they will often keep buying it as long as it sells on the shelf. This can be used to amortize out the cost of investing in new placements.
Next, we need to talk about supply chain cost. I’ve got product in my warehouse and you would like to get it delivered to your place. I’ll need you to cover appropriate freight and handling cost. In reality, logistics cost as a percentage of sales can often vary quite widely. I can ship direct truck loads for a few percent of sales. On the other hand, small e-commerce packages and deliveries can be extremely expensive. This could include direct cost (freight), labor cost, and indirect costs allocated to a customer.
And while we’re at it, don’t neglect differences within a distributor’s product assortment. The balance of their assortment may move at 15% since the items are expensive and lightweight. Your low-priced and bulky item may need 25%. One pricing strategy doesn’t fit all.
My wholesale cost is determined by dividing my selling price to the retailer by the distributor’s target profit margin percentage. While a distributor probably won’t give you a precise number, you can guess it based on watching the price at which I sell similar items.
But What About My Product Cost?
Bear in mind that everything we’ve discussed up to this point is market driven. You are setting a recommended retail price based on competitors and perceived value. From there, we work back through markup formula math to cover your channel partner’s gross profit margin goals.
The final result of this pricing formula is a wholesale customer price. This is the amount you need to be competitive in this distribution channel.
So what if this wholesale price is below your product cost and desired profit?
You either take it or leave it. Assuming that you’ve done the math correctly, this is the minimum amount you need to get your channel partners on board with promoting your brand. Cutting corners is counter-productive: you end up making / slotting the item and it sits on the wholesaler / retailer shelf due to lack of interest.
If you want a higher price, you need to cultivate either another target market or a more efficient path to market. Tweaking your product pricing may help a little bit – but in the long run, you’re going to need to deliver a competitive return for your channel partners.
Along the same lines, the market doesn’t care about your fixed cost or overhead cost. Step back and look at your business strategically: if you can support the overhead cost, do so. But avoid trying to allocate it to specific transactions. That tends to product dysfunctional pricing that doesn’t really suit any of the constituents.
Product Launch Risk
If you’re trying to promote a new product or enter a new channel, you need to tweak your wholesale pricing strategy to reflect this.
As mentioned above, it’s harder to generate demand for a new product than sell to an existing buyer who just wants a supplier. If the product is new (or unknown) this only gets harder.
Some hard math: most new items don’t work out. This applies to both B2B products and consumer packaged goods (CPG). Any smart distributor knows this and will be keen to make sure they price this risk into the deal.
This is where your slotting terms and the amount of a minimum buy becomes a big deal in getting your distributors on board. The higher the minimum buy, the more value the wholesaler has at risk if the item doesn’t work out.
New product launches are basically like venture capital: you take a lot of bets, most of which will be either losers or “nothing to write home about” You’re hoping to catch a big winner early enough to make some money when it takes off.
Want to take a deeper look at these ideas? Check out our markup calculator.
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