Consider Line Profitability
At what retail price will you sell your products? It's a vital question. As introduced in Chapter 1, pricing used to be simple: double the wholesale price. Today's retail pricing is much more complex and competition has reduced the opportunities to price at “whatever the market will bear.”
What are the options in setting a retail price? Following are some of the most common methods of computing a retail selling price:
Break-even point means that the income covers the expenses. If your store has to sell 120 widgets to cover the wholesale and overhead costs of a 400-widget order, that's the break-even point. Your profit will begin when you sell the 121st widget. Break-even calculations are more common to retail stores that buy large wholesale lots, such as dollar or bargain stores, though a break-even analysis can be calculated for any product.
Cost-plus pricing is more common among smaller retailers. Products are priced at a predetermined percentage above the direct costs to achieve an expected gross margin. To understand this method, some terms need to be defined.
The gross margin is the relationship of the profit to the cost. A widget with a wholesale cost of $6 is sold at a retail price of $10. Calculate: (10 − 6) ÷ 10 = 40%, the gross margin.
The markup is the relationship of the profit to the selling price. It's the percentage added to the cost to get the retail price. Consider another widget with a retail price of $5 and a wholesale cost of $2. Calculate: (5 − 2) ÷ 2 = 150%, the markup.
In the real world, most retail stores have a number of gross margins and markups. Primary merchandise may have one gross margin or markup while an impulse department or one that has less local competition may have a higher gross margin or markup.
Should your store use gross margin or markup? There are two ways of looking at cost-plus pricing. Many stores prefer using markup. It's easier to calculate. For example, if the wholesale cost is $4 and the markup is 100 percent, simply add 100 percent of the cost to get a retail price of $8.
Your business plan helped you calculate a rate of return on your initial investment. Maybe you selected 12 percent. That means a $100,000 investment should pay back $12,000 a year or $1,000 a month in interest from the profit. The same method can be used to calculate a price as long as all other fixed and variable expenses, including payroll and your salary, are already factored in.
Retailers with large sales volumes, such as $1,000,000 a year or more, frequently use ROI (return on investment) pricing. It's also more common for stores that require an extensive initial investment in land, fixtures, and other costly components.
Airlines are notorious for demand (or yield) pricing. Buy the ticket well in advance and the price is lower than if you walk up to the counter on the day of the flight. Retailers can't use this method as easily unless they sell hot/cold merchandise. If your store gets the hottest new widgets in and everybody knows that supplies are initially limited, your price can be high—maybe even higher than the manufacturer's suggested retail price (SRP). When supply catches up and the market is saturated with these widgets, prices will slide until the merchandise hits the clearance table at prices below wholesale.
There are many other types of retail pricing methods. As you research and develop your own store you will find those that are most popular for your type of store. Remember that the key to pricing is profitability more than ease of use. That's why there are handheld business calculators and software to do the figuring for you.