Product pricing and profit margin calculations for sales success: The definitive guide
For any business to be successful, it is important to price your products and services properly. At Uphance, we deal with product-based businesses and hence we will focus our conversation on pricing your products appropriately.
For fashion brands, product pricing is even more critical due to the number of products or styles that these brands bring out each season.
Let’s dive right in.
Know your costs
You need to know exactly what your product costs before you can even think of what you should price it at. There are essentially two types of costs in running a business – fixed costs and variable costs.
Fixed costs or operating costs
There are many fixed costs in operating a business. These costs such as employee salaries and payroll expenses, rent for the office space, utilities, insurance, legal, accounting, etc. are incurred irrespective of how many units you manufacture and sell.
We will set the fixed costs aside when looking at product costs. Under most accounting practices, operating costs have no effect on gross profit. They only affect your net profit. Once you understand your gross margins, you will be able to estimate the total sales needed to cover your operating costs.
Cost of goods sold (COGS)
If you outsource your manufacturing or just acquire finished goods, you would just have to look at the cost of product and any associated freight/shipping costs and tariffs/duties to arrive at your total landed cost.
If you supply raw materials to your external manufacturer, you would have to estimate the quantities of each of those materials needed in the making of each unit of your finished product. If you use apparel production software such as Uphance, the software can do these calculations for you.
If you do all of your manufacturing in-house, you would also need to track the cost of each step in your manufacturing process. Patterns, markers, cutting, sewing are some examples of these steps.
Costs you have to consider include
raw material costs
internal and external manufacturing costs
Keep in mind that some of your costs may be in a currency other than your home currency. In that case, you want to convert all of your costs into your home currency or the primary currency in which you would be selling your products.
If you track any raw material costs, it would be best to use a bill of materials that considers the quantity of each material used in the making of each unit of your finished goods along with any wastage. Be aware that these are still estimates of raw materials needed and, in practice, the actuals could differ from the estimates.
Once you have a clear idea of the costs, you need to understand how much to markup your products to arrive at wholesale and retail prices. A simple suggested rule of thumb is to markup your wholesale at 100% and retail at 250%. If a product that costs you $10 to make, you would wholesale at $20 and retail at $35.
However, there are no hard and fast rules. If you can sell a much higher volume at a slightly lower price, you should consider the lower price. Your goal is to maximize your total profit and for that, you should be flexible in your pricing.
Your pricing will also depend on where you are in your business lifecycle. A startup business looking to establish a brand name and reputation may choose to sell products at a lower margin when compared to a business that is already established.
Pricing is also based on your product positioning. A product positioned as a high quality, premium product needs to be priced as such.
A lot of gut feel and instinct come into play at this stage. Pricing becomes less of a science and more of an art.
Margin vs. Markup
While we may at times use the terms margin and markup interchangeably, they are two different terms and are calculated differently.
Gross margin is the profit or difference between the selling price and the total cost.
Gross margin = Selling price – total cost
The selling price is the wholesale or retail price depending on whether you are selling wholesale or retail.
Gross margin can also be expressed as a percentage of the sales amount.
Gross profit on a product that costs $8 and wholesales at $20 is $12. The gross profit margin, in this case, will be $12/$20 = 60%.
Gross profit on the same product when sold direct-to-consumer at $40 is $32. The gross profit margin will be $32*100/$40 = 80%.
While margin is expressed as a percentage of the profit out of the sales amount, markup expressed as a percentage of profit over the costs.
Markup % = (Selling price – costs) * 100 / costs
The product that costs $8 and sold wholesale at $20 is sold at a markup of $12 over the cost of $8. That would be a markup percentage of
(20 – 8) * 100 / 8 = 150%.
That product when sold direct-to-consumer at $40 results in a markup of
(40 – 8) * 100 / 8 = 400%.
From these examples above, you see that a markup of 150% results in a margin of 60% and a markup of 400% results in a margin of 80%.
A few other observations:
Markup and margin can be negative when selling below cost. Of course, you would never do that.
Margin will never exceed 100%
Free profit margin calculator
If you are not using Uphance, you can access this free calculator to help you with pricing your products. Enter in your costs and desired markup, the calculator will show you the retail or wholesale price you for that product and the gross profit margin. Access the profit margin calculator here.
Uphance maintains all the costs and allows you to set your desired wholesale and retail markups. On the Product’s Variations tab where you set your prices for each channel, the built-in calculator shows your total costs, suggested prices based on the desired markup. Once you set your actuals, it also shows your gross profit margins.
Did I miss anything?
Now I’d like to hear from you:
What pricing strategy do you use?
Or, did I leave out your favorite pricing strategy?
Either way, let me know by leaving a comment below right now.
A seasoned executive with 25+ years of experience in enterprise software, SaaS, and cloud computing. As CEO and founder of Uphance, he is currently focused on helping brands streamline and scale their operations with simple and complete software.