Price right your top 10,000 products. Repeat weekly

Are you making a profit every time someone buys from you? Are your prices too high or too low? Would you like to earn exact margin % over actual product, dropship and freight costs on every sale?

I truly believe that cost reconciliation is a cornerstone of any business. One of my past engagements was an inventory program analysis - digging up freight inbound costs, product costs, warehouse order processing costs, outbound freight, returns, damages etc. Inventory products were responsible for 25 % of company`s sales and everybody considered the program to be a huge success. My findings were quite shocking, but before I share them with you let me discuss the basics of pricing.

The formula:
Free Shipping Retail price = Product Cost + Dropship Fee + Freight Cost + Target Gross Margin.

Let`s take a coffee table currently selling for $100 and see what should be our retail price if we want to keep 30 % gross margin.

1. Product Cost
Product cost is manufacturer`s cost after all the discounts applied. A typical product cost formula is 50/20/20 or 50 % of recommended retail (wholesale cost) minus 20 % minus another 20 % of the result. For a $100 coffee table the 50/20/20 formula gives us $50 * 0.8 * 0.8 = $32 product cost.

First level of complexity: product lines. Different lines can have different formulas. Next, vendors. Some manufacturers have one tier discount, others multi-tiers.

To get the product cost right you either need a manufacturer to provide you with per product accurate cost or program exact formulas for each vendor - product line - product combination. It can be done but requires a lot of discipline from the vendor management team.

An alternative way to get accurate product costs is per-product invoice reconciliation. That requires Accounts Payable to enter invoices on per-line item basis but provides accurate per product costs.

2. Dropship Fee
This is probably the smallest of the challenges. Most manufacturers have either per order or per product fees that can be easily imported. For our table the dropship fee is $10.

3. Freight Cost
Here is my beloved one. Take any of your products and check expected shipping cost. I will bet $100 that actual shipping cost differs from your expected by more than 25 %. Two most common reasons for having wrong expected shipping cost in your system:
  • Public UPS/ FedEx rates (instead of your discounted ones) used in the calculation.
  • Shipping costs were calculated a few years ago and don`t reflect annual rate increases.
To get exact per product shipping costs for my customers I`ve developed a script that connects to UPS/ FedEx or LTL carriers and quotes specific for the customer discounts. With such a tool obtaining actualizing shipping costs for 10,000 products is a matter of hours.

Back to our coffee table: original shipping cost was $25 and recalculated one is $17.

4. Gross Margin
A 30 % Gross Margin can be expressed as as 42.86 % of your costs. Our costs so far were $32 (product), $10 (dropship) and $25 (expected shipping) or total of $62. If we want to have 30 % Gross Margin - we must add $28.7 to the product cost.

5. Retail price re-calculation
Let`s say everybody else is selling at recommended retail price of $100. Given our costs and target margin we can lower our price to $90 and steal a lot of sales from the competitors who didn`t do the math.

Moreover, given our re-calculated shipping cost is just $17 - we can sell for $84, keep 30 % actual margin and kill the competition by selling $16 lower than everyone else.

Conclusion
In the example above I`ve shown that a table currently selling for $100 could be sold profitably for $84 more than doubling total sales. All we needed to do is to run the numbers.

If this is so simple, wouldn`t it be nice to price right all your products and double the sales overnight? Why people still do numerous pricing errors and what does it take to get prices right?

In my experience, price management is a very scalable process and can be applied to your entire catalogue. It can even be done weekly if you want to take a full advantage of manufacturers` promotions.

Four simple steps:
1. Get the shipping right. Consolidate with fewer carriers, negotiate as hell, leverage my script to recalculate per product cost.
2. Get accurate product costs and dropship fees.
3. Do the math :)
4. Repeat 10,000 times.

I ran number of small scale experiments resulting in 10X increase of per store sales and am in the middle of a large scale one. Exciting times!

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Oh, almost forgot to finish the story about the inventory program. While everybody did a rough calculation similar to mine - 25 % gross margin didn`t cover warehouse fulfillment costs and costs of damaged in transit/ returned products. Two of the products sold had 15 % damage in transit rate making the entire program widely unprofitable.

Reboxing helped a little but the program was still marginally profitable at best. My bet is - if the person who designed the inventory program used a better model - the company would have never bought any inventory.

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3 Comments:

Anonymous Justin Palmer said...

Great post Maxim.

You're right on about retailers not knowing their actual shipping costs. I've found that fuel surcharges are often excluded from calculations or rate shopping programs.

February 10, 2009 at 8:35 PM  
Anonymous Anonymous said...

your maths does not seem right. 32+10+25=67 whereas 17 was the corrected figure hence
32+10+17= 59

September 29, 2010 at 6:41 AM  
Anonymous Anonymous said...

I also did not get your cost calculation 48% of cost. I have a product that cost me 32 $. I added freight 17 $ and dropship fees of 10$.
My total cost is 59 $.

If I want a gross margin of 30% then would'nt I have to sell my product for 84.29 $.
Sales=84.29
COGS=59
GROSS MARGIN=25.28 OR 30%

Sorry I lost your train of thought with the maths for 62 instead of 67 and with the actual cost being 17 then it should reduce to 59.

September 29, 2010 at 6:54 AM  

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