You might say that there are two main considerations in retail – buying and selling. From production to storefront, every link in the chain relies on low cost and higher margin.
But your own costs and margins are not the only things you’ll need to consider. The supply chain is just that; a chain, with individual pieces linked inextricably together. What happens to one link affects them all.
As a manufacturer, you do not do the same job as the retailer. Not remotely. But your costs and margins may well determine the success along the entire chain. We’ll take you for a bird’s eye view of the process, so that you can lay the groundwork for a profitable venture.
STARTING WITH THE END IN MIND
Unless you’re creating an entirely unprecedented product, the end consumer has already set an upper limit for your margins. After all, a product’s value is determined not by the excellent craftsmanship put into it, but by what the market is willing to pay for it. (Craftsmanship is one of many considerations for the end user.) Therefore, the first step to calculate your prices is to think teleologically, meaning, working backwards from the target to the starting point.
The consumer pool generally pays the max that they will ever pay for a product. Thus, retailers are continually squeaking in just under that amount, in order to optimize their profits. Based on their overhead and wages, it is common for them to mark up their goods by 50% or more. This gives the distributors a guideline for their maximum price point, and in turn, a guideline for the manufacturer’s selling price. The exact markups along the chain can vary from one industry to another, but they invariably reach a natural equilibrium. As a very general example, here are common figures implemented at each stage:
- Retailer’s markup: 50%
- Distributor’s markup: 25%
- Manufacturer’s markup: 20%
As such, if a manufacturer knows the optimal retail price for their goods, they can work backwards to arrive at their ideal unit price. If they can operate within a 20% markup for their goods, they have a viable place in the market. This brings us to our original considerations: cost, and profit.
A manufacturer doesn’t buy goods the same way that distributors or retailers do. Their purchases obviously come from the acquisition of raw materials.
Scarcity and competition can both cause some fluctuation in your costs, so for this exercise, use high assumptions of cost for your raw materials.
Processing, Fabrication, Assembly
Costs are also incurred by the processing of those materials (if necessary,) as well as their fabrication and final assembly. These costs fluctuate a bit less, but still need to be factored in to your red column. These processes typically include machine operation and employee labor.
Next, let’s say that your distributors agree to purchase your max production capacity of 10,000 units per week. This gives you the maximum amounts you’ll need to consider for storage, packaging, and shipping.
Lastly, we’ll look at overhead, otherwise known as operational costs. These are expenses which come from the general cost of doing business; the rent for your facility, your utility bill, your marketing efforts, everything down to your office supplies. Factor these into your production costs.
You may need to adjust these values based on the differences between your production quota and the timing of your bills – 10,000 units per week is 40k per month, to align it with your monthly expenses.
Add your monthly costs together, divide by your monthly production count, and you arrive at a reliable cost per unit. If your actual costs are usually lower, then that’s where you can do a little happy dance. Just make sure the math adds up agreeably in a “worst case scenario” when your costs are at their highest, because it’s bound to happen from time to time.
So now you know your production cost per unit. You know what the consumer will pay for your product. And you should have a well-researched idea of the sequential markups taken along the way for your industry.
Your markups, as dictated by your industry, must satisfy the following:
- Your costs, including a reasonable growth rate
- Your reasonable wages, and those of your employees
- Your overhead
- Your distributors
If they can, you’re in business. If they can’t, you have a number ways to trim the fat in order to become sufficiently profitable. Search for more affordable materials, invest in more skilled labor (to save time or increase productivity,) or acquire tools and machinery which would significantly boost your efficiency.