How to set prices that will earn

Some businessmen still confuse the concept of margin with the concept of trade margins and set prices for their goods, guided solely by the example of competitors. No wonder they go broke! Analyst at the Academy of Retail Technologies Maxim Gorshkov gives several tips and formulas with which you can set not only ruinous, but also profitable prices.

Maxim Gorshkov - Commercial analyst at the Academy of Retail Technology. He has 14 years of experience in the fashion industry, including as director-curator of the Sportgrad retail chain and Sportcourt high-end sports shops, as well as the director of the Nike retail chain. Specializes in commercial and financial analytics for retailers.
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Margin and margin - “two big differences”

In a business environment, you can sometimes hear a phrase like “This company works with margin in 200%,” which is actually incorrect, since in this case we are not talking about margin, but about a margin. Unfortunately, these two concepts are often confused. Let's dot the “and” and see what margin, margin and margin ratio are.

When we purchase a product from a supplier, we pay a certain amount of money for it. For example, 1000 rubles for a pair. This is the purchase price . When the product arrives in the store, we add an additional cost so that the customer pays 3000 rubles for the pair, which is the retail price . There is also the concept of the actual price —the price at which the product was actually sold as a result of promotions or loyalty card discounts. Having defined the types of prices, we can understand the margin. The margin is the share of added value in the retail price of the product, that is, the difference between the retail price and the purchase price. It indicates how much profit the company will receive if we sell the product at a given retail price. In our example, the margin, that is, the share of added value, is 2000 rubles, or 66,6%. But no matter what examples we give, the margin will always be lower than the retail price. So, if you hear someone talking about a margin exceeding 100%, be aware that they are confusing margin with markup. Markup is a markup on the purchase price of a product, that is, the percentage by which the retail price exceeds the purchase price. In our example, the markup is 200%. Relatively recently, the markup coefficient has come into use in retail . Like markup, it demonstrates the ratio of the retail price to the purchase price, but it is expressed as an absolute value rather than a relative one (percentage), and is used only for simple calculations. The markup coefficient in our example is 3: this is how many times the retail price exceeds the purchase price.

The question arises: which indicator should be used in the work? From the point of view of financial accounting and budgeting, the most important indicator of margin, since many other calculations are associated with it. But for simple operations, you can use all the other indicators.

How to set prices that will bring profit

It is possible to cover all costs and provide profit for the sake of which any normal business functions using well-calculated trading margins. Our goal is to establish with its help a retail price that will cover all fixed and variable costs, and will be as large as possible with the solvency of your customers. Do not be shy to sell expensive: if you buy a product even at a very high price, then it's worth it. You also do not need to rush to the other extreme, selling goods at cost or even lower than that - and it happens! Remember that low prices not only do not provide you with customer loyalty, but also slowly, but surely ruin you, especially if you really cannot afford these price games. To set the right prices for your store, first answer yourself a few questions.

What is the product cost? Calculate the costs you incur when receiving goods in your store. This always includes the purchase price, and for non-franchised stores, it most often includes the cost of delivery. For companies that manufacture and then sell their products themselves, the product cost includes the costs of raw materials, labor, design, and other expenses.

What is the threshold price? The threshold price is the minimum price for a product that ensures a business breaks even. It includes all costs that must be covered even if you offer a discount. Some retailers, inspired by the example of their chain competitors, lower prices in an effort to please customers. But they often fail to take into account the fact that chain stores can actually afford such price manipulation, as they can often obtain goods at a fraction of the cost of a private entrepreneur. As a result, the store owner, without calculating their threshold price, enters into a price race with a large retailer and operates at a loss. They can do this until they go bankrupt or drop out of the race. By raising the price back up, the retailer will likely lose customers—after all, they only came to them because of the low price—and find themselves on the brink of bankruptcy once again.

What's the pricing situation in the industry? Of course, you need to understand what prices your competitors are charging and what prices consumers are willing to pay for your products.

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Is demand for your product elastic? Demand is considered elastic if it changes with price increases or decreases. Only then does it make sense to offer a discount; otherwise, you won't make a profit. If demand is inelastic, meaning sales don't increase with price reductions, or increase only slightly, you won't be able to profit from a sale on such a product. Since a shoe store has product categories with different elasticities of demand, you should measure and calculate the elasticity of each category using the formula E = K/P, where K is the percentage change in demand and P is the percentage change in price.

Will additional services increase sales? One of the most attractive services for buyers right now is consumer financing for shoes. So far, only a few companies sell shoes this way, which is surprising, since the seller incurs no expenses and merely enjoys increased sales.

What price is a customer willing to pay for a product? This figure depends on many factors, such as store location and the target audience's income. Knowing a precise customer profile gives us a clear understanding of what they need and how much they're willing to spend on shoes per month. For example, after all expenses, a customer at our store has about 6 rubles per month, meaning we can set a price around that for most styles in the store. However, this is an average price, so we need to add two increments: 25% down and 25% up. Increasing the price increment by more than 25% within a single store is unwise, as such a price range will dilute your target audience and force you to compete with more expensive or cheaper stores, which is of no interest to you or your customers.

What is the nature of competition? Competition is like radiation: it's always there, everywhere, but you can't see it. But you still have to keep your finger on the pulse of your competitors and outperform them. Those who monitor their competitors open 200-300 stores a year, while those who sell at cost and learn nothing from others will spend their entire lives with just one store.

How to calculate prices

Once you understand your pricing options and desires, use one of several pricing methods.

Method 1: Average Cost + Profit. This is a fairly simple and effective pricing method that's based on costs—which is crucial—although it doesn't take market fluctuations into account or indicate the extent to which prices can be reduced during a sale. The essence of the method is to calculate the price of a product by adding all costs for the reporting period and the desired profit margin. For example, let's say we purchased 5 million rubles worth of merchandise during the season, and we find that our total costs for the same period will be approximately 8 million rubles. If we mark up the product by 100%, our profit will only be (5 x 2) - 8 = 2 million rubles. If we mark up the product by 150%, our inventory will be worth 12,5 million rubles, which, in an ideal case, will bring us 4,5 million rubles. Obviously, "perfect" situations don't exist: the season always ends with some inventory, and the market dictates its own terms. Some of the product range will be sold at a discount, so in this situation, a 150% markup will at least allow us to stay afloat.

Method two: calculating pricing based on break-even analysis. In business, there is a concept called the break-even point. The essence of the break-even principle is to establish the sales volume at which no loss will be incurred. The break-even point is always calculated for new businesses, as it helps clarify how long a store will operate without profit, just enough to cover the initial investment. Some elements of break-even analysis can also be used for pricing, and this method helps us determine the minimum profit required for a business to survive (something the "average cost plus profit" method cannot provide). To determine the minimum profit margin, subtract variable costs from the planned gross revenue and divide the resulting figure by the planned gross revenue. For example, (15 million – 5 million)/15 million = 0,5. This ratio dictates that the difference between the purchase and selling price should be 50%, otherwise we'll be operating at a loss. This method can also be used to calculate the trade margin. To do this, use the formula "1 - (planned gross revenue / variable costs) * 100%." ​​In our example, the calculation might be: 1 - (15 million / 5 million) * 100% = 200%. This is the trade margin needed to at least cover all costs without making any profit. The upper price limit is dictated only by common sense: we should sell as high as possible, ignoring those who advise selling at a lower price. Typically, such advisers are people of low social status who understand little about making money.

In principle, these methods are sufficient to set prices that are appropriate for your business. However, in some cases, prices are set using other methods. One such method is the "current price method ," which uses competitors' prices as a benchmark. This method hasn't yet caught on in the fashion segment, but it's already being used by electronics retailers. Its advantage is that it prevents price wars, but not all stores can afford to maintain the same prices as large chain stores. The "dumping price method" is used to attract customers. Its essence lies in setting low prices on bestsellers, that is, particularly attractive items, while raising the prices of all other goods. This method can provoke price wars and create a cheap image for the store, so it should be used with caution. The advantage of the "demand elasticity method" is that it can be used to track the dependence of sales and profit growth on price changes, while the "consumer behavior analysis" method is used at the stage of introducing a new product to the market.