In this article we discuss profit margins and retail pricing, how they are different based on where you sell your product, and why retail price consistency is important.
Recently, a member in our Hardware Academy asked how to price their product for different distribution channels.
They were looking at selling their product in various ways – on their own website, through Amazon, through distributors, small retail chains, and hopefully, eventually, through big-box retailers.
How should you price a product for all of these different distribution channels?
Should you have different suggested retail prices, depending on where it is sold? For instance, if you sell directly to a consumer from your website, you won’t have any distributors or retailers taking a percentage of the profit.
If you sell through a distributor who then sells to retail chains, then you’ve got multiple people taking a percentage of the profit, or the markup on the product.
Retail Price Needs to Be Consistent
As you sell in different distribution channels, you’re going to have different profit margins. That’s assuming you keep your retail price the same for all channels, which is what you should do.
For instance, it may seem like a good idea to sell your product at a lower cost when selling it on your own website, because you don’t have any middle people taking any money. You may think that selling your product at a lower cost will help to boost your initial sales.
Let’s say, your product has a suggested retail price of $100, and that it roughly costs you about $25 to have it manufactured.
If you’re selling through your website, you’re paying $25 per unit, and you’re selling them for $100. You get to keep $75.
Versus when you sell through a retail chain, they’re going to want to buy it from you at half of the retail cost, typically. If the retail cost is $100, they’re going to want to buy it for $50.
In this case, you’re buying it for $25 and selling it for $50. You’re only making $25 per unit versus making $75 when you sell it through your website.
It can be enticing to sell it through your website for only $50 to try to boost sales. But that’s not a good idea for several reasons.
If you’re trying to sell through retail stores and distributors, then you’re going to turn them away really quickly. This is because no retailer wants to sell a product that can be found for a much cheaper price online.
Let’s say you are selling your product at Walmart for $100. Walmart is not going to like it if your product is available for $50 on your website. This can make them decide not to carry your product.
Undercutting your own product’s retail store price is a good way to irritate buyers. So be sure to sell your product for one consistent retail price, across all buying platforms.
Even though your profit margins will be higher when selling through your own website, you must keep the suggested retail price the same.
Having this higher profit margin can help offset the higher cost-per-unit price during early production runs that are low volume.
Don’t Focus on Profit Initially
On your first units, especially at really low manufacturing volumes like hundreds of units, if you even have to sell your product at break-even, or even at a loss, that’s okay. You don’t typically make much profit on your first units.
There’s no middleman when you sell it yourself, so you can make a profit even if the manufacturing costs are less than optimized.
Selling yourself can help fund your startup as you ramp up to higher volume production, and the subsequent lower per-unit-cost.
That’s why I always recommend that you start off selling your product on your website, and it has other advantages too.
It allows you to build up a sales reputation and sales history. If you’re selling the product like hotcakes from your website, then trust me, Walmart will be a lot more interested in you than a product with an unproven sales history.
That’s why it’s good to start with your own website, since it has the highest profit margins.
The lowest profit margins are most likely selling through big-box stores or selling through a distributor who then sells to big-box, because then you’re going to have a lot of people wanting to take a percentage of each unit.
Retailer Profit Margins
How much do retailers and distributors typically want for your product? What percentage of the profit margin do they want to take?
It varies from industry to industry, from retailer to retailer, but the standard is for a retailer to double the price that they pay for a product. There’s even a retail term for this – keystoning.
Keystoning means you double the price that you pay for a product. In this case, you buy it for $25 from the manufacturer, you sell it to Walmart for $50.
That’s equivalent to a 100% markup or a 50% profit margin which is fairly typical for physical products.
A distributor, typically, will take a lot less of a percentage. Instead of a 50% profit margin, they may take maybe a 10% to 15% profit margin.
Each type of industry has different profit margins based on their business model, and what type of profit margins they expect.
Even though 50% is very typical, I would say profit margins for a brick-and-mortar retailer can vary between 40% to 60%.
The final suggested retail price needs to be the same for all of these different channels. What will change is the profit margin that you make on each of those different distribution channels.
In general, you’re going to make lower profit margins on higher volume distribution channels.
The highest profit margin is through your website, but that’s probably going to also be the lowest volume. Contrast that with Walmart that will sell at really high volume, but you’re going to make a lot lower profit margin.
That’s just the nature of selling physical products. Your profit margins are going to be different based on the different distribution channels, and the types of production and sales volumes that you experience from those different channels.
Setting Your Suggested Retail Price
As far as setting the retail price for your product, there are different ways to do it. You can set a price based on the value that someone gets from the product. But you also want to factor in your manufacturing cost.
The different ways of determining how to price your product have to come together. Here’s an example. Let’s say you determine that people value your product at only $50.
If your manufacturing cost is $25, that’s not going to be enough profit margin for you. Typically, you want your retail price to be at least four times your manufacturing cost so you earn close to a 50% margin when selling through retailers and distributors
I should clarify that for some products, if you can hit three times your manufacturing cost when you’re first starting off, that’s still good, because you can work on optimizing your profit margins down the road.
I wouldn’t focus too much on maximizing profit margins in the early stages, when you’re running low volumes. Profit comes later.
But you need to forecast your future profit margins. Once you get production volume up your profit margins need to be up to at least 40%, although 50-60% is ideal if possible.
Other content you may like:
- How Much to Charge for Your New Electronic Product
- Episode #16 – Questions on Outsourcing, Distribution Channels, and the Cost to Market
- Lesson 2: The Strategic Way to Develop and Sell Your New Electronic Hardware Product
- Why You Should Begin With a Preliminary Production Design for Your Product
- 12 Ways to Select the Best Product Idea to Bring to Market
Affiliate programs are getting more popular every day. Affiliate percentages for hardware (vs digital goods/services) seem to range from 10-30%. Thoughts?
Thanks Dave, great point you raise. Yes, affiliate programs can also be a great way of getting your product in front of a new, but targeted audience. A 10-30% commission is still going to be better than a 50% discount if you sell via retailers. If there are some big online influencers with audiences that match your target demographic then by all means explore affiliate programs.
Just keep in mind, that to an influencer their reputation with their audience is their most important asset that they will protect fiercely, so they will not just offer to promote any product, and you generally will need to prove to them that you have some real data on the conversation rate and the product quality.
How about subscription based products/services.
If businesses take advantage of our hardware /iot to lowers or eliminates some labor costs and energy bills.
How to charge them by sell/install the hardware also monthly fee for the continuous services. (mostly commercial)
Is the any formula for this as well?
Thanks Mehdi! Yes, if you have a back-end subscription component to your product then that definitely lowers the profit margin requirements per unit sold. Some subscription-based hardware companies even go so far as to sell the hardware at cost, while they make ALL of the profit on the backend subscription. I’m a huge fan of subscription revenue and encourage all hardware startups to incorporate some into their business model when possible. Thanks again for the comment!