Setting price for a product is tough – keep it high and miss out on valuable sales. Set it low and miss out on revenue target. Fortunately, there are industry conventions and realistic ways of determining final price. This articles discusses how to realistically price a product keeping in mind distribution cost and avoid common mistakes.
Choice of distribution channel plays major part in determining right end-user or consumer price. The journey of a product from factory gate to consumer door passes through a chain of businesses or intermediaries – CNF agents, super stockists, wholesalers, distributors, retailers etc. Each of these intermediaries charge a fee or commission (called mark-up). Manufacturer must take into account all these commissions while determining final end-user price. Sum of all these commissions to intermediaries is collectively called trade margin. So, Final Price = Product Cost + Manufacturer’s Profit + Trade Margin.
Realistic Trade Margin
While manufacturing cost and profit margin is known – manufacturer has to estimate a realistic trade margin figure that takes into account intermediary commissions + discounts. The figure varies from product to product and market to market. General consensus is a range between 2.5X – 4X of manufacturing cost. So, if the manufacturing cost is Rs. 20.00 – the final price could be between Rs. 50 to Rs. 80.
Approximate Structure Of Trade Margins
Trade margin is not static – it varies widely on various factors, such as:
- Industry FMCG, Healthcare, Food, Apparel etc.
- Market Premium, Base of Pyramid, Urban, Rural etc.
- Product Fragile, Heavy Weight, Perishable, Requiring special treatment (e.g. cold storage)
Depending on demand, availability, cost of handling, logistics, storage requirement and various other factors – trade margins may be decided. For FMCG sector, a rough trade margin structure is as follows:
- CNF Agent / Super Stockist : 3 – 8 percent
- Distributor : 8 – 20 percent
- Retailer : Upward of 20 percent
*All figures in percentage of end-user/consumer price
As one can see, total trade margin may be between 30 – 50 percent of consumer price.
MRP and MOP
For many products, particularly pharmaceuticals, Govt has set a maximum retail price called MRP (Maximum Retail Price). Selling above MRP is a punishable offense. For products where there is no Govt mandated MRP – competitor’s price could be considered as market rate. Manufacturer-calculated final price must be in consonance with MRP or prevailing market rates.
So, marketers have introduced another concept – MOP. MOP or Market Operating Price is the price at which manufacturers make available a product to retailers. By definition, MOP is lower than MRP and the difference is retailer’s margin – part of which may be offered as discount by retailers to beat competitor products. The retailer is free to fluctuate his selling price as long as it is below or equal to the MRP and above or equal to the MOP.
Balancing MOP and Competition
High MRP and low MOP could be a deterrent factor for many products, particularly where competition is stiff. So, manufacturers often set a minimum order value for retailers to qualify for higher trade margin. In addition, discounts, incentives, schemes etc. are offered to retailers for achieving higher sales. Distributors are rewarded with incentives for achieving targets. All these offers and incentives are generally over and above trade margins. So, estimated trade margins must keep provision for discounts and incentives.
Common Pricing Mistakes
Myth Of Price As A Tool To Beat Competitors
Using price or rather low price as a weapon to beat the competition is a shaky proposition. Buyers may be attracted this way – but they are unlikely to remain loyal. If low cost attracted them to your business, they may abandon your company when a less expensive option comes along. A better approach is to differentiate your business from competitors in other ways, such as superior customer service, enhanced product features, or finer quality.
There’s a Subtle Link Between Price and Quality
Consumers instinctively attach a higher value on high priced products. This is specially so in premium market segment. Offering a low cost alternative to a high priced product may be viewed with suspicion – sinking overall brand value. This is not to advocate high prices – but to make entrepreneurs aware of pitfalls of very low price.
Myth Of Market Capture Through Low Price
Many entrepreneurs believe that setting low price is enough to capture a market. Though it may be partially true in certain cases, there’s another important condition that must be fulfilled – price elasticity. If demand rises with lowering price – the product is elastic. However, if price elasticity does not hold – entrepreneur is set to make deadly mistake by underselling.
Dilemma Of Raising Price
Increased demand or rising input cost may put one in quandary – whether or not to raise prices. Some business owners avoid increases because of fear of losing customers. However, the flip side is losing opportunity at best and making loss at worse. It could be a better strategy to make regular, small price increases than to hit customers with one large increase. In other words, a 10 percent price increase is likely to draw more negative attention than two 5 percent increases.
Dropping Price At The Drop Of A Hat
Lowering an agreed price at last minute may inadvertently send a negative message that initial prices were too high, that all future business is open to price negotiation. A better approach is to agree to a lower price through a give-and-take negotiation such as slight change in supply condition (e.g. delivery time). This helps you earn customer’s respect and future-proofs rest of order.
Best pricing strategy is the one that maximizes profit and revenue. The trade-off between profit and revenue is finely balanced – a nuanced pricing strategy helps organizations keep the balance steady.