For many years now, retailers have used keystone pricing for setting sales prices of their items. It goes something like this: Buy a product for $10 and then sell it for $20, and you get double your money back. The problem with this formula is it overlooks the highest cost in retail, the markdown, which you’d have to mark down an item’s price because it didn’t sell at its initial markup price (IMU).
When setting the IMU on a particular item, you should always factor in the net profit you require, operating cost, and potential markdown. Having sufficient IMU in your items would enable you to implement different types of pricing strategies and achieve a nice margin.
With this in mind, you could calculate IMU as such:
- IMU = markdown % + operating cost % + wanted net profit % / 100% + your markdown %
To illustrate clearly, let’s say you have $100,000 in yearly revenue — about $40,000 of operating costs (which is 40% of your revenue) and an anticipated 20% markdowns of revenue — and you’re looking to increase your net profit by 3% to 6%. Using the formula above, if you want to boost your profit by 6%, you’d only have to increase your IMU to 55%. What’s great about this formula is that it shows how a small raise of your IMU could boost your profits.
Be wary of implementing the cost-plus pricing strategy, however. Many specialists in competitive pricing and MAP policy monitoring say that retailers, usually out of habit, instantly restrict themselves to random IMUs even if some items could command higher IMUs.
The Bottom Line
Your profit as a retailer depends heavily on setting an ideal IMU, so determining the magic number for your items is vital. Ask yourself how much an item could sell, determine its cost, and then increase the price as much as you can without offering a ridiculously low or high price for it.
Keep in mind that consumers look at retail prices in terms of a product’s perceived value. This means that if you value your price and product/service accordingly, customers would sense your confidence if your offerings and find the value in them too.