How to Price Products in the Cottage Industry

To price successfully as a small cottage industry manufacturer, you must do margin calculations that consider ALL players within the distribution chain and market. These players must not only be your current contacts but also potential ones (like distributors, wholesalers, final consumers and so on), even if you do not yet have foreseeable plans for them.

On one hand, each player in the distribution chain must make enough money. On the other, your retailer's price must be at a level that customers are happy and willing to pay. The price should not be too high and not too low, ie depending on your product, your unique value proposition and desired market position. After all, avoiding an excessively low price is equally important since some products and their corresponding target market associate lower prices with inferior quality). Furthermore, the price should reflect the appreciable / perceived value of the product to ensure repeat sales which is another key factor in retention marketing. After considering the potential prices you may charge, you may need to change the quality of materials, to take extra time finding and negotiating with suppliers for better raw material prices. In short, whether your current plans involve selling only at the wholesale or retail, you should markup twice, for both. You never know what future opportunities will arise.

In short, this process is unlikely to be neat and linear for the best of us. The following discussion shows 3 pricing methods that are best used together to hopefully streamline the pricing process. These methods are 1) the cost based, 2) customer based and 3) competition based pricing methods. They consider the perspectives and consequent influence of very noteworthy stakeholders. Specifically, the cost based method considers your perspective as the manufacture. It illustrates the lowest price that you can afford to offer the market to ensure that you make profit. However, this very common approach can fall short and rob a business of further profit by considering other pricing methods. The customer based pricing method considers how the customer perceives value as it relates to pricing and product value. Finally, the competition based pricing method considers the ways in which each competitor's brand positions itself in a specific way on the bases of price on one hand and value on the next. You can then decide how to use pricing to gain some type of competitive advantage based on how 1) pricing (whether high or low) signals the brand's relative position and 2) perceived customer value (whether high or low). Essentially, the different methods help you establish a range of prices within the low and high point.

COST BASED PRICING METHOD

To know your minimum price using the cost-based pricing method, you will need

• production cost per unit. Remember to include factors like the following as they all have a cost, even if an opportunity cost.
• labor per unit, even if you are making the product. If unsure of the rate to use, consider the wage  or salary you can reasonably expect to pay someone else.
• packaging per unit. 
• If applicable, fees that retailers charge like:
• slotting charges aka shelving fee. Slotting fees [or 'tarifas de asignación' in Spanish] are one-off fees payable to retailers for placing each new product on retail shelves and or in the warehouse, ie until the performance of the product can be established within a period of usually 6 months.
• Instore advertising fees. In some cases, this can even involve shelf talkers and other types of point of purchase (POP) messaging.
• per unit cost for anything else involved in your costing like the following. Be mindful of the part of these costs that may be considered expenses for tax purposes.
• overheads per unit (utilities, warehouse costs, promotional costs, taxes, etc)
• your margin goals (ie the amount you decide your business should make per unit. Ideally, your margins should not be below roughly 50%. Margins below 35% are questionable regarding whether the business is worthwhile, especially if your business has longer term goals of not needing to sell retail again.
• your retailer's margin goal requirements. This varies according to the industry and the type of retailer, whether your retailers are mass or boutique retailers and whether there are other middle men involved. You must therefore ask your retailer this direct question, "What is your margin requirement?" They will generally respond immediately. If you can not get this information, assume a goal, like a 'keystone markup' or a variation of the classic keystone markup. (A keystone markup occurs when the retailer doubles your wholesale price. In other words, if your wholesale price per unit was $1, the retailer's price to the consumers will be $2). Consider factors that may affect the retailer's goals. Such goals may include his location. For instance, touristy or high end locations tend to be pricier. High end products in high end locations may reach the triple key point. Consequently, the retailer's markup goal may exceed the classic keystone level. Some variations may not even be rounded numbers as shown in the image below. For instance, some people use 2.2. Seek out the industry and other standards.
  

Here is an example of how you can establish the wholesale price based on the consumer's reservation price and your wholesale customer's margin goal. Example(s) 

Your wholesale customer's Markup = 25%

The consumer's reservation price aka your customer's 'SP' = $125  (ie 125% of your customer's 'CP' or 1.25)

What should be the CP?

SP = 125% (or 1.25)

So CP = $125 / 1.25 = $100

Check back to verify your calculation is correction:  $100 X 1.25 = $125

 

Example(s): 

Markup = 30%

SP = $200 ... (ie 130% or 1.3 of CP)

CP = 200 / 1.3 = $154

• your discounts policy (example a 5% discount for wholesalers who pay immediately)

Here is how to do the calculation: 

***Step 0: Lowest tolerable sale price for the highest CP that you must pay at some time.

If you want a fixed sale price but your cost price varies according to different suppliers, different volume-related prices, price changes by suppliers, market forces and so on, calculate your highest probable cost price (so you can know your lowest tolerable wholesale sale price / SP). For more complex cases like if your product comprises multiple components from numerous sources and even more price variations, make an estimate using the percentage of change of the most costly component(s).

CP scenario 1 = 0.75

CP scenario 2 = 0.85

CP scenario 3 = 1.00

Highest CP: 

1.00

Lowest tolerable sale price should have a margin (of the cost price) of 51%:

X 1.51

Lowest tolerable sale price

1.51

Highest tolerable cost price / CP 
Consider the highest CP you should pay to be justify making the product and to remain profitable. Your internal cost relates to the highest sale price that your target market throughout the distribution channel will pay. After all, if your CP is high or rises but the market finds the sale price (SP) unbearable, it may no longer be worthwhile to carry the item.


If you have more data to start from the CP perspective (ie versus the SP perspective), this part of the pricing process is non-linear.  

Specifically, when you calculate the final price to be offered to retail customers, you will then need to return to this step. If market research suggests the highest SP your target will pay 

• is $5.00, ie it exceeds the final standard retail price, your CP is acceptable
• is $3.00, ie it falls below the final standard retail price, your CP is NOT acceptable

Markup / Margin (Cost price) # 1 (to set a price for distributors. This gives the distributor the potential to earn apx 20% in a fictitious scenario.)

Unit production & other costs:                 

1.00

Based on your margin goal of +80% (ie 100% less a premium for distribution services):                            

  X 1.75

Full price we charge to the distributor:      

1.75

Optional: less discounts like for extra large orders, convenience distributors can provide to customers, full prepayment, EXW, etc (5%):                

-0.0875

Discounted price we charge to the distributor:                

1.6625
NB. Exceeds my lowest tolerable SP***

Markup # 2 (to set the wholesale price you charge to retailers)

Unit production & other costs:

                                          1.00

Based on your margin goal of +100%:   

                            X 2

Full wholesale price we charge to the retailer:  

2.00

less discounts like for advance payment (5%):                

-0.10

Discounted wholesale price we charge to the retailer:                

1.90

NB. Exceeds my lowest tolerable SP***

Markup # 3 (to set a retail price you charge to consumers)

Considering your retailer's margin (keystone) goal of  +200%:  

X4

Full retail price:                                     

4.00 

A retailer that may have bought at the discounted wholesale price may calculate based on a margin (keystone) goal of  +100%:  

X2

retail price:                                     

3.80 

Are the prices higher than you worry people will pay? 

If the minimum cost is higher than you think your market will bear, consider the following.

• Do NOT rush to reduce the prices, especially if you are trying to build a business for the long term. There are dangers of not accounting from early for dealing directly with other players. For instance, if you begin by selling only retail to consumers for $2 (which should have been your wholesale price), when you want to eventually sell wholesale, those wholesale customers will expect a discounted price, usually at 50% of what they know to be your current retail price. Furthermore, you will not want to suddenly increase the price for your retail customers.
• Maximize your operational efficiency. Example:
• Make larger batch sizes that can also become your minimum wholesale order size.
• Streamline your processes.
• Lower your material costs however possible. Do not scoff at 'small' savings that wholesalers can give because remember that that cost gets multiplied 4 times and will be felt by retail price customers. Example:
• Buy raw materials in huge bulk 
• Negotiate discounted rates even if you already receive the wholesale price.
• Find creative ways to add or generate perceived value. As much as possible, work on creating a premium brand. Example:
• Sell at high end stores whose stock already have a high perceived value. Essentially, generate more perceived value by using the power of association.
• Wherever possible, highlight the product benefits, especially those that give you competitive advantage. Do this on a product descriptions, your label, advertisements and so on.
• Provide superior customer experience and service.
• Create credibility. You can do this with the help of persons that the market values highly. For instance, for health care products, you may use persons from the medical profession that can endorse the product's value. For instance, if you make and sell skin care products, consider respected professionals as spokesmen like school nurses, pharmacists, makeup artists, influential community member, a celebrity with the characteristics that your market desires (through the product) and so on. 
• Use high quality images on websites, labels and so on.

CUSTOMER BASED PRICING METHOD

Do your product and price reflect the image and unique value proposition of your brand? Find out the highest your target will pay for your product. If your target market is most concerned with

• AN IMAGE OF PRESTIGE that burnishes the customer's reputation, prestige-oriented customers will believe a higher price signifies higher quality and will be happy to pay for the product. They are more likely to consider the product part of a premium brand. If the quality is truly as they expect, you can generate loyal customers. Higher priced items may limit your market volume but, if your product meets the customer expectation, the customer base will be loyal enough keep you in business. Also, running the business can become easier since you can better reach the ideal of spending less time actually making your product and more time strategically marketing it for high sales.
• conversely: ECONOMIZING, bargain seekers are likely to buy only if the price is low.
• PRODUCT QUALITY, your customers are likely to be willing to pay a premium for the special qualities that you offer.
• Does your product have 'lower cost of ownership?' For instance, when compared with cheaper alternatives that need to be fixed and replaced with greater frequency, a more costly product that is well-built costs the customer less in time and money from not needing to service the product, convenience of hassle-free good performance, etc. 
• The 'extended perception of a product includes customer experience and services. Customers often pay a premium for better quality of the extended product. Do not underestimate these things.

If pricing is very important to your product's perceived value, consider establishing policies for the following.

• a manufacturer suggested retail price (MSRP). 
• minimum & / maximum allowable retail prices like a minimum advertised price (MAP). Note however that a MAP is not necessarily the lowest price of the final sale but of advertising. This minimum protects the perceived value of the brand and ensure that customers will still pay the MSRP which is higher. Consequently the MAP is often used as a discount or sale price. Sometimes, the MAP is set as a fixed percentage below the MSRP. However, if you are likely to make changes to the MSRP for some and not all retailers but must maintain the same minimum price among all retailers, it is better to separate the 2 rules, ie as opposed to making the MAP a percentage of the MSRP.
• restrictions against liquidation pricing, using the product as a loss leader and so on.
• Bundling. If bundling is allowed, consider whether you are trying to build a premium brand and whether the retailer must get your pre-approval of the other brands with which your brand should be bundled.
• Promotions. 
• Customer experience bonuses the retailer will value like assistance with brand awareness promotions that also help your business.

COMPETITOR BASED PRICING METHOD

This pricing method is based on determining where your competition exists on a matrix of the 4 following possible positions. 

High Price, Low Quality

High Price, High Quality

Low Price, Low Quality

Low Price, High Quality

Consider your unique value proposition and what your target market values. There are no good or bad positions, only appropriate ones. Each position on the matrix can be used as a positioning strategy as follows. 

Consider the previous pricing method, customer based pricing method. Ask yourself what a price signals to your target market about your brand. ie relative to the competition.

Skimming. This method involves setting a price that is high, relative to the norm. This strategy attempts to 

• signal a higher quality price to customers who are willing to pay a premium for some perceived high value
• reap as high profits as possible from a novelty before the competition can copy it, after which the high price is usually reduced. 

Undercutting. This method involves trying to take away some price conscious customers from a competitor. A safe way of managing this is by undercutting only in a small area that just gets new customers in the door without lowering all of your prices.

Penetrate. This strategy is used by newcomers to the market wanting to gain market share. For instance, you may offer a lower price for a high value product. However, be very careful with it as it can depress market prices and create a poor impression of your product. Consider the matching strategy as an entry alternative if you have concerns.

Match. This strategies involves setting your prices on the same level as that of your competition. A safe approach to this is to have another product that is priced only slightly higher. 

• This may be a way of showing your customer that you have a comparable price but a higher quality product, ie low price, high quality.
• {Perhaps this can be a way of safely entering into a market.]

CONTENT RELATED TO PRICING IN THE COTTAGE INDUSTRY

• Beware, do not leave money on the table if possible. To know if the cost-based pricing method illustrated on this page does this, find out the highest your target will pay (ie the reservation price or walk-away price) for your product. 
• After you know the highest your target will pay, calculate the highest tolerable cost price you should pay to ensure you remain profitable. 
• Consider the retail price you will charge consumers directly as well as the realistic price that retailers are likely to charge consumers. Then consider establishing a Minimum Advertised Price (MAP) to protect your brand and other retailers.
• Distribution channels 101, distributors and knowing when to use them.
• Retailers really want to see your website and social media presence. Social proof is very useful to retailers.
• A new trend is to have a road rep, ie someone who literally travels throughout your country with samples with the hope of finding buyers. This is a new means of connecting with buyers since the influx of markets makes it difficult to meet many customers. The earnings of a road rep may come entirely from commissions.
• Consider your internal pricing policy. For instance, under what circumstances will you change prices in a market used to fixed prices? If the highest cost price scenario raises and I must use that option consecutively for a certain period beyond its otherwise random probable chance of being applied, I might want to raise prices.
• Wholesale payment terms
• Tier pricing establishes price tiers and is often used in wholesale pricing, an area in which sale volumes are considerably larger (than retail). Notice the volume ranges in the example immediately below. Tier pricing should not be confused with volume pricing, which is more commonly used in retail (for which sale volumes are considerably smaller).
• When approach sellers, get an advantage by introducing you and your company effectively.