Wednesday, November 28, 2012

Selling Wholesale: Thinking about Costing and Pricing

One of the first challenges with any business is determining your pricing structure, and many businesses go under because they are not charging enough. If your marketing strategy is to be a low cost leader (think Walmart) this may work for you as the volume of sales will drive your revenue. But when starting a business, we're often think about any sales, not yet volume of sales.

The first step in determining pricing is to be knowledgeable of your costs. Be sure you have a clear knowledge of cost per unit when calculating your product costs.

For example, assume I make a necklace comprised of three simple pieces.  Piece A is available in units of 10 for $1. Piece B is available in units of 12 for $1. Piece C is available in single units for $1.  Your units costs are:

Piece A = $1/10 = $0.10
Piece B = $1/12 = $0.08
Piece C = $1/1 = $1.00

Now, assume the necklace needs 7 units of Piece A, 5 units of Piece B, and 3 units of Piece C.  Your products costs are:

Piece A = $0.10 x 7 = $0.70
Piece B = $0.08 x 5 = $0.40
Piece C = $1.00 x 3 = $3.00

Total cost = $4.10

But don't forget about labor and overhead costs.  Yes! You need to pay yourself! This example is going to assume $10 per hour labor, although I know your time is valued at much more than this!  Assume it takes 15 minutes to make one necklace. Total labor cost for one necklace is:

Labor = $10.00/4 = $2.50
Add product costs = $4.10
Total cost so far = $6.60

Then the dreaded overhead costs: rent, marketing, insurance, utilities, machinery.  For easy math, let's assume these costs equal $10.00 per day.  Total overhead cost to make one necklace per day is:

Overhead = $10.00
Add labor costs = $2.50
Add product costs = $4.10
Total cost so far = $16.60

Your wholesale price should be at least twice your costs.  Therefore:

Wholesale price = $16.60 x 2 = $33.20

Whoa!!!!! That's what I'm selling my necklace for as retail!!!! It is so easy to fall into this trap, because we know what a similar product may sell for in similar online shops, and even in our local department store. The online competitor may sell for $25.00 and the local department store for $15.00.  But, you say, mine is hand crafted with better quality items. Cost is not always a deciding factor with the customer, sometimes quality is.  But you still need to be competitive.  That's where selling wholesale can help you break even and become profitable.

Let's use the same example. You know you can make a single necklace in 15 minutes, but because of working in larger quantities, you can make 6 necklaces in one hour.  Now, your costs looks like this:

Product costs = $4.10 x 6 = $24.60
Labor costs = $10.00
Overhead costs = $10.00

Total costs = $44.60
Per unit cost = $44.60/6 = $7.43
Wholesale price = $7.43 x 2 = $14.86

Now you're competitive! The necklace can be sold for retail price of wholesale x 2 = $29.72, which I would round up to $30.00.

This is truly a contrived example, but it demonstrates what I like to call Economies of Time. We're familiar with Economies of Scale, in which buying larger quantities drives down the cost per unit.  With Economies of Time, doing repetitive tasks successively can help you to build speed, allowing your to accomplish more per units of time.

But I also use this example intentionally, as it's the model on which I base my pricing.  I sell my candles wholesale for $10 each, and cases of 12 for $120.  Pretty simple math.  But it takes just as long to make 12 candles as it does to make 1.  (Think preparing a batch of cookies then putting only one into the oven). I use Economies of Time to provide a 10% savings to the buyer if each case is one fragrance only.  I'm willing to pass my savings in time on to the buyer and sell one fragrance case for only $108.00.

Now, as someone just beginning to gain wholesale orders, I realize it will take some time for a buyer to want to buy an entire case of one fragrance. But I believe they will see this as an incentive as as they become more comfortable and intrigued with my product!

What also goes unsaid in this example, is the extra costs of supply inventory for unmade product. Using my batch of cookies example, when I only bake one cookie, I have not only excess flour, sugar, and butter (supply inventory) but excess unbaked cookie dough (product inventory). This carries a cost as well as the excess flour, sugar and butter are opened and will only be used when I make another batch (sunk costs), and I can't sell the dough until I bake again (inventory).

This week I encourage you to think about you can maximize your time by producing in larger quantities. Even in the example above, each necklace will be slightly different due to the natural variance in hand crafted items. But if our goal is to make money from our craft, we need to analyze the costs associated with our business.

I welcome your thoughts, feedback, and questions. Until then, happy sales!

Dorene
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