Shop Talk: Practical answers for tough business questions.
Question: It seems we are always financially behind. Our accountant has suggested our gross profit margin is too low and we need to raise our prices. We have agreed to do this, but it seems a daunting task. Should we start on one side of the store and just re-price everything? Can you suggest an easier way?
Answer: Pricing merchandise high enough to maintain a profitable business is very important. “Profitable” means you have money to keep your doors open, pay your employees, take a salary, and live comfortably. Many independent retailers do not price for enough profit until they face the situation you describe. Everything can seem fine, especially when you are enjoying good daily sales and a strong cash flow. But if you are not pricing your merchandise to more than cover your expenses, you will eventually fall behind. Thank goodness your accountant is pointing this out before you are in more serious trouble.
Ask your accountant to suggest a pricing formula and a target gross profit margin that covers all your costs and leaves a positive number on the bottom line. Once you have this information, you can approach this project in a couple of ways.
One way is to determine how many items you have in inventory and price them all 50 cents more. For instance, if you have $260,000 in sales and your current cost of goods sold (COGS) is $135,200, then your gross profit (GP) is $124,800 and your gross profit margin (GPM) is 48 percent ((Sales – COGS)/Sales = GPM). If you have 7,500 items in your store and you increased the price 50 cents per item, you would generate $3,750 more in sales (7,500 items x 50 cents = $3,750), which would increase your sales to $263,750 and your GP to $128,550, or almost 49 percent GPM. Will that solve the problem?
If the increase meets your accountant’s suggested percentage, you will need to determine what merchandise can be re-priced. You obviously cannot increase preprinted prices on items such as books and greeting cards, so you will have to increase some items, such as clothing, jewelry, or statuary, by $1 to compensate.
Another approach is to determine, with your accountant’s help, a minimum formula for across-the-board mark-ups. Our mark-up formula is a 2.6 + shipping minimum, and we price some items higher if the perceived value allows. For example, if an item costs you $7 plus $1 shipping, the formula would set the price at $19.20 ($7 x 2.6 + $1), although depending on the item we might price it at $19.95 or $20. If this seems a lot, remember you have merchandise you cannot mark up more than the preprinted price, so you have to offset that fact in your equation.
Once you set the formula, you can start re-pricing merchandise currently on your sales floor. The easiest way is by vendor. Each time an order comes in (you are reordering because the merchandise is selling), assess all the merchandise you receive from that vendor and increase prices on what you ordered, including those items on the sales floor. Also increase prices on what you are not reordering. If you decide not to increase prices on your slow sellers, put that merchandise in your next sale.
Pricing your inventory fairly is a balance between being profitable and offering true value to your customer. I find most retailers tend to underprice their merchandise—and therefore struggle financially in an effort to be fair and competitive—and they sometimes underprice themselves right out of a job! Most of your customers are happy to pay an extra dollar or so to know you will remain in their community for a long, long time.
First published in Vol. 26 No. 7 of Retailing Insight. © 2012 Continuity Publishing Inc. All rights reserved.