Back to Basics: Profit Margins & Pricing Markups in the Supply Chain

 

In the standard supply chain of manufacturer to distributor to retailer, one of the most consistent challenges is marking up prices so that companies return a profit while also staying competitive.

The distributor level has the most variation. While they would prefer to buy in high volumes to keep prices low, distributors don’t always have that luxury.

Distributor Pricing Dilemma

Say a retailer has an urgent issue and needs to rush order something for a customer. The distributor may be forced to buy just one of that product from the manufacturer to satisfy the customer, but buying only one means that they’ll pay more per unit than if they bought, say, 50. This decreases their margins. The distributor may choose to buy 50 anyway to enjoy the low prices but, there’s risk involved with that, as well, since that could also become deadstock if a better product hits the market or demand from retailers declines.

Let’s use the example of a company that distributes automotive parts from manufacturers to mechanic shops and auto repair stores. As new cars are made each year, this distributor has to keep up with which parts are still in use, which ones are incompatible with new models and what new parts they must offer as a result of a new car. Their catalog of products spans everything from door handles to floor mats to exhaust pipes and alternators for several different makes and models, bringing their number of SKUs into the thousands.

The prices that this distributor charges to the retailers is not only determined by how much they bought the parts from the manufacturer for, but also what the retailer wants to sell it for along with the basic economics of supply (how much is available) and demand (how many people need the product).

In such a dynamic environment, it’s important for distributors to have a well-defined and thorough distributor pricing strategy. Even without the ability to predict when certain things will happen and how it will affect pricing, a comprehensive pricing strategy that adheres to parameters that ensure profitability, flexibility and reliability will serve them well.

 

Marking up Prices in the Supply Chain

There are certain windows that manufacturers, distributors and retailers often fall into when figuring out how much to markup a product in order to maximize margins.

For manufacturers, markup is typically determined by the bill of materials (BOM) or however much it cost them to make the product. It’s not a simple calculation, but manufacturers can easily figure out the per unit cost. Once they know their BOM, they will mark it up however much profit they want – typically 15-20%.

The average wholesale or distributor markup is 20%, although some go up as high as 40%. Now, it certainly varies by industry for retailers: most automobiles are only marked up 5-10% while it’s not uncommon for clothing items to be marked up 100%.

A large factor is the market value of the product when sold at retail, the third level of the chain. Because manufacturer and distributor pricing strategies have downhill ramifications for retailers, how much a customer is willing to pay for a product can be the starting point for determining realistic markups and profit margins back upstream. After all, if the retailer is forced to sell the product at a price that’s too high and, as a result, they lose customers, that hurts the manufacturer’s chances of repeating business in the future.

While the market value can be determined by many different things, one of the suggested prices actually comes from the manufacturer. The MSRP, or manufacturer suggested retail price, is the price that the manufacturer suggests the product should be sold at by the retailer. This number usually includes markups and margins for all of the necessary levels of the supply chain. Now, obviously, things like competition, supply and demand often cause the actual retail price to be different but it’s helpful to understand what MSRP is, where it comes from, and what factors contribute to it.

Ultimately, pricing at all levels must align with each other enough that everyone returns an acceptable profit margin and is comfortable making another purchase when the inventory needs to be replaced. Manufacturers that price too high won’t find distributors or wholesalers to buy from them. Distributors who price too high won’t find retailers willing to carry their products. And retailers who price too high will be left with dead inventory and absent customers. Everything has to work together for the whole supply chain to thrive.

How PROS Tools Eliminate the Hassle of Pricing

Now that we all understand the complexity behind manufacturer markups, strategic pricing for distributors and retailer margins, we also better understand how PROS Pricing Optimization software can save time. Many companies still operate with a person or team of people making pricing decisions and constantly trying to keep themselves in the most beneficial positions in terms of profit and customer satisfaction.

PROS Pricing Optimization tools are geared by a thoroughly developed algorithm known as Dynamic Pricing Science. This algorithm looks at market data, trends in purchasing behavior and a company’s pricing strategy to determine the best prices for winning business, at all times. Rather than having to manually run analyses and discuss options and priorities, PROS pricing solutions allows businesses to configure around important milestones, establish pricing guidelines and implement those guidelines across an entire sales force with minimal interaction to slow down the process.

Readiness is everything in sales so anytime minutes can be cut out of the decision-making process, especially if a sales person can achieve the same results without that lost time, the better chances they have of winning the deal. PROS Pricing applications are designed to minimize wasteful or inefficient interactions with (potential) customers and produce winning prices by combining all of the factors mentioned above along with other, more specific factors like customers with similar traits and what they bought as well as a customer’s willingness-to-purchase.

In competitive sales environments where immediacy can be the difference between winning and losing, and where pricing in a dynamic industry can have downhill or uphill effects for the rest of the supply chain, PROS pricing software can equip manufacturers, distributors and retailers with the power to maximize their profits at all times.

 

About the Author

Richard Blatcher

Richard is the Senior Industry Solutions Manager at PROS. He manages the global go-to-market strategy for PROS Automotive and Industrial Manufacturing solutions.

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