No matter what type of business you run, pricing is always a concern. Whether it be figuring out how much to charge for your services or the products you sell. While service based businesses tend to have more flexibility in pricing due to low overhead costs, retail businesses don’t have the same luxury.
There are several pricing methods used by retail businesses, such as cost plus pricing, premium pricing, and competitive pricing to name a few. However regardless of which one (or ones) you use, you need to consider the often high costs of running a retail business.
Understanding Retail Costs
The highest cost for most retail businesses is the cost of goods sold (COGS). The percentage of COGS to gross revenue (referred to as COGS margin) can vary based on your specific industry. A coffee shop for example may spend about 20-25% of their gross revenue on COGS. This means that for every $1 you generate in sales, $0.20 to $0.25 goes to cover the cost of what you’re selling. The rest goes to cover your remaining business expenses, with some left over hopefully for profit.
This percentage may also be higher if you haven’t been monitoring your financial performance on a regular basis or taken the time to do a full cost-analysis of your business to ensure you are keeping up with current market conditions. Perhaps when you first launched your retail business you came up with pricing based on your financial situation at that time. But it is important to continue reviewing this information to make sure you are still covering your costs, and generating a profit.
The second highest cost is usually payroll, which is typically between 10-20% of gross revenue for most retail businesses. If you value your employees and strive to provide competitive wages and good benefits, this percentage will be on the higher side. However, despite the increased cost, many small business owners may see this as a worthy investment. Employees who feel appreciated and valued, as well as fairly compensated, may be more likely to contribute to increased sales as well as stay with the business longer. Since employee turnover and training can be costly, maintaining employees will reduce costs in the long run.
While COGS and payroll can make up to 50% or more of your gross revenue, there are plenty of additional costs to consider as well. Rent, utilities, insurance, maintenance, advertising, software, etc., can all add to the overall costs of running your business. When these costs are added together, it is not uncommon to see profit margins of only 2-3% in certain retail businesses, such as in the food and beverage sector. However some online retailers may have profit margins as high as 40%, or even 50%, such as with beauty products.
Does this mean you shouldn’t open that coffee shop you’ve always dreamed of having? No, of course not. (Where would we be without our beloved coffee shops?)
Improving Profit Margins
What it does mean is that reviewing and monitoring your finances on a regular basis is essential to keeping profit margins in the positive. This includes looking at your profit and loss statement each month to see how your costs compare to your sales. Don’t just look at the overall amounts, but review the percentages of gross revenue allocated to the various costs. Look for trends and see if there are any inconsistencies.
For example, if your COGS is typically around 28% of your gross revenue and then you notice it’s up to 32% for a few months, look into why this is happening. Did your vendors increase their prices? Have other external factors affected an increase in costs such as market trends, the economy, or taxes? Have you been relying on your staff more so than usual? If any of these scenarios apply, they may indicate it is time to review your pricing to ensure you are accounting for these increased costs.
Maybe costs haven’t changed but you notice a dip in sales. Most retail businesses have fluctuations throughout the year; this is normal. You have busy seasons and slow seasons, and many factors can affect sales fluctuations even from day to day. Weekends are usually busier than weekdays, unless you cater to the work crowd (again, think of our coffee shop). Mondays are the slowest for restaurants, which is why many locally-owned ones are closed on this day. You get the idea. The key is to determine if the dip in sales is consistent with expected trends, or is due to changes in customer behavior, increased competition, or some other unexpected event.
Using Financial Performance to Make Decisions
In order to know whether the change is following an expected trend or an unexpected event requires you to review past financial performance. This process can help you identify trends as well as get an idea of what to expect in the future. While many retail software products can provide this information, they may or may not have the functionality to create the types of reports you’d like to see. An option is to use the information from your accounting software or from your POS software to create simple spreadsheets that will track your monthly budget and the associated profit margin percentages per item sold.
Reviewing and analyzing your financial performance is only the first step, however. The next is to use this information to make ongoing decisions for addressing issues and moving forward in the best way possible. These decisions may include reconsidering vendors you work with, or renegotiating prices with them, making changes to your staff, making changes to your offerings, or updating your prices.
However, before updating your pricing, make sure you’ve looked at all other possible factors affecting your profitability first. The most successful retail businesses are ones that have repeat customers. Those customers will most likely notice price changes, especially if they are significant or happen too often. This is why you want to start by looking at your costs to see if there is a way to reduce them, or make better use of what you have to maximize your resources. And if sales are down, you want to gain a better understanding of why sales are down and address those issues if you can.
It’s also important to look at profit margins for each of the items you sell, which can be done through a cost-analysis. Once you have this done, you may see that some items will have higher margins than others. This is OK as long as they balance each other out, and your desired profit margin overall nets positive. In fact, it is natural to have various profit margins among your products due to the individual costs associated with each item. For example, a restaurant may have higher profit margins on beverages compared to seafood items.
Optimizing Your Prices
Once you’ve looked at the costs of running your business, as well as the costs of what you sell (COGS), and you’ve analyzed sales activity, then it’s time to re-evaluate your pricing. Having accurate pricing is key to the success of your business. Without it, everything else may suffer. You need accurate pricing to cover your costs, pay your employees, and pay yourselves. You also need it so that you can continue to stay competitive, while providing value to your customers so that they keep coming back.
Pricing, however, is tricky for retail businesses. There are many factors affecting your costs that are out of your control. Inflation, the job market, vendor pricing, the real estate market, taxes, the list goes on. These external factors push your costs up, which in turn, push your prices up. However, what your customer values and is willing to pay creates a cap on what you can charge, pushing your prices back down. Add into the mix competition and market demand, and you have a limited range of what you can charge for your products.
Therefore, in order to have the best chance of optimal pricing, it is necessary to keep up with the financial health and performance of your business. This includes reviewing past performance to identify trends and creating projections for the future. It also includes analyzing costs, especially as they relate to sales, and ensuring that your prices cover the costs of running your business as well as generating desired profit margins that are consistent with your industry.
Are You Interested in Optimizing Pricing and Improving Profit Margins in Your Retail Business?
If you’re looking to gain a better understanding of the financial health and performance of your business, while positively impacting your profitability, and making pricing decisions much easier, you can schedule a free consultation. Together, we can put together a plan that includes a full cost-analysis for your business, as well as a pricing strategy to help you stay competitive and drive your business forward.