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Determining MSRP and channel pricing based on the quick formula: 7x COGs

Determining MSRP and channel pricing based on the quick formula: 7x COGs

In my prior blog “How to price your product for retail, distributor, and direct to consumer sales” I allude to and then expand upon in the comments a quick rule of thumb equation for determining your MSRP. But this has led to many follow-up questions from blog readers asking if they should use the 7x COGs formula to determine their MSRP and subsequent channel discounted pricing.

The short answer is, well it depends.

There are many factors that will determine your overall MSRP and various discount levels (for distributors, retailers, etc.). The quick formula of 7x COGs is merely a handy guide to determine if you’re “able” to support various, typical discount levels across various sales channels. Of course determining your actual MSRP and discount rates is hardly ever as simple as multiplying your costs of goods by seven.

There are many factors that might contribute to reduced margins across your sales channels and/or a lower MSRP than the 7x COGs formula would dictate. For one, your COGs may be high. Perhaps you’re establishing a premium brand and paid extra for better ingredients or materials - this by default will create a higher cost to you. But if the market and your customers are unwilling to accept a premium price you’ll have to establish a MSRP close to the established market price - or spend heavily to create and support your premium brand position and pricing. Or perhaps you’re competing against a manufacturer that is direct selling - and in the worst case - that’s also your supplier. Of course they can sell the product cheaper - to them direct to consumer sales offer big margins - so if they’re aggressive on pricing, it’s still more profit for them. In this case you’re stuck again accepting a lower MSRP and lower margins (and should probably find a new supplier).

If your MSRP isn’t 7x COGs it doesn’t mean the end-of-the-world.

Whatever the cause, market pressures, competition, higher initial costs, if you can’t establish an MSRP at 7x COGs it doesn’t mean the situation is dire. First, your industry may not support 7x multiples through the channels. This type of margin isn’t standard in all industries or across all products. You will need to do your research to determine the typical margins.

If 7x margin is typical, but for some reason your final MSRP is out-of-whack with the standard accepted price, this simply might mean you can’t support several levels of distribution. You may be forced to abandon distribution and wholesale and offer only direct to retailer and/or direct to consumer sales. That is, if your product costs $10, the quick formula 7x COGs would suggest an MSRP of $70. But if the consumer will only pay $40 it’s likely you’ll have to forgo distribution initially (distributors will often expect to pay 70% off MSRP - so $12 on a $40 MSRP). Unless your industry works on lower margins across the sales channels you may be forced to sell only to retailers and to consumer directly. Which isn’t the end-of-the-world, it simply presents different challenges.

So, after the long explanation, the answer is still, it depends.

Hopefully I’ve shed some light on the quick formula of 7x COGs. It’s not a hard and fast rule, it’s simply a guideline for quickly determining if you “can” support various sales channels - including distributors. But failing the 7x COGs check doesn’t mean you’re doomed - your industry may function with smaller margins across channels. Or it may guide you to support fewer channels initially. So don’t panic. Do some research within your industry to determine the standard discount rates and margins expected by distributors, wholesales, and/or retailers. Then adapt accordingly.

Related Reading:

  1. Channel Margins Tool by Harvard Business School

Sep 21, 2013
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There are 3 comments for this entry. Leave a comment below »


Bill,

We are a start-up hair care company that has been utilizing social media to launch our product to the masses. We were selling individual units for $12.99 and cases of 12 units for $65.00 ($5.41 each) up to 24 units for $120.00 ($5.00 each). This was an attempt to get our product to the barber / beauty shops and get the word out about our brand. Now manufacturing has been obtained and our COGS is $2.95, Distribution Cost $5.20 (60% of SRP $12.99), OTC Cost $7.80 (40% of SRP $12.99).

Here lies the issue our first real distributor contacted us and purched 50 cases at a $5.50 rate including shipping which we were very happy about. We only have one distributor at the moment and we can not sell at the same $5.00 rate online what we previously were, but if we take if off our site that will decrease sales. Once we have established more distributors this will not be an issue.

How would you calculate an additional price point called BARBER / SALON PRICE??

COGS: $2.95
DIST: $5.20
OTC: $7.80

BARBER / SALON COST: ?????

Don't want to alienate the barber / salons who helped up get to this point and don't want to undercut our first distributor, that may stop the re-order and other distributors to purchase.

New business questions.

James

James
May 02, 2014


@Chris

You're welcome. Glad you're enjoying our blogs.

As for your question about typical mark-ups for an item similar to but different from an electric corkscrew - that's a tough one. It's going to depend on whether is a home good or an electrical appliance. And then where you want to position it in the market.

Even for a lowly corkscrew I can pay anywhere between $2.00 (simple metal) to $20.00 (for an OXO). So it's not always a simple mathematical formula. It also depends on positioning and where you'll be sold. You also don't mention your COGs so it's tough to gauge what MSRP you need to be at.

William Levins
Nov 27, 2013


William,

Thanks for the all the information on channel pricing and MSRP. As so many people have said before in your earlier blog, this is great information. And thanks for including the link to the Harvard Channel Margins Tool.

With respect to my product, I am developing a product for the Wine and Beer Industry. The product is similar to an electric cork screw but different and with a different application. Do you know the MSRP COGS multiple for this industry?

Chris Maier
Nov 21, 2013


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