Calculating prices can be a challenge for any business, but things can become even trickier when you’re selling items or materials wholesale.
With more competition and lower profit margins brought on by that competition, it’s more important than ever to price your products appropriately. Aim too high and you’ll lose sales to competitors. Go too low in a race to the bottom and you’ll never turn a profit.
So, how do we strike a balance between profit and customer satisfaction? The good news is it’s not as complicated as you think.
Today we’ll talk about how to properly price items for wholesale so both you and your customers are satisfied.
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What is wholesale pricing?
Before we take a deep dive into the details of pricing, we need to take a moment to discuss what a wholesale price is in practical terms.
Wholesale price, for the purpose of this article, is the price one business charges another business for products or materials. That’s really all you need to know. And because it’s a business-to-business transaction, usually involving larger quantities than you’d see at retail, wholesale prices are often significantly lower than what a person would pay for the same item in a store.
When it comes to wholesale vs. retail, the thing to remember is that a business buying wholesale has to pay a low enough price for the good or material so they can still sell it in a store or commerce channel while making a profit. If the wholesale price is too high, the retailer then has to either add more markup to turn a profit or reduce their profit margin.
So, finding the right wholesale price is all about finding that sweet spot where you can purchase items at a price point that allows you to still make a profit down the road. Keep that in mind as we move forward.
Wholesale pricing methods
Now that we know what wholesale pricing is and why it’s important , let’s talk about methods we can use to determine wholesale prices. Warning: there’s going to be some math ahead. Don’t worry, though. It’s not calculus.
1. Absorption pricing
We begin with the absorption method, which basically has you “absorbing” (clever, eh?) all the various costs to determine the final selling price. To use this pricing method effectively, you will need to figure out three different things.
We can figure out the total price pretty easily. All we need to do is use this formula:
Total price = Variable Product Cost + ((overhead expenses + administrative costs)/number of units).
If you’re wondering what “variable product cost” is, it’s basically a fluctuating price point for a product determined by changes in the market. You may have a product or material that’s always the same price 99% of the time – meaning you can just plug in the current product cost and go from there.
Once we have this number, we can move to the next step.
Calculate your profit margin
If you need a quick refresher on what profit margin is, it’s the ratio between net profit and revenue. We can find net profit is figured by taking revenue and subtracting the cost.
Use math magic to get the wholesale price
Now that you’ve got those numbers, it’s time to plug them in.
Wholesale price = total cost price + profit margin
Now that we know how it works, let’s do one as an example.
- Production/Purchase Costs: $75,000
- Administrative Costs: $25,000
- Variable Cost Per Unit: $20
- Amount of Units Produced: 10,000
Price = $20 = ((75,000+25,000) /10,000) = $30
Pretty simple, right?
Now that we know how absorption pricing works, let’s breakdown the pros and cons of this approach.
- Simplicity – You don’t need a degree in advanced mathematics to figure out the price with this method. It’s really simple.
- Accuracy – If the numbers you plug into the formula are reliable, then you’re pretty much guaranteed to come away with a wholesale price that guarantees some level of profit.
- Doesn’t consider external influences – One of the big issues with absorption pricing is that it fails to consider the pricing of your competitors. So, while you may wind up with a price that guarantees you turn a profit, it may be significantly above your competition if you’re in a really competitive space. That can be bad news.
- You can still miss the mark – Because of the insular nature of the calculation, it’s still entirely possible to set your price too high (thus driving off potential customers) or too low (ensuring you never turn a profit).
2. Differentiated pricing
Now that we’re finished with absorption pricing, let’s talk about our second method: differentiated pricing. In this methodology, prices are determined by the law of demand – meaning customers pay different prices depending on their circumstances.
For example, prices would be set higher than average in low competition areas. Suppose you have a business in an airport. Your customers don’t have a lot of options in this environment, so the price can be higher. The alternative here is offering products at a lower price.
In this situation, you want to move product quickly to keep a steady stream of revenue coming in. Your margin might be smaller, but the reduced price moves inventory quicker, so it theoretically balances out. This could be a clothing retailer looking to blow out their stock of summer clothes in August, for example.
We can even take this a step further, differentiating according to the amount purchased. If we have a customer buying in bulk, we might increase the discount or offer incentives for future purchases. If the customer is only buying a small quantity, we can adjust the pricing upward to maintain the profit margin.
- Flexibility – Differentiated pricing allows you to be really flexible when it comes to figuring out what to charge. You can adjust on a case-by-case basis, meaning it gives you a great deal of control over how much profit you can generate or product you can move.
- Customer satisfaction – With absorption pricing, the price is essentially set and if the customer doesn’t like it or doesn’t feel it’s a fair deal, their primary option is to go somewhere else. With differentiated pricing, we eliminate that – the flexibility mentioned above means there are ways we can arrive at prices that make both the business and the customer happy.
- Lots of work – Plugging information into a formula and getting an answer is really pretty simple. Adjusting prices continually based on dynamic situations is less so. With differentiated pricing, you’ll be constantly determining prices on a sale-by-sale basis in many instances. That can become a lot of work.
- A High Margin for Error – All this freedom and flexibility coupled with a constantly changing price system dramatically increases the chances of error. Differentiated pricing can absolutely work, but you really need to understand your markets and customers to avoid pricing yourself out of the market or racing to the bottom.
Both approaches can work. It’s really a matter of choosing which one feels right for you. At the end of the day, wholesale pricing comes down to figuring out a way to provide products for customers at a price that seems fair to them and still allows you to be profitable. Both of these systems can help you achieve that goal.
Additional wholesale pricing formulas
The beauty of wholesale pricing is that there’s not just one formula to figure out the best price for your products.
The one we used in the sample above is a popular option because it’s simple and doesn’t require a ton of math (or an advanced degree), but it’s hardly the only method. In fact, here is another option you can play around with. Our advice is to try as many different formulas as you can and compare results to find the one that works the best with your specific business and industry.
1. Supplies + Overhead costs + Labor = Break even price
Here we can basically figure out the exact amount we need to charge to break even on a product or material. Why would you want to know this? Because if you know what the break even point on an item is, it’s easier to then figure out an acceptable profit margin.
Here we take the cost of supplies (basically all the raw materials required to make or repair your product) and add the cost of overhead (which are all your business expenses. Don’t forget things like credit card processing fees, shipping, and so on).
Then we add labor (take the hourly rate of an employee and multiply by the number of hours to create the product). Add those together and you get the break even price.
2. Break even price X 2 or more = Wholesale price
When we know the break even price, we can start to figure out a good wholesale price – and this is where the real fun starts.
One of the common ways to determine wholesale price is to take your break even price and multiply it by two. That then becomes your new wholesale price. If you don’t like that number, you can also just add an arbitrary amount to the break even price. To do this, you need to figure out what you would like your profit margin to be.
This can be customized by changing how you want to set your profit margin. Do you want to set the margin by piece? Do you want to set it by time period? Do you have a minimum order quantity? You can set the margin however you choose.
3. Wholesale price x 2 or more = Retail price
And finally, you have to factor in the retail price of your wholesale items – because retailers who buy your stuff need to make a profit too.
The general standard is that retailers expect to charge the wholesale price times two at minimum. This is why wholesalers will often include a manufacturer’s suggested retail price (MSRP) with their products.
Of course, retailers are able to charge more than the two times wholesale – but if you’re setting your wholesale prices, you need to keep this number in mind. Retailers aren’t likely to purchase products from wholesalers who have a price so high it cuts into their profit margins.
Like many things in inventory management, wholesale pricing can be as simple or complicated as you want it to be.
In this article, we’ve scratched the surface of how to figure out your wholesale pricing strategy and the philosophy behind it. You can use this information to set your prices and move forward, confident that you have a handle on how to price things effectively – but you can also dive even deeper if you’re really into this sort of thing.
No matter which path you take, the key takeaway remains the same. Setting the right wholesale price is vitally important to your business’s success.
And to do that, we must always consider two things – our costs and profit margin (including what our competitors are doing) and customer satisfaction. Wholesale pricing is like all pricing in that it’s about striking the balance between finding a price that allows your business to be profitable while also giving your customers a fair and competitive price based on the market.
When you keep these goals in mind, figuring out wholesale pricing using these simple formulas becomes much easier. Try it for yourself and see how it works. Want to learn more about pricing and inventory management across a wide range of industries? Then be sure to subscribe to our blog so you don’t miss our latest posts!