Consider the Neverlate clock.
It’s a great item during back-to-school season. But the economics are difficult. Each clock costs $18 plus about $2 freight, if I can afford $960 to reach their 12-case discount (48 clocks). Because my open-to-buy is chronically struggling back up to zero, I have to go for their 3-case minimum instead, and pay $22 apiece.
The Manufacturer’s Suggested Retail Price (MSRP) is $34.99. To me, “.99” price points mean sale items, so I use $34.95. That four-cent difference happens to make me the cheapest vendor on the internet, and lately I have sold a goodly number. Each sale brings in $12.95 ($34.95 retail minus $22 cost). Profit! Right?
I wish it were that simple.
My cost structure requires a 50% average markup. 50 cents of every dollar goes toward replacing merchandise; the other 50 cents covers all of my other costs (or will, when I'm profitable). When I sell a Neverlate, only $17.48 goes back into my OTB. Because the clocks cost me $22, my OTB actually declines by $4.52 (the $22 cost minus the $17.48 infusion) every time I sell one. That’s another way of saying that I take a $4.52 loss.
When sales are broad-based, some of my merchandise that costs less than 50% of retail makes up the difference. But when an item like the Neverlate surges, as it did last month, I have a real problem.
This is a pickle, George. This is a pickle.
I know of five other web retailers selling this thing. Their price points are $34.98, $34.99, $39.95, $39.99, and $44.99. It’s tempting to simply raise my retail. But with two other online stores underselling me, I’d never sell another one. Only bricks-and-mortar stores can get away with price gouging (because in-store consumers can’t easily comparison shop). You can bet that the $44.99 retailer is not selling any clocks online.
When I went to reorder recently, I learned that the supply is limited; soon everyone will run out. I immediately raised my price to $39.95. And as expected, sales immediately stopped. Hooray! I'm no longer losing money on Neverlates.
That's obviously self-defeating.
What to do?
First, I’m going to have to cough up the $960 to get my cost down to $20 apiece. That cuts the loss from $4.52 to $2.52. I’ll have to risk getting stuck with 48 of these things if sales drop off when the back-to-school season ends. Second, I can inflate the weight by a few ounces to nick people a little bit extra on shipping. It goes against my own policy, and I hate doing it; but I’m desperate here. Let’s say that I can recoup another $0.52 that way and reduce the loss to $2 apiece.
By squeezing my budget mercilessly, I increased my OTB percentage from 50 to 50.75%. Now each sale replenishes $17.74 instead of $17.48. The gap is down to $1.74. I can’t figure out how to make that last $1.74 go away. I’ll have to absorb it, and make it up on other products.
After considerable deliberation, I decided that building volume is more important to my business than maximizing revenue per sale. So I dropped my price to $34.99. Now I'm tied for second-lowest price, with the difference being only a penny. The manufacturer sold me two more cases (eight clocks) from his limited supply. That gives me a total of 12 more in stock between today and the time the supply returns to normal in November. If I can sell all 12 between now and then, I’ll assume that the demand is sufficient to justify placing the big 48-piece reorder next time. If the item dies on me despite my loss-leader pricing, then I will instead try to trickle them out at the 39.95 retail.
Footnote: More than half of my recent Neverlate customers have paid an extra $2 for giftwrapping. If only I could get everyone to buy giftwrapping, I’d be all set.
(Update, August 2007: I've restored the original version of this post. It replaces a bowdlerized version that removed all price specifics at the vendor’s request. Since I decided to sever communication with that vendor after he removed my page link -- and especially because the post didn’t make sense when purged of numbers -- I have replaced the censored version.
(Ultimately, I ended up marking my stock down a couple of bucks to clear it out. At this writing, I’m down to four left. Thanks to its already inadequate markup, I just about broke even on this product. That’s too bad; it was a nice clock. I actually bought one of the last copies for myself.)