I talk about it with founders; read about it in posts and listen to it on podcasts. How does something so central to the entire business - how should we price our products - get so screwed up?
Before we dive in, let’s do a quick review. I am defining product margin as net sales less the cost to get the product ‘ready to sell’ in the warehouse. So the actual cost of the product plus the inbound shipping, customs, tariffs etc.
This number is so important because everything else is deducted from it. Your merchant fees, shipping and fulfillment and your marketing to get your contribution profit and then OpEx to get your Operating Profit and then CapEx and debt payments to get your free cash flow.
Start with a product margin that’s too low and you will likely never make the numbers work and get to a place where you generate organic cash.
Here are 3 reasons I see this happen.
#1 Low margins are used as a weapon
This is pretty rare in nascent brands, but I suspect AI will enable it as a strategy, so let’s address it. NewBrand has identified a way to get scale in cost reduction, marketing reduction, customer acquisition or some other cost advantage and purposely prices low (or not as high as they could) in order to quickly gain share and leverage their scale advantage to win the market. I struggle to find any COGS scale advantages, but celebrity backed brands can reduce their marketing and thus make average or below average pricing work. In essence they could be charging a premium but instead gives that value away in exchange for faster growth.
#2 Don’t know any better
This usually starts with our founder looking around the category, seeing the prices of competitors and then setting a price somewhere in the middle or below the average. The problem for this founder is that competitors will have the advantage of more efficient processes which should enable them to make a higher contribution profit on each unit than our NewBrand founder. And competitors have the advantage of returning customers so don’t have to acquire every customer like NewBrand. The result for our founder is less organic cash generation, more capital needed with a steeper and longer curve until they can get to cash self sufficiency.
Our founder hasn’t adequately forecasted the cash needed for them to build a customer base and wring the inefficiencies out of their processes. And because their product margin is too low, their contribution profit is too low. The business isn’t generating enough cash and it doesn’t look exciting to investors or lenders making additional capital harder and more expensive.
#3 Fear
I believe fear plays the biggest role in setting prices too low. The NewBrand founder looks around at their competition and worries that customers won’t pay the same prices for a new brand so they decide they will compete on price. And because they have no scale advantage, all they are really doing is deciding to compete in the market based on their willingness to eat ramen noodles for years to come.
Forecast the margin you need and time to get there
Put another way, if you can’t imagine a way to market your product at a price that makes sense for you, then you either have a product problem or a market problem or both. Figure out the margin you need to build a business that will create wealth, solve for the pricing you need, then plan and forecast accordingly. Plans based on a day or two of this thinking will save you months (or years) of future pain.
I offer brand leaders a 10 day sprint to a clear plan for cash, capital, and profitability. If you are struggling with pricing, product margins and cash generation, let’s talk.