2.5 How to build pricing architecture

After you’ve done your research on assortment and trends, the next step is to build your pricing architecture.

 

The Three Types of Pricing Methods

  • Markup method
  • Cost-plus pricing
  • Value-based pricing

 

Markup method

Markup refers to a percentage calculated based on the cost of goods that contributes to your profits. This is the simplest pricing method as it requires a straightforward mathematical multiplication. The formula is as below:

 

 

As the formula shows, the markup is the difference in ratios of selling price to cost of goods. Cost here typically includes raw materials, wholesale price and taxes. The markup percentage can be determined ahead of time to ensure a profitable margin. Standard retail markups range from x2.5 to x3.

 

However, do keep in mind that this is a traditional method – it does not optimise pricing.

 

Cost-plus pricing

The first method is the easier option, but it’s not the most accurate. The cost-plus pricing is more reliable as it takes profit margin for each product into account. The equation is as follows:

 

  1. Cost price = cost of materials, trims, labour and shipping costs including import tax and duties where applicable
  2. Overheads, admin expenses and design expenses = the cost of these expenses divided by the number of items produced in this style
  3. Profit margin = your profit %
  4. Wholesale price = add up steps 1, 2 and 3 and this is your wholesale price
  5. RRP = multiply your wholesale price by 2 or 3 to get to your retail price

 

 

This method involves calculating a profit margin for each product. The margins are then added to the cost before multiplied by 2 or 3 to get your retail price.

 

Value-based pricing

This method greatly differs from the rest, as the price is set based on the perceived or estimated value of an item. In today’s fashion landscape, consumers may purchase fashion apparel or product based on emotions – rather than an actual need.

 

Generally, in retail, there are 3 tiers of fashionability that we categorise an assortment into:

 

  • Core items
  • Fashion items
  • High-fashion items

 

The margins for each tier can differ as sell-out rates for higher fashion items tend to be lower than core items. By balancing out the margins of the items according to their perceived values, you can ensure profitability is evenly distributed across the assortment.

 

3 Tiers of Fashionability

Core products

  • Core items are products that are considered basics and less seasonal, items such as white t-shirts or plain jeans can be considered core items.
  • The margins for a core item can be the lowest as core items tend to sell better and have a lower production cost due to higher order quantity.
  • From the perspective of a customer, core items are also the most basic level in style, therefore the selling price should be reflective of this.

 

Fashion products

  • Fashion products would be your mid-tier products, items that are more trendy than basics but are not the most elaborate items in your assortment.
  • Fashion items can have moderate margins as they will most likely have fewer sales compared to core items and have a higher production cost.
  • These items will have a higher perceived value, as customers can justify paying higher prices for a more trendy design.

High-fashion products

  • High-fashion items are the most elaborate items, with intricate designs and details, in your assortment based on design.
  • These items have the highest margins as they have a lower sell-out and high production cost.
    • There are cases where margins have to be sacrificed due to high production cost and low order quantity.
  • Still, it is important to still stock this category as it elevates brand perceived value and drives brand PR.

 

Fashion brands typically deploy a combination of the cost-plus method and value-based method.

How to build a price architecture

 

The first step is to identify the price range for each tier of fashionability. Note the fashionability of your assortment should also be reflective of the focus of your brand.

 

In the case of Zara, the main focus of their brand is to have a larger mix of core and fashion – with little high fashion to maintain affordability.

 

 

Core Tops (Under $25)

 

Fashion Tops (Under $75)

 

High Fashion Tops (Under $125)

 

As the table shows, these are the findings you can conclude:

  • Zara’s assortment is more concentrated in $25-$50 range – which are the fashion items.
    • The designs feature more intricate patterns and trendy designs.
  • The second highest category is the under $25 range which houses core items such as plain t-shirts.
  • The items within the  $75-$125 range are considered high fashion items and are the least in terms of volume.

Entry price

The entry price for Zara’s core items, such a plain white t-shirt, begins at $5. Although the profit margin for this t-shirt is considerably low, the high volume in sell-out will make up for the lack of margins.

 

Psychologically, $5 is perceived to be a very accessible price – it’s cheaper than an average cup of coffee. This is a trick retailers use all the time, by setting the entry price of a product to a common price for a regular everyday item – it further justifies the affordability of the price.

 

Get an idea of which style is at which price

Similarly, if you price something that’s way over the market expectation, it’ll drive consumers away. If you price too low, then you miss out on a higher margin. Finding that sweet spot is ideal – and not impossible to achieve.

 

Under the Pricing Analysis module, you’ll be able to see the bestselling price range of your market for each subcategory.

 

Try it out!

  1. Go to Omnilytics Pricing Analysis module.
  2. Select a market and retailers/brands of your choice.
  3. To find out the price spread for each category or the median price, scroll down to price summary.
  4. To view how many SKUs under each price range, scroll down to price breakdown by category and select your desired value interval.
  5. Click on any range to view the products and analyse the products under each price range.
  6. This should give you an idea of how a retailer/brand structures their pricing architecture for their assortment.