The Life Cycle of Products

NEW YORK (MainStreet) – It may surprise you to know that anything you buy does not begin its life on the store shelf, and it does not end when you bring it home. It travels a long and winding path, and along the way it can go through numerous price changes, all the result of feverish behind-the-scenes negotiations.

The path from the manufacturer to the retail store is fairly straightforward at first glance: The manufacturer makes a given product at a certain cost, and thousands of them are sold wholesale to large retailers at a slightly marked-up price to ensure profit margins. The retailer sells it to consumers at an additional markup to secure its own profit – often at a manufacturer’s suggested retail price.

But this seemingly simple process is fraught with negotiation on numerous points.

Marked Up

First, the actual development of a product is often a collaborative process between retailer and manufacturer. No, Apple isn’t consulting Best Buy when it determines specifications for the new iPhone, but a large clothing retailer may work with manufacturers to determine exactly what sorts of dress shirts it will be getting – and, in the process, minimize how much it will cost to buy those shirts wholesale.

“A retailer will go to a vendor and say, ‘This is what I’m looking for, I want to offer a shirt in this price range,’” says Daniel Butler, vice president of retail operations for the National Retail Federation. “If I want that extra button, it adds a dollar. Pleats, another dollar. The cost of raw materials drives the cost of manufacturing it.”

That manufacturing cost is obviously the biggest factor in determining how much the manufacturer actually charges the retailer for the product – the wholesale price. But it’s not the only factor. Butler, a 26-year veteran of the retail industry who spent years negotiating such deals as a buyer, notes that larger orders will necessarily bring down the per-unit cost, just as buying in bulk at Costco will save you money in the long run. Retailers can also bring down the costs by offering manufacturers prime placement for their products.

“Vendors will negotiate for space and location,” he explains. “Retailers will set a premium for the best location.”

As a result of the myriad factors that must be negotiated during the buying process, it’s hard to put an exact figure on the markup a manufacturer will ultimately charge the retailer at wholesale. Much depends on the proficiency of the negotiators involved. The type of product matters, too.

“Every industry is different,” says Marshal Cohen, chief retail analyst at the NPD Group, a market research firm. “In electronics and footwear, the margins are lower. In apparel, the margins are higher.”


He estimates that those markups tend to run between 25% and 30% for lower-margin products and around 35% to 40% in high-margin industries. In other words, a clothing manufacturer who spends $100 to produce a product can expect to get about $135 per unit wholesale from the retailer. An electronics manufacturer will likely see lower margins, netting more like $125 for a product that costs $100 to make.

Once that shirt or cellphone is in the retailer’s hands, a further markup will take place. Cohen estimates that the ultimate cost to consumers – to start out, anyway – will be a little more than twice what the company paid at wholesale. In other words, if the retailer paid $135 for a dress, the price will run about $280 a pop on the shelves.

“Obviously, consumers get the raw end of the deal because they don’t have the wherewithal to go directly to Coke and say, ‘give me 10 cases of [Coca-Cola],’” says Brian Sozzi, an analyst for market research firm Wall Street Analysts, which covers the retail industry.

That said, it’s important to note that this markup is nowhere near pure profit, as retailers have a multitude of costs to consider. A bricks-and-mortar store must pay rent, and the cost per square foot for an urban retailer will far exceed that of a rural manufacturing plant. Paying an army of retail workers to maintain the store also cuts significantly into profit margins. And various ancillary costs, from debit card swipe fees to the absorbed costs of shoplifting and returns, must also be taken into account. Ultimately the retailer will net around 15% of that 100%-plus markup, says Cohen, who adds that the figure can be as low as 2%-3% for grocery stores.

Marked Down

Of course, the story doesn’t end there.

Sure, a consumer might walk into a store and buy something off the shelves at the original MSRP, and the retailer will realize the full extent of profit that its cost-saving measures allow it to collect. The consumer will go home and enjoy the product for a while, then either give it away, throw it away or sell it on the secondary market.

But not everything sells right off the bat. If a retailer has trouble selling a shipment of dresses, it will eventually be forced to drop the price, either through a permanent price reduction or via a targeted sale or coupon. The relatively healthy margins allow retailers considerable leeway when it comes to making such reductions, though it should also be noted that the retailer likely has an agreement in place whereby the manufacturer agrees to cover some of the cost of marking down an item.

“If the merchant doesn't sell to completion, the vendor will absorb a ‘partnership’ in the product,” Cohen explains. That agreement will be made during the initial buy and can be used as a point of negotiation in the final wholesale cost. In other words, the manufacturer will be able to net more on wholesale by promising to help out the retailer in the event the item sells poorly.

Sometimes lowering the price isn’t a possibility under the initial agreement.

“Every once in a while a vendor is able to drive that MSRP,” Butler says. “They’ll say, ‘If you want to buy this product, you have to sell it at this price.’ Manufacturers want to protect the value of the product.”

One example would be a video game console that’s priced uniformly across all retailers and can’t be discounted by any merchant unless Nintendo or Sony announces a price drop; even if market forces dictate a drop in price, no video game company wants to see its flagship console relegated to bargain bin status while competitors command premium prices. That’s why you’ll sometimes see big retailers try to undercut competition by tossing in freebies while keeping the price steady, as Wal-Mart did this week with the Xbox 360.

Given a Second Chance

Still, even when price drops are an option, they’re not always effective. Some products are simply duds that take up space in the stock room, and when that happens the product will once again be on the move – to outlet stores, for instance, or to discount stores such as TJ Maxx that get some of their stock from other stores’ unsold inventory.

Similarly, websites such as Overstock.com will buy unsold merchandise at a deep discount and try to make whatever profit they can from them.

And there is one final, nuclear option when it comes to unsold inventory: The retailer can sell it back to the vendor. Just as a manufacturer may agree from the outset to help retailers absorb the cost of price cuts in the event of sluggish sales, so too may it agree to buy back unsold merchandise after time at an agreed-upon price. This is a scenario vendors want to avoid at all costs, Cohen says.

“The best option is to absorb some of the [retailer’s] margin erosion,” he says. “The last thing a manufacturer wants is to get the product back.”

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