Price is the most sensitive topic for companies, and it is also the most troublesome. At the same time, price is the most confidential topic; every company regards its pricing system and prices as highly classified. In marketing, price is like the last face-down card in a game of SHOW HAND.
Through years of sales practice, I have discovered an intrinsic connection and pattern among price, pricing methods, channel models, product distribution breadth, and brand. This article will focus on the relationship between channels and retail terminals.
After studying the channel pricing systems of most product categories, I have summarized three pricing methods:
1. Retail Price Deduction Pricing Method
As the name suggests, the deduction pricing method is derived by deducting from the retail price. It involves three key price points: the retail price, the price supplied to retail terminals (or wholesale price), and the price supplied by the manufacturer to distributors (or factory price, ex-factory price).
Cosmetics companies and certain home appliance companies that primarily use department stores as their main retail channels typically adopt the retail price deduction method. Taking cosmetics as an example, for a product with a retail price of 100 yuan, the price supplied to retail terminals is usually around 75 yuan, and the price supplied by the manufacturer to distributors is around 65 yuan. (This pricing system is not fixed; it is influenced by brand strength and distribution breadth.)
In the above assumption:
Factory price discount rate = (100 - 65) ÷ 100 × 100% = 35% Wholesale price discount rate = (100 - 75) ÷ 100 × 100% = 25%
In common sales jargon, we say the wholesale price is at a 75% discount, and the factory price is at a 65% discount.
In the typical retail price deduction method, the retail profit margin of a store is always slightly higher than the wholesale profit margin of a distributor. This actually reflects the different profit models of retailers and distributors. Taking cosmetics as an example, suppose a store carries 10 brands, all with a gross margin of 25%. Then its gross profit equals the total sales of these brands × 25%. Suppose a distributor has 2 brands with a wholesale gross margin of 10% each, and they distribute to 20 stores. Then its gross profit equals the total sales of these 2 brands in 20 stores × 10%.
We know that return on investment (ROI) = inventory turnover × gross margin. Whether for retailers or distributors, their profitability can be understood through this formula. Overall, in a fully market-oriented economy, ROI will not have too significant a difference, because capital will always choose among these investment projects. Even if a temporarily high-profit industry emerges, capital will quickly enter to compete, driving the industry toward the social average ROI (or within a tolerable difference for capital). This is also why we often say the market has entered an era of meager profits.
Since ROI tends to be at the same level overall, inventory turnover and gross margin will have a certain inverse relationship. In other words, it is difficult to increase both your inventory turnover and gross margin simultaneously, because this is the inevitable choice of capital.
In the retail price deduction method, it is not difficult to see that the retail price is assumed to be constant. Similarly, through observation and research on the distribution and branding of these products, we will find that products using this pricing method mostly have fewer distribution points (some are even limited to mid-to-high-end department stores) and mostly emphasize brand image. These factors are mutually reinforcing: emphasizing brand image creates the possibility of premium pricing. With fewer distribution points, there is a need to pursue higher retail and wholesale profit margins (compared with the other two pricing methods, the retail price deduction method has the highest profit margins). As I mentioned earlier, this is the inevitable choice of capital—an invisible hand—capital will achieve a balance of returns among factors such as GDP growth, bank loan interest rates, and inflation coefficients in a free economic environment.
2. Wholesale Price Deduction Pricing Method
The wholesale price deduction method is generally applicable to products sold in hypermarkets and supermarkets.
Suppose a product supplied to a supermarket has a wholesale price of 10 yuan, a retail price of 11.5 yuan, and a factory price of 9 yuan. Then we can say:
Its retail price markup rate = (11.5 - 10) ÷ 10 × 100% = 15%. We say it is a 15-point markup on the wholesale price.
Its factory price discount rate = (10 - 9) ÷ 10 × 100% = 10%. We say it is a 10-point discount on the wholesale price.
Generally, most fast-moving consumer goods (FMCG) supplied to hypermarkets and supermarkets adopt the wholesale price deduction method. It also has three important price points, but unlike the first method, its pricing benchmark is the wholesale price, which is theoretically the price supplied to hypermarkets and supermarkets. However, its retail price markup method differs significantly from the first method. This also reflects the characteristics of the distribution channels for such products. The mainstream channel for FMCG is modern retail channels that use a markup gross margin method, which is different from the deduction method used by traditional department stores.
As we have observed, supermarket products typically have greater price variation across stores than department store products, and their gross margins are usually lower (the wider the distribution, the lower the margin, but supermarket private-label products are usually higher). This on one hand shows that extensive distribution inevitably affects price stability and reduces high gross margins; on the other hand, it shows that supermarket products are more homogeneous than department store products, and that the brand premium capability in the FMCG sector is lower than in high-value-added product areas such as cosmetics and high-end home appliances.
Many products are also supplied to large supermarkets at a few points discount from the wholesale price, which proves two points: first, the profit of any best-selling product tends to approach zero; second, in modern retail channels, retailers' bargaining power is becoming stronger. Undoubtedly, sales volume determines bargaining power. Many manufacturers now divide their sales channels into distributor channels and K/A (Key Account) channels—which are the modern retail channels we often refer to. Moreover, the supply price to modern retail channels is approaching or even falling below the supply price to distributors. Even if on the surface their supply price is still higher than that to distributors, a large amount of off-invoice subsidies has made up for the difference. Taking Procter & Gamble (P&G) as an example, they supply distributors and K/A at the same price. This situation shows that distribution plays a decisive role in the pricing system, and the result of distribution—sales volume—is the most important bargaining chip in price negotiations.
For such products—those distributed in hypermarkets and supermarkets—we can foresee that in the future, as modern retail channels establish their dominant position, the role of distributors will become smaller and smaller, and may even disappear locally. This is because K/A's bargaining power no longer allows a profit extractor—the distributor—to exist between them and the manufacturer. Similarly, for manufacturers, K/A will be their future "distributors"—what we often call direct-supply customers. With intensified competition and increased K/A bargaining power, it is an inevitable trend that the profit margin from the wholesale price deduction in this channel will continue to shrink.
3. Factory Price Markup Gross Margin Pricing Method
This pricing method is common in high-volume distribution products. The so-called high-volume distribution products refer to products with the widest distribution. These products typically cannot rely on manufacturer or distributor personnel to do point-to-point sales and service for every retail terminal; they also need the help of wholesalers for distribution. We sometimes call this natural distribution.
In the above two pricing methods, it is not difficult to see that the wider the distribution, the lower the profit margin. From an ROI perspective, to achieve a relatively stable ROI, a lower profit margin means a higher requirement for inventory turnover. By observing high-volume distribution products, we can see that they have wide distribution, mostly use cash settlement or very short credit terms, and have the shortest turnover time and the highest turnover frequency.
Suppose a product has a factory price of 1 yuan and a wholesale price of 10.1 yuan. Then we say it is marked up by 0.1 yuan. In practice, most high-volume distribution products are measured in cases. Suppose this product is 30 yuan per case, then its wholesale price is 33 yuan, and we say it is marked up by 3 yuan.
In economics, there is a famous market demand curve that shows how the quantity demanded of a good changes with its price. In real-world operations of high-volume distribution products, we often use this curve. The market is usually very sensitive to the price of such products, and they no longer need percentages to estimate this sensitivity; they use yuan or even jiao to calculate.
For such products, the factory price often changes. For example, some beverages have off-season and peak-season prices, which is also a way to use price to increase sales volume. According to the law of demand, a decrease in price usually leads to an increase in quantity demanded.
However, in this pricing method, it is difficult to list an average retail price. In the pricing system, the farther the benchmark line is from the retail price, the wider the distribution, but it also indicates a lower control over retail terminals, and correspondingly, lower control over retail prices. Especially for products sold through wholesale channels, different wholesale levels and different retail terminal formats—they may be distributed to mom-and-pop stores, supermarkets, or convenience stores—result in different prices. This is because each retail format has a markup method that suits its ROI.
What Does the Channel Pricing System Actually Tell Us?
The purpose of studying the channel pricing system is mainly to explore the relationship among product distribution characteristics, distribution quantity, and profit margins at each channel level. This relationship helps us understand and formulate distribution strategies for a product at various stages.
Taking cosmetics as an example, through analysis we can draw the following conclusions. Counter products entering hypermarkets, supermarkets, or even broader distribution areas must sacrifice retail and wholesale gross margins, which is the inevitable result of mutual bargaining among channel levels. Cosmetics that were originally counter products often experience "price chaos" after entering circulation channels, but that is mostly an illusion. The reality is that the forces among channel levels are forcing them to become similar to FMCG products. However, if they do not have the inventory turnover speed (or working capital turnover in trade) of FMCG, the invisible hand will still appropriately raise their gross margins to achieve a normal ROI.
Taking P&G as another example, although it still uses hypermarkets and supermarkets as its main channels, its astonishing sales volume has already given it the characteristics of a high-volume distribution product. In fact, the channel is forcing P&G to adopt a pricing method equivalent to the factory price markup gross margin method. I often hear merchants complain about P&G's low gross margins, saying things like "doing 10 million in business yields only so much profit." But such statements often cannot withstand analysis. After calculation, most P&G customers can achieve an annual inventory turnover of 20 times. That is, as long as they have a gross margin of more than 1% each time, they can maintain an annual ROI of more than 20% in normal trade. In contrast, an ordinary supermarket product has an annual inventory turnover of about 4 times. To achieve the same ROI as dealing in P&G, it would need a profit margin of 5%. This analysis also explains why best-selling products have low gross margins.
The analysis of the channel pricing system also explains why deep distribution often fails. In high-volume distribution products, normal ROI is mostly obtained through inventory turnover rather than high gross margins. Deep distribution significantly increases personnel costs. At this point, if you cannot continue to increase inventory turnover (which is usually difficult), you have to raise gross margins. But raising gross margins causes prices to rise and demand to fall. Therefore, the way a business exists has its own economic rationale; artificially creating it without following the rules is not advisable.
The channel pricing system also shows that brand premium capability can only exist in the high-end market, because price itself has a destructive effect on the brand, and distribution also has a certain negative impact on the brand, as there is a connection between distribution and price. This is especially important for the Chinese market. Coca-Cola's "ubiquitous" presence and its difficulties in deep distribution are undoubtedly affected by price and the associated distribution costs.
The channel pricing system is a rarely studied field. I offer this modest article to discuss with peers and experts, hoping to conduct deeper research and exploration, summarize the mathematical model within the channel pricing system, and quantify the brand premium at each channel level.
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