Demystifying Profit Margins and Markups

You should also figure out your retailer's gross margin (I'll explain why this is important in the next section). Calculate it the same way, only using the retailer's markup ($5) and price ($8). So: 5 / 8 = .625, or 62.5%. Thus, the retailer's 166% markup resulted in a 62.5% gross margin.

Retailer Markup and Gross Margin

So why is it important to know your retailer's gross margin? Well, retailers often have minimum margin requirements, so this will help determine what price you'll set. Although minimum requirements will vary widely depending on the type of retailer, it's not uncommon for a retailer to expect a minimum gross margin of 50%. This is often referred to as a "keystone" markup.

An easy way to figure out this number is to double your wholesale price. For example, if you sell your product wholesale to the retailer for $5, the retailer will need to charge the consumer $10 to achieve a keystone markup. When you need to work backwards to figure out a price that gives your retailer the desired margin, it's helpful to use the 50% "keystone" expectation as a starting point.

Another good thing to know is that high-end specialty retailers will often require an even higher gross margin. So don't be shy about asking your retailers their margin requirements -- it's how retailers think. Most of the more experienced buyers you'll deal with will offer either a specific number or at least a pretty narrow range.

Now that this is clear, or at least a bit less murky, I'll throw in a new wrinkle -- distributors.

Distributor Gross Margin

Distributors are companies that typically buy products (and store inventory) from manufacturers and sell them to retailers. They're commonly used by larger retailers that handle a large volume of products, such as grocery stores.

Distributor margin requirements vary by product price point, industry, segment, country and size, but they're typically lower than retailers -- 20% to 40% is not uncommon. That's because, as the middleman, there are two markups required -- the distributor's and the retailer's.

For example, the margins and markups for a product sold through a distributor might look something like this (assume a 50% gross margin for the retailer and a 30% gross margin for the distributor):

Gross Margin = GM
$10 retail price -- sold by retailer to consumer (Retailer GM = 50%)
$5 wholesale price -- sold by distributor to retailer (Distributor GM = 30%)
$3.50 distribution price -- sold by you to distributor (Manufacturer GM = 43%)
$2 -- your cost to produce product