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ARE YOU GETTING AN ADEQUATE INITIAL MARKUP?

Many times, when talking with retailers, I find that they are not pricing their new merchandise in a manner that will give them the profit they need to stay in business. Some use the manufacturers recommended retail, thinking that the vendor ‘knows best’. Or, they multiply cost by 2.1 or 2.2, etc. Some tell me they multiply cost times 2, then add $5 or $10. For one retailer who told me this was their method of determining retail, I showed them what Initial Markup they were really getting. The table is below:

Cost
Retail
IMU%
20
50
60.00%
30
70
57.14%
40
90
55.56%
50
110
54.55%
60
130
53.85%
70
150
53.33%
80
170
52.94%
90
190
52.63%
100
210
52.38%

As you can see above, as the cost of the merchandise increases, the Initial Markup % declines.

Why is it important to get a good Initial Markup?
A good Initial Markup is important because it is what gives you, the retailer, the profit you need to survive. As the cost of doing business continues to increase, the Initial Markup must increase. When I began my career in retail, rent was commonly 3-4% of sales. Now I regularly see rent expense at 7-10% of sales. And, we all know how medical insurance for employees has sky-rocketed! Add to that the usual markdowns that are a part of retail and also shrinkage, and you must keep increasing your Initial Markup.

Just what is Initial Markup and how is it calculated?
Initial markup is the difference between the cost of an item or service and the selling price. The store’s cost of doing business is made of two separate components: the cost of goods and the operating expense. Cost of goods is the amount paid for the product, plus any shipping or handling expenses. Operating expense is the store’s overhead—the rent, marketing, office supplies, payroll, etc. As any of the expenses go up, initial markup must follow. No one can remain in business if they continually sell below cost.

The IMU% is calculated as a percentage of retail price. For example, if an item cost $4.50 and was priced to sell at $10.00, the IMU% is 55%, $5.50 / $10.00 = 55%. This 55% must cover the operating costs plus the store’s profit

What can you do to increase Initial Markup?
Pricing merchandise is an art whose goal is not to achieve the highest possible markup but to maximize the store’s gross profit (and bottom line). If the initial markup is too high, sales volume will decline. If the initial markup is too low, the store will not generate enough gross profit to cover its operating expenses.  So what can you do to increase initial markup?

Check out new vendors. If you carry all the same merchandise as your competitors, you must also use comparable prices. If you carry unique, quality merchandise, you can take a higher initial markup on those items, increasing the total IMU% for the store and your bottom line.

Use an Open-to-Buy. 
Proper use of your Open-to-Buy will allow you to take advantage of in-season purchases, very often at an attractive discount to you. This allows a higher initial markup on these items because your cost will be less. It will also help you limit markdowns. While some markdowns are unavoidable, excessive markdowns kill a store’s profits.

Every classification will have a different IMU%. Even within a classification, there will be a variety of markup percentages. 

To see the affect of in-season purchases, look at the table below showing 2 different possibilities in a single classification. Each case represents a $10,000 purchase at retail.  Sales and markdowns are the same. The only difference is that in case B, $5,000 was brought in at an initial markup of 76.0% rather than 60%. Notice the increase in the gross profit % and dollars.

A
Retail
Cost
IMU %
IMU $
 SALES
MD%
MD $
GM $
GM %
10,000
4,000
60.00
6,000
8,500
12.00
1020
4500
52.94
B
Retail
Cost
IMU %
IMU $
 SALES
MD%
MD $
GM $
GM %
5,000
2,000
60.00
3,000
4,250
12.00
510
2250
52.94
5,000
1,200
76.00
3,800
4,250
12.00
510
3050
71.76
TOTAL
10,000
3,200
68.00
6,800
8,500
12.00
1020
5300
62.35

Be warned. Simply marking up inventory for the sake of higher initial markup may lead to higher markdowns. These higher markdowns can consume all your profit. Initial markup, like retailing, is an art requiring careful consideration.

© THE RETAIL MANAGEMENT ADVISORS, INC.