Set Target Costs
Once you’ve set your target profit margin, the next step is to determine the target cost that ensures you achieve it. This involves a detailed breakdown of your expenses, from sourcing and shipping to final delivery. Here’s a guide to calculating your target cost and ensuring your product pricing aligns with your profitability goals.
1. Start with Your Target Margin
Your target margin should guide your cost calculations. For example, if you aim for a 40% gross margin, your cost (inclusive of all expenses) must be no more than 60% of the final retail price. Use this formula to determine your target cost:
Target Cost = Selling Price × (1 - Target Margin)
For instance, if your selling price is $50 and your target margin is 40%, your target cost must not exceed $30.
2. Break Down Costs
Understanding your total costs involves assessing each component of the product journey, from the supplier to the customer.
> Landed Cost (to Your Warehouse)
Landed cost includes all expenses required to get your product to your warehouse, such as:
Product Cost: Price paid to your supplier.
Freight Costs: Shipping fees for air, sea, or land transport.
Import Duties: Customs fees based on product classification and country of origin.
Insurance and Handling: Additional charges to safeguard and manage the shipment.
> Total Cost (to the Customer)
In addition to the landed cost, consider what it will take to deliver the product to your customer:
Fulfillment Costs: Warehouse storage, order picking, and packaging.
Final Shipping Costs: Costs to transport the product from the warehouse to the customer.
Marketing and Sales Expenses: Fees for promoting and selling the product.
A business owner in the Supply Chain Shark community shared how accounting for both landed and total costs allowed them to avoid underpricing and maintain healthy margins, even after scaling operations.
3. Account for Variable Costs
Costs can vary based on shipment size, delivery methods, and market changes. Be conservative in your estimates to allow room for fluctuations. For example:
Freight costs might increase due to supply chain disruptions.
Fulfillment costs can vary with order volume and product size.
We’ve worked with startups that built buffers into their cost calculations, ensuring profitability despite unexpected expenses.
4. Verify Costs Through Supplier and Service Quotes
Before finalizing your pricing strategy, confirm your cost assumptions with suppliers, freight forwarders, and fulfillment providers. Request detailed quotes that include:
Unit price for products at various order quantities.
Freight costs based on weight, dimensions, and shipping mode.
Customs duties and other import fees.
These verified costs will help you determine whether your target cost is achievable.
5. Iterate If Necessary
If your total costs exceed your target cost, revisit your pricing strategy or negotiate with suppliers and service providers to reduce expenses. For instance:
Negotiate bulk discounts with your supplier.
Explore alternative shipping routes or methods to cut freight costs.
Streamline fulfillment processes to lower overhead.
Several business owners in the Supply Chain Shark community have successfully reworked their cost structures, achieving their target margins through strategic adjustments.
Conclusion
Determining your target cost is crucial to meeting your profit margin goals. By calculating both landed and total costs, accounting for variable expenses, and verifying costs with suppliers, you can create a pricing strategy that ensures profitability. These best practices, drawn from the experiences of business owners we’ve supported in the Supply Chain Shark community, provide a roadmap to help startups succeed in managing costs effectively.
Need some guidance on this topic? Don’t hesitate to send us a question on the “Messages” tab at portal.supplychainshark.com.
