Lesson 4: How does a distribution chain impact mark-up?

Wholesale and retail

A hair stylist holding scissors and a comb. Think of a hair stylist who offers premium care services at clients' homes, or a singer who sells their music straight to fans on the internet without going through a record label. These services demonstrate fundamental aspects of direct and indirect value chains in business.

A product’s supply chain demands added value at each step from the initial manufacturer to the retailer. The manufacturer sets a selling price to cover its production costs and produce the desired profits. The wholesaler purchases the product, marks up the goods to cover costs, and makes its own profit. Later, the retailer who purchases from the wholesaler marks up the price again. Thus, the initial selling price set by the manufacturer is raised several times before the retailer sells the product to the customer.

This is how various components of the supply chain determine the price of goods and services.

Optimizing the distribution chain

Athletic shoes displayed on multiple shelves in a store. Entrepreneurs can design their distribution chain around efficiency and sustainability instead of profit.

Consider a product like athletic shoes, manufactured, and then wholesaled and sold through stores. With each stage of distribution, the product increases in price, and the institutions involved put their markup on the product. By moving to a more simplified distribution model, with less intermediaries, companies can reduce the cost of doing business and increase value to the customer.

What is a markup?

A man and a woman are looking at a pair of jeans on a sales rack. Markup is the higher price set on a product line, according to trends in the market, time of year, overall strategy, and profit goals. It’s a price rise at each stage of a distribution chain or channel. Markup is very important for a business. High markups can lead to loss of customers, and low markups will not cover costs. Businesses decide on markups based on multiple factors such as competition, customer demand, economic conditions, and supply availability.

Let’s explore what markup means at various stages of distribution.

Ever wondered how your favorite jeans make it from the factory to your closet? Let’s follow the journey of a pair of jeans through the supply chain and see how pricing changes along the way.

It all begins with the manufacturer. Here, raw materials like cotton, buttons, and thread are transformed into a finished product.

The cost of producing a pair of jeans? Just $12.
The manufacturer sells these jeans in bulk to a wholesaler.

The wholesaler stores them, manages distribution, and adds a markup to cover costs. Now, the jeans are priced at $20.

Finally, the jeans arrive at the retailer. The retailer factors in operating costs, marketing, and profit before setting the final price. You, as the customer, will find these jeans tagged at $40.

Although you would typically buy the jeans from the retailer for $40, is there a way to pay less? Let’s find out!

What if you could buy directly from the manufacturer or wholesaler? You’d pay much less, just $12 or $20 instead of $40!

By eliminating middlemen, you get the same quality jeans at a much lower price.

Understanding the supply chain helps you make smarter buying decisions and save money.

So next time you shop, think about where your product comes from!

Choosing the right distribution channel

Finding the right distribution channel affects the value delivered to customers. It applies to physical products, services, and intellectual property.

Key Thought
A well-chosen channel can reduce costs, speed up delivery, and create a better customer experience.

Select each tab to learn more about the importance of distribution channels.

Services

Service providers can optimize the way they distribute. This adds value and allows for premium pricing.

Example: A hair stylist who comes to your home, instead of working in a salon, needs to market to busy customers who prefer convenience.

Allocation of intellectual property

Intellectual property, like music or digital products, can be distributed more efficiently. This reduces costs and allows the artist to focus on creativity while keeping prices lower for customers.

Example: A singer who sells music directly to fans on the internet removes intermediaries.

Cost and time efficiency

The more cost-effective a distribution channel, the lower you can keep the price of a product.
The more time-efficient a channel, the faster the customer will get the product, and the greater their satisfaction.

What can businesses do?

Use the most efficient distribution channel to steer ahead of the competition.
Provide better prices, faster delivery, and more customer satisfaction.

This could differentiate your business from others in the market.

Check your understanding

Why do markups matter?

The term ‘markup’ refers to the increased price of a product based on certain factors. These factors can include industry trends, the time of year, overall strategy, and profit goals. Entrepreneurs must understand markups to run a profitable, sustainable, and competitive business.

Let’s learn more about why an entrepreneur must care about markups and how it impacts business.

Profitability
Goal: To make sure the business is profitable
Example:
If a boutique buys t-shirts at a wholesale price of $8 each and resells them for $8, they do not make a profit. But, if they decide to sell the t-shirts for $20, they will make a $12 profit.
This markup is calculated based on cost. In contrast, businesses can also calculate markup based on the final retail price to plan competitive strategies.
The boutique could also make profits through custom designs to earn more money.
Next: Why does a business need markup to survive?
Sustainability
Goal: To ensure the business can continue and operate for a longer time
Example:
That $12 profit per t-shirt can be spent on marketing, advertising, and customer outreach.
Profits of $100 from custom shirts can be used to purchase new design software or equipment.
Without enough markup on the product or service, there would not be enough margin to pay the bills and grow. This is sustainability.
Next: What about being competitive in the marketplace?
Competitiveness
Goal: To consider both price and non-price competition, including direct and indirect competitors, when setting markups that attract and retain customers and to remain competitive while upholding ethical pricing
Example:
Company A sells t-shirts that cost them $8 at $20, and Company B also purchases their shirts for $8 but sells them for $40. If a customer discovers the discrepancy in cost, they will not purchase from Company B because they seem to be overcharging for the same product. However, if Company B charges $25 or even $15, this can be considered fair competition while still making a profit.

Markups should be similar and fair.
A company can increase or decrease the price a little as long as it is competitive.

Check your understanding

Think about this

Markup isn’t simply setting prices. It’s a strategic decision that can affect how sustainable or competitive a business is. Determining the selling price of a product means evaluating all costs involved—like labor, materials, and overhead—along with market demand and customer expectations. Knowing how markups function and how to use them will dictate the success of your business and its value to customers.

You can use the following questions as a guide:

What strategy will your markup use to keep your business profitable?
How can you manage competitive pricing for long-term sustainability?
What will you take into account in coming up with the proper markup for your products or services?
How will you leverage your markup profits to reinvest in capital growth and innovation?