How distribution affects your margin: direct e-commerce or a network of shops?

A business owner's question

This video answers a question from Davide, a business owner who bought the Luxury Masterclass, the training programme of more than 20 lessons for taking your company into the high end of the market. Our students have a Facebook group where they can interact with me and the team, and monthly Q&A webinars. His question is complex and deserves a closer look that will be useful to the whole group.

Davide sells quality Made in Italy clothing under a brand he created and registered ten years ago, distributed worldwide through e-commerce, with Italy as the main market. In past years, driven by the anxiety to sell and to make themselves known, they set their prices too low. For two years they have been bringing the price list up to a more suitable level, but still well below products in the same band sold in shops. They are raising prices both to make the numbers add up and because a price that is too low disqualifies the product. If one day they distributed through a network of shops, the mark-up would have to be bigger. The question: is it right to charge the online customer the price the product would have in a shop? Is a garment that would cost €350 in a shop, sold direct at €200, a further disqualification? Shouldn't the price list be brought up gradually to its final level?

Let's take for granted what we learnt in the Masterclass: to sell at a high price you have to develop a brand and marketing tied to the product's storytelling. Product and marketing play the same game: content marketing, with video, photos, text and audio, reaches users in the target, then comes the advertising campaign, then delivery of the product. Between advertising and delivery sits distribution, underestimated in business literature today, but it is the element that decides the fate of the company's margins.

How to work out the price of a high-end product

There are two elements to consider, one external and one internal. The external element is the market and the competition: what the mass market sells at, what the premium market sells at, what the luxury market sells at. Based on the brand you have created, the marketing and the product, you understand where you want to position yourself and where the market allows you to, obviously not in the mass market but in premium or luxury. The estimate is that there is about a 40% difference in list price between mass market and premium: if you have done everything properly, you can afford to sell at 40% more than a mass-market product.

The internal element is the multiplier: what the finished product costs me, whether it comes from an outside supplier or from in-house production makes no difference, multiplied to cover all the fixed and variable costs and leave me my profit at the end. Once I have chosen the multiplier, which for a premium band can be 4, 5 or 6, I find the price of the product.

Then, as a business owner, I do a comparative analysis. If the external analysis says the mass-market product is at 100, the premium competitors at 140 and luxury at 320–350, and I want to slot into premium at 140, the internal exercise should give me roughly the same figure, 150 or 160. I average the two pieces of information and decide the price taking into account both my margin and what the market allows me. Once the price is set, I have to distribute the product, and this is where the specific point of the question comes in.

How distribution affects the margin

A clear example. I buy an accessory from one of our contract manufacturers, to our design, and I multiply it by six, a 600% mark-up on the product bought from a third party, regardless of who makes it: I buy at 100 and go to the public at €600 plus VAT. That is the selling price.

If I sell direct through e-commerce, and a garment or an accessory lends itself to this because it doesn't need consultative selling but a basket sale, with a product already configured that isn't modified or made to measure, I have a margin after distribution of 83%. The cost of distribution is practically zero, apart from the few euros for running the e-commerce site, marketing and advertising, because distribution goes direct from producer to consumer. And I have no collection risk, because the customer pays by credit card.

If instead I distribute through other business owners' shops, not my own, I have to give distribution a margin: in our sector it is 50%. Then there are costs that e-commerce doesn't have, the sales force: a salesperson or an agent and a sales management. Let's assume the two people cost 15% of sales, that is another €45 to take off on top of the €300 already left to distribution out of the €600 list price. Instead of €600 I take €255. The margin falls to 42%, which is still a decent margin to run a business on, but it is nothing like the e-commerce one, because on that 42% you have to load all the fixed and variable costs of the organisation, and from there you get the final EBITDA. Obviously, starting from 83% the EBITDA will be much higher than starting from 42%.

The answers to the question

On price: try not to sell too far below products in the same band sold offline, otherwise you disqualify the product and sell only because you have a low price, the exact opposite of what I teach in the Masterclass. You have to improve the brand, the marketing and the product, and from there raise the price, because the perception of the brand will be higher.

On the network of shops: you tell me that once the price is raised, going into shops is inevitable. My question is: why? Because you want to earn a smaller margin? If I develop an excellent e-commerce site that works, I prefer margin to revenue. In shops the product is more widely distributed but suffers on margin, and today, as taught in the course, we are in a historical phase in which margin matters far more than revenue. Coming from e-commerce, not from a background in distribution, ask yourself whether it is really worth going into shops or staying focused on e-commerce while raising prices and image.

On price across channels: the list price of the product sold in shops and on e-commerce must be identical. If I buy an Apple computer on the Apple website, in an Apple Store or from MediaWorld, the list price is exactly the same regardless of the distribution network; the company's margin will differ depending on the channel, but the price is the same. You have to work out a price that supports distribution in shops, if you want to do it, and that lets you earn a bigger margin through e-commerce. So you raise the price list gradually, while raising the quality of the marketing and the perception of the brand so as not to lose sales, until you reach the same price list for indirect distribution and direct e-commerce.

On discounts: never talk about discounts. We don't run any promotions and we have the same prices everywhere, but if you want to give an advantage to people who buy on e-commerce, use promo codes. Velasca, the guys in Milan who sell men's shoes online, have a code on their home page such as WINTER21 that gives 20% off: the list price stays the shop price, €350, and with the code you pay €280. Of course your margin suffers: it can be your decision at the start, for a launch, and then you bring the code down from 20 to 15, from 15 to 10, until you gradually remove it. The content is in the book and the course, and see you at the February webinar.