Who is to blame for $550 khakis?

The intertubes are awash in debate over the $550 khakis described in yesterday’s NY Times article. Grace mentions an interesting point -also commonly debated:

The first article gives me pause. Here’s why. In lower cost areas of the country, the realtor commission is 7%. In my high cost area, it runs 4-5%. There is a certain cost floor because it takes time and money to market a house. But it doesn’t scale linearly with price.

Why should retail markups scale linearly? Why can’t the retailer charge $300 (instead of $550) for the pants and make up the difference in volume?

This is a running debate among consumers and manufacturers but manufacturers really shouldn’t be pointing any fingers (nor should consumers because everyone likes signaling) when they stand just as much to gain. Consider: if retail mark ups should not scale linearly, then why should the contractor and manufacturer scale their wholesale pricing linearly? They can make it up on volume too so it is rational to assume they’re avoiding unwanted consequences. Manufacturers have no problem justifying wholesale pricing based on linear scale so the debate could be reduced to one party not having as comprehensive an understanding of the retail cost floor (theft, fixtures and amenities, higher rents etc).

Another issue is merchandising and display. A retailer needs a spectrum of pricing on the floor and product selection is broken down into percentages. x% at the low end, x% at the middle and so on. Available floor space for display is divisible by x dollars per square foot with each price category expected to pull in x dollars for the space it occupies on the floor. Therefore, you will find higher display density of lower priced goods within a range of floor space as compared to higher value items. For example, low cost tee shirts will be folded and stacked in cubbies (there are a lot of those) but tailored blouses (fewer of these) will be hung on racks (comparative space hogs) but each price category pulls their weight for the floor space it is “renting”. Still higher priced items may be an island all to themselves. Higher value items also cost more to sell because of security (anti-theft tags, security cameras etc).

There’s the matter of enforcing price points too. I don’t think it is fair for retail to be considered the responsible party for keeping prices at a certain level because the manufacturer takes anticipated retail mark ups into consideration when they price their items. And how. They know exactly who they want to hang with so they must be comparable to those brands in quality and pricing (the value equation). Assuming retailers could painlessly slash 50% of their costs across the board, pricing wouldn’t change until the gamut of pricing related behaviors of manufacturers (and consumers) changed too. Which is not to say a segment of the market hasn’t but it’s not a market everyone wants. Particularly not this maker of $550 chinos. And then, we couldn’t feel as smug about not needing to signal $550 pants if they weren’t so costly. :)

Manufacturers are also accountable in ways retail is not because manufacturers can legally refuse to sell to retailers (pdf) who will not enforce the suggested retail price. This is a common strategy used by manufacturers to maintain the perceived value of their brand. It may seem counterproductive but on the other hand, many retailers will not buy from a manufacturer if they don’t enforce price points. More so these days than ever before. Retailers are wary of people who will come into the store to try on products (items become shopworn, a loss to the store) but who will then buy the item on the internet at a lower price. If price points are enforced, then free-riding is reduced; they may as well buy it at the store. This is just one reason that internet retailers have problems picking up lines. Manufacturers are wary that internet retailers won’t enforce price points and end up cannibalizing their brick and mortar stores who will then stop buying from them. One hand washes the other; it’s the anti-trust paradox. It is all so very complex.

Thoughts? Opinions? Why shouldn’t retail prices scale linearly? Perhaps a better observation is why aren’t realtor commissions scaling commensurate to other parts of the country? I’ll pass on what I think those reasons are -having flogged this for all it’s worth- but don’t let that stop you.

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  1. Emily says:

    Interesting – hadn’t looked at the article that way. I live in DC – realtor commissions here are 3-4% tops and probably due to the large population of over-eager new lawyers, many clients demand 1% of that back at settlement. I work in condo development and the sales companies we use get a flat 1-2% of the total sales netted – the idea being that since they have exclusivity with a building, they have $50-200Million in potential sales (depending on the size and relative “luxury” of the building). If a company can sell a few of those buildings…that’s very lucrative even at a lower commission rate.

    Anyway, if the real question is why is everyone marking up at a fixed rate? and I guess my question is, is everyone marking up at a fixed rate? I’m not trying to be smart here, I honestly want to know. Doesn’t wal mart take a hit on margins to sell better in volume? Including apparel? And I thought they also forced manufacturers to do the same to lower the whole sale prices too? or did I miss the point?

  2. A psychologists answer: There are costumers who only buy items that are expensive enough to be sure, that not everyone else can afford it. And this can be assured best by not linear prices. (Because if the difference is only 10 whatevercurrency you can not be sure, that someone who is not es “good/ rich/ exclusive” as you are will be able to afford it. But if the gap is 100/200/300 dollar/euros you can be sure that “ordinary” people will not be able to make it.)

    And if I was the producer… I also would prefer to make only 50 items and sell them at a super high price than to have to make 10000 items (way more work) to earn the same money.

    So no one is to blame, they just serve the requirements of their customers.

  3. Rocio says:

    The laws of demand and supply are the foundation of any market economy…

    My goal would be to offer a 3.0 mark up to a US retailer for a new line, so as demand increases consecutive seasons can be adjusted accordingly to something closer to 2.3

    Just my opinion :-)

  4. Emily says:

    Yes, the bottom line is that the best price is whatever the market is willing to bear. But up to that point? Not all apparel is made equal and so the article seem to be highlighting the fact that in this case, the cost is higher because a. he produces small runs with high cost goods, b. he produces in the US where there are unions and workers rights and minimum wages and c. he produces garments by hand. After that, what is the formula for figuring out the mark up on the manufacturer’s or designer’s or retailer’s side? Cost + Overhead + Profit?

  5. Sorry to go off topic but these made me giggle:

    “Another man basted panels of suit fabric to springy canvas, which makes the garment more flexible.”

    “The fabric, which costs $24 a yard, plus $3 a yard to import, is a cotton gabardine fine enough to withstand basting stitches.”

  6. Vesta says:

    I think one reason that realtors can afford NOT to scale linearly is that they’re not actually purchasing the house before they sell it. There’s no real inventory risk, or capital tied up waiting for a sale. Relative to retailers, realtors are risking very little of their own cash, proportionally. Time, yes. But cash, no.

    With a retailer (or wholesaler, for that matter), generally they’re paying more for inventory that sells at a higher price point. Those t-shirts didn’t cost them much compared to the blouses. And to stay in business, we all need a certain return on our investment. Or else, you should just take that $1000, or whatever, and buy bonds, right?

  7. Eric H says:

    It’s a function of both the production cost and the demand. In a very apposite analogy for this forum, economist Alfred Marshall famously wrote, “We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by [the consumer’s perceived] utility or [the producer’s] cost.” The demand, the consumer’s willingness to pay, “what the market will bear” are all different ways of saying the same thing, and have just as much to do with the selling price as the production costs, with one setting the upper bound and the other setting the lower bound. The same thing occurs with hotel rooms in seasonal tourist spots, whose production cost is pretty much year round, but the price varies seasonally because the demand does.

    I always wonder in these cases: if retailing is so lucrative, how come more manufacturers don’t move into it? I suspect that they find the grass isn’t as green. How many pairs of equally expensive pants are those retailers sitting on month after month? Their losses also scale linearly with their target market.

  8. I’m sure supply & demand has something to do with it, but also fixed costs of the retailer must weigh in. The boutiques that carry my things in the midwest are marking up anywhere from 2.0 to 2.4, while the boutiques in the northeast are higher on average. The highest I’m aware of is 3.22. I’m certain the cost of real estate is much higher in the northeast and have wondered if this can explain at least part of the discrepancy.

    This wide discrepancy has prevented me from pursuing online sales via my own website. Regardless of the markup I choose for myself, I will certainly be underpricing some accounts while at the same time appear to be gauging my prices in the eyes of customers who’ve purchased my products from boutiques with lower markups… Frustrating.

  9. Barb Taylorr says:

    Timo – Thanks, I’m glad to know I wasn’t the only one thinking …”huh”? I would love to have seen the craftsmen in that shop reacting to that article.

    Emily – In order to win a bid for Walmart manufacturers do have to sell at a much lower margin. However the volumns are so huge that it can still be lucrative for the manufacturer if they want to sell to that customer base.

  10. LizPf says:

    And, as Eric alludes to, there is a cachet in paying *a lot* for an item most people don’t pay much for.

    In the WOAT (words on a t-shirt) world, there’s one fellow that sells a shirt with the words “I paid $100 for this t-shirt”. The shirt body is the same Gildan product we all use, costing about $10 (this is the cost to the WOAT designer, and includes the print-on-demand printing billing, shipping, marketing, etc.). He actually does sell the shirts, at $100 a pop.

    When I hear of $550 chinos, I do think some of the same attitude is at work. Yup, they’re probably better than usual pants, but a lot of the price is brag factor.

  11. Doris W. in TN says:

    The true market value of any item is what someone else is willing to pay.
    Customers are the #1 key to success of any business.
    Someone is paying $550 for the chinos, or they’d end up on on a sale rack.

  12. Sandra B says:

    Timo, those sentences raised my eyebrows, too. I quite like the idea of springy jackets. I’d wear one on days I feel a bit down, to counteract the contradictory gaberdine. We should be thankful for media spin, it makes us all seem so much cleverer. ie Sewing springy jackets is beyond ordinary people – you have to catch the darn things first, I guess.

  13. cdb says:

    A whole other issue that isn’t addressed in the article are charge backs – money charged by retailer to manufacturer for all sorts of reasons (some legitimate, and some just plain iffy…). As well as the 90 to 120 days (generally) that the manufacture has to carry retailer until they get paid. So while retailer does have their additional expenses, they are also often getting paid at both ends of the transaction while the maker is getting it taken off top if not accounted for either in their mark up or otherwise. All this I think, would be more expensive for the smaller/ independent maker, than for the mass maker.

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