Given the proliferation of recession sales lately, I’ve been wondering about its effects on retailers, specifically women’s apparel. I recently purchased a linen dress from Banana Republic. It’s MSRP (manufacturer suggested retail price) is $98, but after several discounts, I purchased the dress for $20. So, how much of a markup did Banana Republic still receive? Did the retailer still make a profit off that dress?

According to my research, the clearest and most straightforward explanation on profit margins / markups in the fashion industry came from the Toronto Fashion Incubator website.

What are the profit margins in the fashion industry? What is the mark up for retail?

Susan Langdon (executive director of Toronto Fashion Incubator) says:

The basic costing formula for ready-to-wear apparel is this:

a) total of all raw materials (fabric, notions, cutting, sewing cost i.e.labour, label, ) x 2 = wholesale price

b) wholesale price x 2 = suggested retail price**

**You always need to provide the suggested retail price because this gives all of your retailers the same opportunity to sell the goods at the same price. It puts all of your customers on a fair playing field so that no one undercuts another.

The above basic formula is called “keystone” pricing and it’s suitable for selling in domestic markets. It builds in a basic profit margin of 100% from raw material cost to wholesale and again from wholesale to retail.

If you find that the suggested retail is higher than you would like it to be, you’ll have to reduce your raw material costs somehow by finding less expensive fabric or streamlining your production methods.

If you wish, you can also choose to increase the profit margin to be more than 100% between raw material cost to wholesale (not between wholesale to retail) so that it covers additional expenses like retailer discounts, sales rep commissions etc., but be careful not to price yourself out of the market. Look at where your competition is priced (both the high and low ranges) and try to remain around that.

Taking my $98 MSRP dress as an example:

The wholesale price will be 50%, or rounded to $50. To get down to the raw materials price, will be 50% of $50, or $25. Following the “keystone” pricing model discussed above, the price of the dress should be $25. But, since Banana Republic is part of the largest U.S. specialty apparel company by revenue (the Gap, Inc.) and have most of its clothing made overseas, I would assume the comapny was able to purchase the dress for much less than $25. This is because of (a) the volume discounting the Gap receives from manufacturers and (b) cheaper cost of labor and raw materials (although there will additional shipping costs).

As of the quarter ended in March 2009, Gap Inc’s shows a gross profit margin ( gross profit divided by total revenue) of almost 40%. Assuming a 40% profit margin and $20 sales price, Banana Republic made less than $8 in profit. That means the the cost of the dress to Banana Republic is around $12. (Banana Republic probably made less than 40% profit on this sale. This is because on full-priced sales, the company must be making much more than a 40% profit margin. Discounts are a way of life for mid-tier retailers, and would’ve been taken into account in company’s strategy and forecasting).

The cost of labor and raw materials of the dress is one factor, but taking into account the rent for stores, employee costs, advertising to broadcast sales, general and administrative costs, etc. etc., and the cost of that dress may have very well been close to $20.

So, did Banana Republic make money off the $20 dress?

I don’t know. Working on limited information and broad generalizations, I can only offer a vague answer: I think if Banana Republic did make a profit off the $20 dress, it must’ve not made a healthy profit margin. Sales with 80% discounts will work short-term to move excess inventory, but such drastic discounting is not sustainable nor viable as as long-term strategy.

Fortunately for Banana Republic, most consumers have purchased the dress at higher prices ($98 MSRP, $75 first discount, $50 second discount, $35 third discount), which means higher profits for the retailer. I picked up my dress during the final sale.

I love shoes and clothes, but the intersection of fashion and finance is almost more fascinating! If any readers work in the industry, please share your insights in the comments!