Claire Fitts from Butterfly Bakery of Vermont
Pricing a product is a necessary task that many specialty food producers would like to avoid. Choosing a proper price for your product can feel somewhat nebulous, but there are some hard numbers that can guide your pricing decisions. When pricing your specialty food product you'll need to take into account the following:
- Direct costs
- Guaranteed Sales
- Overhead costs
- Profit needs
- Price of similar specialty food products currently available on store shelves.
Direct costs are tied directly to the production of your product. They include the cost of ingredients, packaging and labels, the amount you may need to pay in wages for someone to make your product, and any other cost that ties directly to the making of one batch of your specialty food product.
One thing that some specialty food producers will need to take into account is guaranteed sales. Many stores will require small food producers to buy back any product that doesn't sell. This often doesn't come into play with products that are in jars or other items with long shelf lives, but is seen regularly in short shelf life products like refrigerated items or baked goods. If your product has a shelf life of less than one year, allow 5%-10% for credits back to the store and roll that number into your direct costs. The longer the shelf life is, the smaller that percentage will generally be.
Your overhead costs are the costs that aren't tied directly to producing your product. These might include your rent, insurance, utilities, loan repayment, internet connection, phone bill, advertising expenses, wages, and employee benefits.
Use your direct cost calculation to figure out exactly what it costs you to produce a single sales unit of a product (e.g. one jar, one bag, or one cookie). Add to that your intended profit. Some business owners choose to add a specific dollar amount, some choose to work with percentages (e.g., 50%, 100% or 200% above the cost of production is not unusual). Before you settle on this number, figure out how many items you can make in a day, a week, or a month. Will the designated amount of profit pay all of your bills and your salary? Also calculate how many items you will need to sell to break even (that is, be able to pay all your direct and overhead costs). Can you make that number of products? Can you sell that number?
The next step in calculating the price of your product is to evaluate how the product will be distributed. Even if you have decided to do all the distribution yourself, you should make sure to pay yourself for the gas, the time, and the wear and tear on your vehicle. The easiest way to do this is to assume that in the future you will be selling your products through a distributor and price their margin into your product. The most common specialty food distributor margin is 25% and is a good place to start. This means that the distributor will charge you 25% of the price that they are charging to the stores (not 25% of the price that you are charging them). To calculate what price a distributor will charge a store for your product, you want to divide your selling price (derived above) by 0.75*. This calculation gives you the product wholesale price.
Other Costs¯ to consider
As your company grows, you may want to consider doing things like putting your product on sale, giving discounts to large retailers or hiring a broker. It is a good idea to account for these things now. What will your sales price be? How low are you willing to go to get your product into a large store? Brokers usually charge 5% of the selling price (wholesale or distributor). Even if you aren't hiring a broker from the start, allow for one in the price of your product at the beginning, so you don't have to raise your prices later.
As a next step it is a good idea to figure out what price a store will charge their customers for your product. Most co-ops and independent grocery stores in Vermont take a 30% or 33% margin. Many specialty food stores, or grocery store bulk departments will charge 40% or even 50%. Keep in mind what type of store you will most commonly be selling your product to when calculating your price. If you decide to sell mostly to co-ops and independent grocery stores you will want to divide the wholesale price (derived above) by 0.7*. This gives you the manufacturer's suggested retail price (MSRP). (However, keep in mind that not all stores will decide to sell your product at that price.)
Is the price you have come up with reasonable? How does it compare to similar products already on store shelves? If your price is coming in too high, you might want to adjust your expected profit per item, or look at how you are sourcing your ingredients. In making these adjustments, however, it is critical that you never charge less than what is needed to make your business viable. Many new business owners simply want to match competitor's prices, but undervalue their own products and price themselves right out of business. Specialty food customers are often willing to pay higher prices for products with higher perceived value. However, if you can't make a price work for your product, you may want to change your ingredient sources or even consider making and selling a different product.
Margin vs Mark-up
In the food pricing biz you're likely to hear both margin¯ andmark-up and itis important to remember that they are two different things. Margin is the percentage of the total price that belongs to a certain entity (e.g. a store buys a product from a wholesaler for $1.00 and sells it for $1.50 would have a 33% margin 33% of $1.50 is $1.00). A mark-up is the percentage of the base price that is added to the base price to equal the sales price (e.g. a store buys a product from a wholesaler for $1 and sells it for $1.50 would have a 50% mark-up 50% of $1 is $1.50). There are many margin/mark-up calculators available online, if you need help with the calculations.
Sonya has decided to sell Grandma's Favorite Chocolate Chip Cookie¯ that costs her $0.44 cents in ingredients, packaging, labor and credits for unsold cookies. She calculated that $0.51 is a reasonable profit; given production time, rent, utilities, possible sale discounts, future broker cost, and the number she can expect to make in a day. So she add the two numbers together to get the price she will charge the distributor.
$0.51 + $0.44 = $0.95 Distributor price
The distributor will charge 25%, which means that she should divide the distributor price by 75%* to get the wholesale price:
$0.95 / 0.75 = $1.27 Wholesale price
She's mostly going to sell to co-ops and grocery stores, so she estimates a 30% margin and divides the wholesale price by 70%* to get the estimated retail price:
$1.27 / 0.7 = $1.81 Estimated retail price
Most stores like to sell products that end in a 9, so Sonja will set an MSRP that Grandma's Favorite Chocolate Chip Cookie's¯ at $1.89, which is right in line with the other specialty food cookies available at her local co-op.
Article on margin vs markup from Lisa of Yummy Yammy