February 6, 2017

Understanding Channel Margins (PODCAST)

channels selling foodThis is a short Q&A style podcast based on a listener’s question about channel margins and how those should be taken into account when it comes to setting a pricing strategy.

TRANSCRIPT:

We have a Q&A podcast today which we do from time to time when I get a question from a reader or listener that I think may be something that a lot of food entrepreneurs are curious about.

Hi!, the email reads. First of all, thank you very much for Food Product Cost & Pricing Spreadsheet tool! I’ve been using it a lot and it’s been very helpful for me in tracking my costs. It’s very detailed and easy to use. I have one question though, in the spreadsheet you talk about Channel Margin percentages. Can you explain what those are in more laymen terms and what numbers I should be using when calculating those? I was shocked that without editing, the suggested retail price ballooned and I want to know the reasoning behind it. Thank you!

 

Here was my response:

 

Thanks so much for your question. First of all, channels, as you may already know, refers to the different type of way you can sell your products to consumers. So, in the food industry, our typical channels are selling direct to consumer, direct to store – which is often referred to as DSD for direct store delivery, through brokers, through distributors, and, last but not least, via private label where you create the product for another company and they put their label on it and are responsible for the marketing of that product.

Before we talk about these though let’s talk about the idea of profit. Remember that for food businesses, our product costs typically take into account our ingredients, packaging, and the labor associated with the creation of our product. You know, as a business owner, that there are more expenses than those associated with the running of your business.   Ultimately, you want to have as high a margin as possible for all the channels you sell through so that the money you make between the difference in your product cost and the price you sell the product for, can be used to pay those other expenses such as marketing, sales generation, and perhaps even a salary for you!

Keeping that in mind, let’s look at the different channels. Selling direct to consumer; be it through your online store, at a farmer’s market, festivals, pop-up stores, your own retail storefront, your food truck, etc, is any time there are no middlemen between you and your customer. Without any middlemen, everything between your product costs and the price you charge is profit for you. Ideally you have enough buffer in here to cover those additional expenses of running your business.   I can’t tell you exactly what the margin percentage should be because it’s dependent on your business, your expenses, and your growth strategy. For example, I could say that 55% is a nice healthy margin on the whole but in the food industry you’re going to find that certain types of products are going to require a higher margin to run a profitable business while others are going to be able to get away with a  lower margin.  If, let’s say, you’re running a cottage food business and don’t plan on making any changes to that in the future then you likely have lower overhead associated with your business than someone who is working out of a commercial kitchen and has a monthly rent.

Going forward, as we start to talk about selling wholesale and working with distributors, you’ll find that many of them have particular margins that they’re shooting for and those may be different depending on what type of store you’re talking to (an independent specialty store is typically looking for a higher margin than a big box retailer like Costco for example) and even different product categories are going to have different margins associated with them.  For example, if you’re product requires that the store and/or distributor store it in the refrigerated section then they may be looking for a higher margin to help them offset some of this additional cost versus a product that is shelf-stable without any temperature control issues.

So, with that in mind, the next channel to look at is wholesale via Direct Store Delivery.   These stores need to make a profit but they aren’t going to take the price you charge consumers and just add cost on top of that.  They want to buy the product at a price that enables them to mark the product up to a cost similar to what you currently charge and/or similar to what competitors charge.  This is where I see a lot of food entrepreneurs get into trouble because when they initially figure out their pricing they are thinking about only selling to consumers and they don’t take into account that when/if they start selling wholesale they need to have a separate price point in here for those store buyers that is lower than your regular retail price that consumer pay.

As the entrepreneur who wrote the email mentioned, things get expensive quickly because you as the business owner still need to have your business costs covered so you want to make sure that you’re still keeping a healthy margin even when selling to stores.  So in this case, you may find that you need to 50% wholesale margin for your business to be able to comfortably meet it’s financial obligations. That would be the price retailers pay and then they will add another, on average, 40-50% margin on top of that though, again, this varies by store and by type of product.

If your goal is that selling wholesale will become a large percentage of your sales reveue, and you are selling direct to customers simultaneously, to be fair to your retail relationships you really should price your products in line with the MSRP that you tell store buyers…this being the wholesale price + retail percentage. If you charge significantly lower than what your ecommend to buyers, you risk losing those relationships you’ve worked so hard to build.

As I mentioned, this is an area I see food entreprenuers get into trouble a lot. They start selling direct to consumers but don’t take into account that one day their business may grow enough that they can start selling wholsale. When that time comes though, they realize that they don’t have enough room in their pricing stategy to be able to give retail buyers a wholesale price and MSRP that is attractive to them while still staying profitable.

If you add a distributor or broker into the mix that’s yet one more person or company in the middle and while what channel partners do is critical for many food businesses, it’s an additional player within your margins, meaing, they also want to get their slice of the pie and that’s coming out of your profits.

This is why spending the time to analyze your product pricing strategy is so important.  You don’t want to just price your product based on what you think the market will pay until you know exactly what your costs are and you have given thought to all the various channels, and their associated margins, you may sell the product through both now and in the future.

In the food cost and product pricing spreadsheet that the original email referenced, you can manipulate the margins categories so you can see what happens to your price points if you reduce distributor margins or increase your wholesale margins.  Those margins that come with the spreadsheet are not set in stone so I encourage you to do your own research specific to your product category and desired channels to determine what makes the most sense for your business.  And, lastly, if you’ve found that after all this playing around with channel margins and pricing that your final prices are too high, go back and look at your original recipe to determine if there are tweaks or adjustments you can make to the ingredients and/or the processes that may help lower your product costs which will, in turn, help lower the price the consumer ultimately pays for your product.

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