Costing and pricing your products correctly can be a minefield for young food and beverage businesses.
No matter how much we wish it was, pricing is a far from exact science. There’s so much more to figuring out how much to charge than the cost of the raw ingredients. But you also need to understand what your customers, and your end consumers, are willing to pay.
And somewhere in all this, you need to make sure you are paying yourself adequately as well. After you’ve signed the deal with a retailer is not the time to find out you’ve forgotten to include a profit margin!
Here are some key issues and questions to consider before you start doing your sums:
- Have you decided who are you going to sell your product to? There’s a difference between customers and consumers, and if you are selling to customers then that must be factored into your pricing as well. (Customers are the people who buy your product to sell to someone else (find out more here). Consumers are the people who will be eating or drinking your product (find out more here).
- Have you considered the different channels of distribution you are considering using? One price for all won’t work – if you plan to use a distributor, for example, then you ensure there is enough margin so everyone can make a profit. If you are selling direct to a retailer, the money you make must cover your time, effort, samples, freight and replacement stock.
- Price is a key signal to your market. Too low a price will signal that your product is lower quality, or that you are desperate for a sale. Analyse your marketplace by visiting supermarkets and other retailers, checking pricelists on the internet, and talking to distributors, and then decide if you want to position your product as a premium, value or discount product and ensure your pricing is consistent with that market.
- Have you discussed your costing and pricing with your accountant? Their job is to help you be profitable and they will be able to help you identify any potential pitfalls in your plans before they become a problem.
- If you are selling products via your own factory outlet or directly via your website, but also have distribution to other retail outlets, does your pricing undercut your retailers? (This is why many factory outlets carry stock that you cannot buy elsewhere. This way there is no direct comparison between your outlet and the other retailers.)
- Not understanding your costing processes and having reliable pricing figures puts your business at risk from:
- under-pricing leading to loss of profit
- overpricing leading to loss of sales
- taking on jobs that are unprofitable or end up actually costing you money
- offering discounts that lead to loss making
- poor cost control, including excessive overheads
- operating below capacity
- unprofitable products being pursued
How to cost and price your product
To work out the actual cost of manufacturing your product you need to break down the cost per unit of raw ingredients and packaging, and add in labour and overheads. Then you can tally the actual cost, add the necessary margins and see how much work you have ahead of you to create a sustainable business.
The costing and pricing process can help you with your business planning and to set yourself realist goals for business growth. It also helps you work out how much you can reduce or manipulate prices to gain a sale without selling at a loss. This information, along with knowing which of your products are the most profitable, will also help you identify opportunities where you can offer a volume discount without adversely affecting your bottom line.
The first thing you need to know is the costs of your raw materials and packaging so that you have an accurate cost per unit of product.
To calculate this, you will need to know what size jar/packet/bottle you plan to use (this is your unit size), how many jars/packs one batch of your product recipe will make (this is your unit total), and the quantity and cost of each raw ingredient you need to make a batch.
Once you have the cost of each ingredient, divide the total amount of each ingredient required per batch by the number of units you can make from one batch to get your cost of ingredient per unit. (You will have to repeat this exercise separately for each pack size if you are selling your product in more than one size.)
Finally, add together the cost per unit for each ingredient to arrive at your total raw ingredient cost.
At this point, it’s a good idea to factor in variables such as seasonal price variations for ingredients, or the cost of having to find a new supplier.
For packaging, you need to calculate the cost per individual pack/jar/bottle plus the cost of labelling and any other direct costs involved in creating your finished product per unit. It’s important also at this point to consider how you plan to account for wastage – are you including or excluding this from your calculations?
Overheads and labour
There are a range of other costs involved in production that must be added to the ingredient and packaging costs per unit, including:
- The hours worked by your production workers for making the product
- Your labour hourly rate
There are a few issues to consider here. You will need to decide whether your hourly rate includes costs such as superannuation, work cover, payroll tax, and employee entitlements, and you will need to calculate the hours of labour required for a day’s, week’s and month’s production to help you understand how many people (or how many late nights for you) will be required to produce enough product to make a profit. The final costs will depend also on whether the owners are involved in the manufacturing process and whether they are paying themselves a market salary, and the methodology used to allocate labour costs amongst the products produced. Your accountant can help with these questions.
Direct overheads include expenses such as depreciation on machines, gas, electricity, freight and so on. Your utilities invoices can help you here, and your accountant can help with questions about depreciation and how to include these in your pricing structure.
Overheads can also include indirect costs include accounting and bank fees, permits, audits and compliance, food testing, insurance, office/production space, telephone, administration and general office expenses. These are necessary to run your business and it is essential to understand how best to manage these in relation to your cost structure and your final pricing.
Your costs to achieve sales are also important, and they include your time, travel, vehicle expenses, accommodation and product samples.
Crunching the numbers
Once you have all these numbers, you can work out what your product really costs to make and you can set your wholesale price. Here’s how:
You now have a raw ingredient and packaging cost per unit. The next step is to work out the overheads and labour component of your product cost.
Do this by estimating the number of units you expect to sell in a given period (say a year). Then estimate the time required to make only one of each product (that’s the time it takes to make a batch divided by the unit total) and record that in hours (eg five minutes is 0.08 of an hour – five divided by 60).
Now take your overhead cost per year (calculated by adding up all the direct and indirect costs for a year) and divide it by the total hours required to make enough of your product to meet your sales target for the year. This figure is your overhead rate and you can add it to all your costings. To find out our overhead cost per unit, take the overhead rate and multiply it by the time taken to produce one unit of product.
Finally, it’s time to add your profit margin. This is the difference between the final actual cost per unit and your selling price. Anything less than 3% is considered to be dangerously low and is unlikely to be sustainable as you will need to allow for varying prices of ingredients, materials and business costs over time. At 3% or less, a slight increase in a raw ingredient could wipe out your profit. Aim for over 10% to sustain a healthy margin. This is your recommended wholesale price.
However, if you plan to sell through retailers or distributors, your final recommended wholesale price will also have to allow for their profit margins as well as your own, so be aware of this to avoid undercutting yourself later.
Consult the market
But that’s not quite the end of the work you need to do.
With your wholesale price in mind (and allowing for a further margin for retailers if you plan to sell through supermarkets or other outlets) you now need to check out the competition, to ensure you haven’t over or under-priced your products for your chosen consumer market.
If your figures are way over or way under the retail price of comparable products, there could be something wrong with your sums. If your wholesale cost is more than comparable products on the shelf, your product will be harder to sell because the end retail price will be higher than your competitors, and that means retailers may be hesitant to stock your product because they may think consumers will not spend that extra money to buy your product.
It’s important to be realistic about this. Ask yourself if it makes sense for your product to be more expensive than your competitors’ products. Perhaps your product is an indulgence rather than an everyday food or beverage, and can command a higher price because of this for example. If not, consider how you can make savings in your production process, or how you may change your marketing mix (see our guide on Marketing Plans for more).
Links and advice
These resources may also be useful:
Food South Australia members can access expert advice and referrals to help you cost and price your products properly. Contact us at firstname.lastname@example.org for more information.
Not a member of Food South Australia? Contact our Memberships Manager at email@example.com.