Initial costs to get started
At the early stage of your business, prioritize cost-saving whenever possible. It will take time to finalize decisions about recipe formulation, packaging, label, and distribution before the business generates income.
“Can I make a profit?” is the leading question for starting a business. Answering it takes a multi-step approach. It includes understanding all the costs that go into making, packaging, storing, shipping, marketing, and selling your product. All these costs will need to be integrated into your retail price. Then you'll need to determine if consumers will pay it.
Estimates to start a food business range widely, depending on the product. The more you simplify and streamline your process and ingredients, expand shelf life, and simplify and lighten packaging, for example recyclable plastic versus glass jars, the fewer changes you’ll need to make over time. Consider working with an accountant or consultant to best understand the cost of production for each unit and pricing strategies. Be sure to set up a separate business bank account to help keep accurate financial records.
Remember that costs will change over time. When you’re just starting out, you will likely pay a premium for the smaller volumes of ingredients and packaging used. As your business grows, you may be able to negotiate lower pricing for larger volumes, though you may need to incorporate distribution and/or broker costs into the unit price.
With growth, you’ll face added costs for marketing, sales staff, and inventory management. Major grocers require marketing or slotting fees, specials, and discounts that add to the costs. And as your business increases, the time lag between when someone places an order and when you get paid will grow. That means more cash on hand to manage operations is needed.
Know your costs
Initially, you’ll want to calculate your start-up costs, including:
- Expenses related to the product launch
- Permits or licenses
- Certification such as ServSafe, food safety testing such as HACCP or scheduled process
- Initial orders of ingredients
- Packaging materials
- Equipment and goods to prepare, package, and store the products
- Website, logo, branding, and labeling materials
- Legal and business support, insurance
You can download a Startup Costs Worksheet from the Small Business Administration. Your costs will likely differ from the example, but it will provide an idea of the expenses to track.
Calculating ongoing costs, both fixed and variable
Fixed costs don’t change whether you produce one jar of jam or 1,000. When they do change, it’s typically in big steps as your business grows. Fixed costs include rent, utilities, insurance, waste disposal, permits, legal, food safety plans and audits, accounting, bookkeeping, and taxes. Advertising and promotion can be fixed costs. Attending a trade show, setting up a website, designing sell sheets and other promotional materials, professional product photos, advertising, or social media costs may be the same, regardless of how many units you make or sell. Fixed costs may be referred to as “overhead.”
Variable costs are expenses directly attributed to the amount of production and may include ingredients, labor for production, portions of overhead related to production, packaging and packing materials, testing, shipping, sales commissions, and broker and distributor fees. Variable costs fluctuate as the number of units produced and sold change. Variable costs are also referred to as “costs of goods sold” or COGS. An accountant, consultant, or business mentor can help calculate costs. Remember to include paying yourself.
What’s your breakeven point and moving to profit?
The breakeven point is the number of units you need to sell to cover all your costs, both fixed and variable. For example, say your company produces 3,000 jars of jam a year, with fixed costs that total $6,000. If your jam sells for $6 a jar with variable costs of $3 per jar, you have a gross margin of $3 per jar. You’ll need to sell 2,000 units to generate $6,000 to cover the fixed costs. Your breakeven point is the two-thousandth jar sold.
After you reach your breakeven point, additional sales yield profit. The margin generated from the next 1,000 jars sold is profit, or net income. So, if you sell all 3,000 jars, you will make $3,000 in profit for the year. Remember, you still must pay the variable costs ($3 per jar) on the last 1,000 units, so the “profit” is the net margin after variable costs have been paid. Consider the amount of time needed to sell 3,000 jars to make a profit and the feasibility of doing so.
Will customers pay your price?
Consumers are often willing to pay a premium for specialty and gourmet products. However, an item’s price needs to reflect what the market will bear. Choosing a price for a product can be challenging. If the price is set too low, you may not cover all your costs. Setting the price too high can deter customers. However, underpricing a product is a common mistake among new food entrepreneurs.
Using what you learned from your customer research will help you judge how much customers will pay for your product. Customer research gives you a clear picture of the income and spending habits of your target consumer. This information will help you predict your potential buyers’ price sensitivity. Combine that knowledge with the retail price of similar products in your target stores to set a selling price.
One way to gauge consumer interest is to test your product at farmers markets. Provide free samples to shoppers in exchange for their feedback, while also selling your product. This experience can help you refine the product, packaging, recipe formula, etc. It’s also a good opportunity to practice your sales pitch.
Cost of Goods and Percent Gross Profit Margin (Table 1) |
|
COGS (cost of goods sold) or variable costs include: |
|
|
|
|
|
Gross sales = Sales-discounts and returns, such as: |
|
|
|
|
Net sales = Gross Sales - variable costs |
|
Gross Margin = Net Sales - variable costs |
|
The gross margin is the percent of the selling price that will cover your fixed costs and profits - (net sales less variable costs). As an example, if you are selling a jar of sauce for $10 with variable costs of $4, then the gross margin would be $6, and the gross profit margin would be 60%. That means, for every unit sold, $6 goes to fixed costs and profit. |
|
Net Margin = Gross Margin - fixed costs including: |
|
|
|
|
|
The net margin is the percent of your selling price that goes to your profits, after covering fixed costs. For example, if you sell the product for $10.00 with variable costs of $4.00 and fixed costs of $3.50 per unit, then the net margin, or profit, is $2.50 per unit, or 25%. Margin is calculated as a percentage of the final selling price. You can adjust your profit margin but be sure your price covers your costs. |
Margin versus markup
Knowing the difference between margin and markup is important. Margin is based on revenue and markup is based on cost. Margins are lower than markups. If the selling price of your product is $10.00 and the total product cost is $7.50, then your margin is 25%, while the markup is 33%.
|
Margin: [(Selling Price - COGS) / Selling Price] x 100 = Margin % [($10.00 - $7.50) / $10.00] x 100 = 25% |
|
Markup: [(Selling Price – COGS) / COGS x 100 = Markup %] [($10.00 - $7.50) / $7.50] = 33% |
It’s important to consider that any discounts or price cuts come out of your margin, not the total product cost. If your sales price is $10.00 with total product cost is $7.50 and a 10% discount, your variable costs won’t change much. It will still cost $7.50 to manufacture that product, but the sales price will drop to $9.00 after the discount. The margin will decrease from $2.50 to $1.50 per unit, or from 25% to 17%.
Here’s another example: if you sell 100 units at $10.00, the net margin would be $250.00. A discount of 10% to a price of $9.00 means an additional 67 units need to be sold to earn the same $250.00. A seemingly small discount can take a big chunk out of your earnings and require more sales to earn the same amount.
As you determine your prices, keep your gross profit margin in mind. Over time, this number will indicate how your business is performing. The gross profit margin shows the income a company has after paying all variable costs related to the manufacturing of a product, often expressed as a percentage.
|
Gross Margin percentage= (Total Sales Revenue - Cost of Goods Sold)/Total Revenue x 100 If you sold 3,000 jars of jam for $6 each, the sales revenue = $18,000. If you spent $12,000 in COGS (variable costs) to produce those 3,000 jars, the gross profit margin would be 33%. |
|
($18,000-$12,000) = $6,000/$18,000 x 100 = 33% Gross Profit Margin Gross margin doesn’t include overhead, or fixed costs. Net margin is determined after overhead costs are subtracted. Note that your overhead or fixed costs, as a percent of costs, will tend to decline with increasing sales volume, while your variable costs will increase. |
|
INDUSTRY MARGINS: Industry standards for margins along the supply chain vary but can be in the range of: retailer - 20-60%, distributor - 20-30%, and broker - 5-15%. |
|
RETAILER MARGINS: Retailers typically operate on a gross margin ranging from 20-30% (grocery stores) to 40-60% (value-added or specialty retailers). Gross margin expectations can vary based on the pricing strategy, but a typical range is about 50% for dry goods, 25-30% for produce/dairy and 40-50% for frozen. 1) Gross margin = percent of selling price over the cost of purchased products. It is this margin that the retailer uses to cover the costs of their store operations and net profits. |
Setting a wholesale price
If you plan to sell your product to distributors and retailers, you will need to set a wholesale price. A wholesale price is lower than the retail price because businesses that sell your product need to mark it up to cover their costs and earn a profit. In addition, it is important to determine distributor pricing and a suggested retail price.
Manufacturer’s suggested retail price
Distributors and retailers may ask for your suggested retail price (SRP). This number helps retailers decide what to charge. It ensures that your product gets priced similarly throughout different retailers (except when it’s on sale). Include the SRP in your price sheet.
Comparison of retail & wholesale prices, margins & gross margin (Table 2)
|
Suggested retail price (SRP) |
Retailer margin: |
Distributor margin: |
Wholesale price: |
Variable costs: |
Discounts: |
Total gross margin |
|
25% |
20% |
45% |
2% |
|||
|
$ 9.99 |
$ 2.50 |
$ 2.00 |
$ 5.49 |
$ 2.47 |
$ 0.11 |
$ 2.36 |
|
$ 8.99 |
$ 2.25 |
$ 1.80 |
$ 4.94 |
$ 2.23 |
$ 0.10 |
$ 2.13 |
|
$ 7.99 |
$ 2.00 |
$ 1.60 |
$ 4.39 |
$ 1.98 |
$ 0.09 |
$ 1.89 |
|
What the consumer pays |
What the retailer earns |
What the distributor earns |
Your sales price |
COGS |
Your allowance for discounts |
Covers your fixed costs and profit |
|
For a food business that sells a product for $7.99 on a retail store shelf, 26,455 units must be sold to cover $50,000 in fixed costs, in the example above. |
Additional Resources
Pricing Strategies
There are many pricing strategies. A few are listed below, including: competition-based pricing, cost-based pricing, or value-based pricing. Many businesses use a combination of these methods to set their prices. SBA has a guide to pricing including a variety of strategies.
Competition-based pricing overview
To determine competition-based pricing, visit the retail locations where you’d like to see your product. Look for similar specialty food products and check their prices. Then, set your per-unit “suggested retail price,” or SRP, to match your competitors. A lower price may entice customers to buy your products but needs to cover all costs and leave a workable margin.
An advantage of competition-based pricing is that your price reflects what customers already pay for similar products. A disadvantage of this pricing method is that it might not cover all your costs. It's important to consider what the competition is offering and at what price. To charge more, you’ll have to convince consumers that you have a better product worth the extra expense.
Cost-based pricing overview
Cost-based pricing is more precise. At a certain production level, the sum of your fixed and variable costs equals your total cost. After you have that figure, calculate your cost per unit. To do that, take your total costs and divide them by the number of units produced. Add your desired profit margin to the cost per unit. That’s your selling price. So, let’s say each jar costs you $3 to produce, and you want to make $3 in profit. Your selling price would be $6.
Value-based pricing overview
A customer’s perceived value of your product provides the basis for value-based pricing. It’s not based on the actual cost of production. This pricing method considers what your customers believe are the benefits of your product. If they think your product’s benefits warrant a higher price than a similar product, they’ll pay more. An engaging brand story and communicating what makes your product stand out from the crowd can support a higher price.