In my last post we discussed alternatives to selling your emerging product. We discussed selling your product direct to grocery chains and the advantages and obstacles of the direct strategy. The primary obstacle to selling direct is the high cost of slotting which is what grocery chains charge to “slot” your product into their warehouse.
We also discussed alternatives of selling your product direct to consumers through web stores and internet sites. This is a growing trend, and some start-ups are happy making their products only available through this channel. I have personally spoken to a number of food entrepreneurs that have no desire to work through gaining distribution at major grocery chains, refuse to pay slotting, or utilize Specialty Food Distributors. They work their products by shipping to small retailers and internet sales only. This is a great strategy for those that want to stay small or grow slowly.
But this blog is about helping you grow your business by getting to the grocery shelf and becoming a national brand. The most viable path to becoming a national brand if you can’t afford the high cost of slotting is through Specialty Food Distributors. Today, I want to address the costs of using SFD’s and the how your retail price is key when utilizing this channel.
The SFD makes money by marking up the products he buys from you and reselling to the grocery chain. The SFD typically marks up the product 30-40% to the retailer. There are no real hard costs to you the manufacturer to simply sell your product to the SFD. As we have discussed in the past, the SFD looks at your product opportunistically and is always on the lookout for new and innovative products that he can sell as a point of difference to what the retailer will source direct. So the sale to the SFD should be relatively easy as long as your product meets manufacturing standards and has the proper universal product codes (UPC) and pallet standards necessary for the warehouse to slot. Don’t worry, in future posts I will discuss logistics and manufacturing basics to prepare your product for acceptance into SFD’s and grocery chains.
The real cost to you is the increase in shelf price to the consumer that your product will take as it passes through the SFD. The question then, is always twofold. Will my product still be competitive with like products that are sourced direct? If so, you are fine. If not, the second question becomes, will the consumer pay a premium price for my product?
Let’s consider an example. Imagine that your product is an organic breakfast bar, and you sell it to the SFD at $12 per case and there are 12 bars in a case. The unit cost of the bar to the SFD is $1.00. The SFD has a contract with the retailer which calls for a markup on items of 40%. The grocer’s cost of the product from the SFD is then $16.80 per case ($12.00 x 140%) The unit or cost per bar to the grocer is $1.40 ($16.80 / 12 bars.)
Now the grocer owns the bars at $1.40 each and must decide the retail price the bars will sell for on the shelf. The grocer’s profit margin requirement is 30% for the health bar section. The grocer decides upon a retail price of $2.09, which is a 33% profit margin, and a 49% markup on cost ($2.09/$1.40). The question that you must answer on your own if you are the manufacturer of the breakfast bars is, will the market bare a $2.09 price point? If all of the other bars on the shelf are in the same price range then you are competitive. If however, all the other bars that you compete with are in the price range of, say, $1.89, the second question comes into play. Will consumers pay the $2.09 premium price for your product?
This is where I see many entrepreneurial vendors get stuck. To get to the competing price of $1.89 you will need to reduce the price to the SPF by somewhere around $.10 cents per bar or $1.20 per case to achieve the grocer’s profit margin requirement for the health bar section of 30%. Let’s work through the new numbers:
- Sell to the SFD for $.90 cents per bar.
- SFD marks up the bar by 40% and sells to the grocer for $1.26 ($.90 x 140%)
- Retailer’s decides on $1.89 and based on a 33% profit margin.
Profit Margin calculation: (($1.89-$1.26)/$1.89) =33%
If your cost and profit structure won’t allow for the $.10 cent per bar reduction, then you have to find it in your ingredients, packaging or manufacturing structure. Alternatively, you have to assure that your product is premium and can sell at the premium price.
I recently met a small all-natural snack entrepreneur who was facing a similar issue. He had successfully made the leap from selling his product at farmer’s markets to some local supermarkets, which is just great to see. For now, he can’t supply enough products to the local grocery, which is a good problem to have. But that problem is probably masking a bigger one, his price. After the grocer takes his markup, the retail price is nearly $8 for a three ounce package. In the long run that is probably not sustainable.
More than likely his cost and profit structure was based on selling the items direct to consumers at the farmer’s market. Let’s assume he established his farmer’s market price at $6.00. When he had the opportunity to sell to a local grocery he couldn’t make money selling at wholesale. With no room in his margin, he had to sell to the grocery at close to his farmer’s market retail. Let’s again assume he discounted the product by a small amount and sold to the grocer at $5.50. Since the grocer needs at least a 30% profit margin on snacks, the new retail price on the grocer’s shelf is $7.99.
Profit Margin calculation: ((7.99-5.50)/7.99) =31%
The long term problem is even worse. If he is ever going to grow his brand he will need to be on many more grocery shelves. That will eventually require him to utilize SFD’s who will add another 40% to that price. That would mean a price of nearly $11! The lesson here is to make sure your cost structure allows SFD’s and grocers to mark up your product, so they can make money and not price you out of the market.
To that end, there are other costs that you need to factor in when attempting to get your product onto the grocery shelf. Unfortunately, as we will find, the cost of slotting doesn’t entirely go away using SFD’s. Additionally, all manufacturers necessarily need to promote their products, and must factor in the cost of trade expense. These will be topics for future posts.
For now, keep working, to the grocery shelf!