In my last post, I discussed costs and pricing when utilizing Specialty Food Distributors. SFD’s look at your product opportunistically and want your product to be a success. However, the SFD makes money by the markup he places on your product when he sells it to the grocery chain. The markup he charges is approximately 30-40% over your wholesale price, and will increase your retail price on the grocer’s shelf by at least that much. With this understanding, it is imperative that your targeted retail price takes into account the necessity of this middle man to stay competitive amongst like products. If not, you will need to lower your wholesale price, and hopefully your cost structure will allow you to do so, otherwise you will need to find efficiencies in the cost of your ingredients, packaging, or manufacturing.
Unfortunately, there are other costs which you must consider to get and keep your product on the grocery shelf. Today, I would like to discuss a cost that manufacturers must plan for as they mature on the large stage of chain grocers. This additional cost is slotting, or distribution cost.
You may have heard that if you use a Specialty Food Distributor that there are no slotting costs. That is a simplification. Yes, it’s true the SFD does not charge slotting for placement into his warehouse because essentially he is your partner building your business. However, the retailer does look at his space on the shelf as premium. While the retailer is not having to “slot” the item into his warehouse, he often will charge the manufacturer something to get placement into the stores. Within the SFD world the standard has become one free case per store per item. Like most charges, this cost is negotiable and dependent on the strength of an item and the entire program that is being presented. However, you need to anticipate the cost of free cases, particularly at major chains, and the cost can be substantial.
Let’s look at an example. If our fictional grocery chain, Really Big Grocery, has 1500 stores, and the cost for you to produce your product is $10 per case, you will have at least $15,000 dollars in free case costs to get your product on the shelf of Really Big assuming you agree to the free cases. But it actually will cost you more than $15,000:
- Your cost to produce the product is $10 case.
- Your wholesale price to the SFD is $15.
- The SFD orders 2000 cases in anticipation of the Really Big distribution gain.
- You bill the SFD $30,000 (2000 x $15).
- Really Big places an order for 2000 cases from the SFD.
- The SFD bills Really Big Grocery $42,000 (2000 x $21/case), which is their standard markup of 40% for the cases ordered.
- Really Big pays the invoice of $42000 to the SFD, by sending $10,500 (500 x $21) and a deduction of $31,500 for the free cases (1500 x $21) that were agreed upon.
- The SFD, in turn, pays your invoice of $30,000 by sending you nothing and a debit memo for a $30,000 deduction with plans to deduct the remainder of the $1500 on your next invoice for the agreed upon free cases at Really Big.
- Your real cost to get into Really Big was $31,500. The cost for the free cases is $15,000 to produce them, $7,500 in lost margin (1500 x $5) and an additional $9000 ($6 x1500 cases) investment to cover the SFD margin.
The key here is that gaining distribution is going to be expensive. Most entrepreneurs do not plan for the investment of paying to get on the shelf. Even big manufacturers tend to ignore the reality that they probably never attain full distribution, and that in each planning period there is going to be some requests for new distribution. Your pricing and margins need to have these costs accounted for so that your price covers the investment.
So, how do you plan for it? I recommend that you at least plan for your manufacturing costs per case, plus twenty percent, times the number of stores that you think you may gain distribution in for the planning period. Although, in the example above we saw that it ultimately cost more than double the manufacturing costs, I like to assume you have some wins where you are getting placement for free, and you must plan for an aggressive store target.
Your SFD’s are the best source for helping you determine the number of stores, the cost for each, and how quickly they can get your product placed. For a start-up you may begin with a small target of say 1000 stores in your first year. If your costs are $10/case and you have a 1000 stores targeted you want to have at least $12,000 planned for distribution costs. ($10/case x 1000 stores x 1.20%) In future years you will need to plan for more stores, so you may want to look at a five year horizon to determine how to plug in a percent to your cost structure to have this investment covered in your price.
In my next post we will continue to sharpen our understanding of all the costs that will be needed to cover in your price when we look at trade promotion costs.
For now, keep working to the grocery shelf!